Four Alternatives To Paying Extra Mortgage Principal
Before you begin making extra principal payments on your mortgage, its best to consider your overall financial goals. Consider how long you plan on living in the home. Assess any money that you can foresee needing in the future . And determine any current debts you are still paying on.
Assessing your current financial position and your future goals will help identify the ideal use for additional funds or maybe even prove that paying more on your mortgage is advantageous.
So, conversely, what are the alternatives , and what could the benefits be?
Understand And Utilize Mortgage Points
Whenever people are curious about how much their mortgages cost are going to cost them, lenders will provide them with quotes that include loan rates and points. Stephanie McElheny, the Assistant Director of Financial Planning at Hefren-Tillotson in Pittsburgh, says that one point is equal to 1 percent of the loan amount .
McElheny adds, there are two kinds of points, discount and origination fees:
- Discount: prepaid interest on the mortgage the more you pay, the lower the interest rate.
- Origination fee: charged by the lender to cover the costs of making the loan.
If you plan on staying in your home for the foreseeable future, it may be worth paying for these points since youll end-up saving money on the interest rate of your mortgage. You could save that extra cash each month and put it towards your overall mortgage payment.
Can I Pay Off My Mortgage In One Lump Sum
The first option is to pay one lump sum that covers the remaining balance. Before doing so, however, it’s crucial to ask your lender if a prepayment penalty applies. The amount of a potential prepayment penalty varies by lender but could range from 2 to 5 percent of the total loan balance, which can get expensive.
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Alternatives To Prepaying Your Mortgage
If youre not sure if you should pay your mortgage off early, consider these other options to maximize your dollars:
- Refinance your mortgage get a lower interest rate and possibly reduce your monthly payment amount.
- Fund your childs education by contributing to an education savings plan.
- Build an emergency fund.
- Pay off high-interest credit cards, personal loans or student loan debt to save a bundle in interest.
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Other Ways To Pay Off A Mortgage Early
Paying off a mortgage early requires you to make extra payments. But there’s more than one way to pay off the mortgage early:
Add extra to the monthly payments, as discussed in this article.
A structured way to add extra: Divide your monthly principal payment by 12, then add that amount to each monthly payment. You end up making 13 payments, instead of the required 12 payments, every year.
A variation of the above tip: Deposit one-twelfth of the monthly principal payment into a savings account each month, then use that money to make a 13th payment.
Pay half a mortgage payment every two weeks. You make 26 half-payments, equivalent to 13 full payments a year. If you want to try this, first make sure your mortgage servicer is set up to receive biweekly payments.
Make a lump-sum payment toward the principal. You might do this after receiving a bonus, inheriting money or winning a lottery prize any time a large sum lands in your checking account. Coordinate with your servicer to ensure that the money goes toward reducing principal.
Refinance to a shorter term. If you can refinance with a lower interest rate, for a shorter term, it’s a win-win. For example, you could refinance a 30-year mortgage into a 15-year loan. The monthly payments will almost certainly be higher, and you’ll pay closing costs, but your overall interest expense will be dramatically lower.
Will Other Investments Beat Paying Off A Mortgage Early
Is it better to pay off your mortgage or invest? Ultimately, its a personal decision, but investing could be more sensible.
Sadly, the math tells us its almost always better to invest in other places than in your mortgage, says Richard Bowen, CPA and owner of Bowen Accounting in Bakersfield, California.
Mortgage rates are lower than theyve been in recent years, so if paying off your mortgage early leads to a return equal to your interest rate, that return would likely be lackluster compared to the annualized return for the S& P 500 roughly 10 percent over the last 90 years.
A potentially better use of the funds might be to take the cash youd use to pay off your mortgage and leverage it into buying a cash flow-positive property like multi-family real estate or single-family homes that have the potential to offer higher long-term returns, Bowen points out.
Any choice poses a risk, however. Even after paying off your mortgage early, real estate prices could plunge, leaving you with a potential loss. Carefully consider which risks youre willing to take. Ultimately, you might be better off not paying your mortgage off early.
The thing is, no one can give you a guarantee on an investment, Bowen cautions. You can put your money in the stock market and lose it. You can put your money in real estate and it doesnt perform as well as you expected it to.
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Make Larger Monthly Payments
The easiest and fastest way to pay down your mortgage is faster is larger monthly payments and extra money towards principal when available, said Ralph DiBugnara, president of Home Qualified and SVP at Cardinal Financial. A 10-year payment compared to a 30-year payment is going to cost a homeowner about $575 dollars extra a month per $100,000 borrowed. That $575 per $100,000 would need to be added to your principal payment monthly.
Drudging up extra money to pay down your mortgage can prove a difficult task. Another similar approach is to take any large sums of money received and apply them to the principal.
This can come in the form of a tax refund, bonus from work, salary increase or overtime earned, DiBugnara said. For every extra payment a year you make on a mortgage you can save between five and seven years. So three to four extra payments a year will get you to the 10 year mark for a payoff.
How To Use The Early Mortgage Payoff Calculator
To fill in the calculator’s boxes accurately, consult a recent monthly statement or the first page of the Closing Disclosure that you received when you closed on your mortgage.
Under Loan term , enter the number of years for which your home is financed.
Under What was your mortgage amount?, fill in the loan amount. In the Closing Disclosure, you can find this on the first line of the Loan Terms section.
Under Interest rate, enter the percentage.
Under How many years are left on your mortgage?, you’ll need to enter a whole number, so round up or down.
Likewise, under In how many years do you want to pay off your mortgage?, you’ll have to enter a whole number, rounding up or down.
Under How much do you still owe ?, look for this figure in a recent monthly statement, or contact the mortgage servicer. Or you can use NerdWallet’s mortgage amortization calculator and drag the slider to find out how much you still owe.
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Overview: Paying Off Your Mortgage Early
Every time you make a mortgage payment, its split between your principal and your interest. Most of your payment goes toward interest during the first few years of your loan. You owe less in interest as you pay down your principal, which is the amount of money you originally borrowed. At the end of your loan, a much larger percentage of your payment goes toward principal.
You can apply extra payments directly to the principal balance of your mortgage. Making additional principal payments reduces the amount of money youll pay interest on before it can accrue. This can knock years off your mortgage term and save you thousands of dollars.
Lets say you borrow $150,000 to buy a home at 4% interest with a 30-year term. By the time you pay off your loan, youll have paid a whopping $107,804.26 in interest. This is in addition to the $150,000 you initially borrowed.
Now, lets say that you pay an extra $100 every month toward a loan with the exact same term, principal and interest rate. At the end of the term, youll have paid $82,598.49 total in interest. Thats $25,205.77 less than you would have paid if you didnt make any extra payments. Youll also pay your loan off 74 months earlier than you would if you only paid your premium each month.
The decision to pay off your mortgage early is a personal one that depends heavily upon your individual circumstances.
How To Pay Off Your Mortgage Early
8 Min Read | Apr 14, 2022
So youre eager to join the nearly 40% of American homeowners who actually own their home outright.1 Can you imagine that? When the bank doesnt own your house and you step onto your lawn, the grass feels different under your feetthats freedom.
But the problem is youre currently stuck dragging around that ball and chain called a mortgagejust like most homeowners.
Dont worry. Well show you how to pay off your mortgage faster so you can finally join the ranks of debt-free homeowners. Lets get started.
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Find A Lower Interest Rate
Work out what features of your current loan you want to keep, and compare the interest rates on similar loans. If you find a better rate elsewhere, ask your current lender to match it or offer you a cheaper alternative.
Comparison websites can be useful, but they are businesses and may make money through promoted links. They may not cover all your options. See what to keep in mind when using comparison websites.
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Choosing Your Next Steps
If youve decided that paying off your mortgage is the best option for you, your next step is to make sure there are no prepayment penalties included in your loan terms. You can find this information on Page 1 of your closing disclosure. Additionally, confirm that your lender is applying all extra payments toward your principal balance, not interest. You may have to make a request in writing or follow a special process when sending in extra principal payments. Youre getting rid of a huge monthly bill and building a substantial amount of home equity when paying off your mortgage early.
If, on the other hand, you decide to stick with your scheduled mortgage payments, make a concrete plan for how youll use the extra money that wont be going toward the mortgage. It may be tempting to treat it like spending money, but bulking up retirement accounts, an emergency fund or long-term investments will likely better serve your financial goals.
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Make One Extra Mortgage Payment Each Year
Making an extra mortgage payment each year could reduce the term of your loan significantly.
The most budget-friendly way to do this is to pay 1/12 extra each month. For example, by paying $975 each month on a $900 mortgage payment, youll have paid the equivalent of an extra payment by the end of the year.
How Much Faster Will I Pay Off My Mortgage If I Pay Every 2 Weeks
Biweekly payments accelerate your mortgage payoff by paying 1/2 of your normal monthly payment every two weeks. By the end of each year, you will have paid the equivalent of 13 monthly payments instead of 12. This simple technique can shave years off your mortgage and save you thousands of dollars in interest.
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Factors To Consider When Paying Off The Mortgage Early
Living without any debt is an exciting goal, but paying off your mortgage needs to be done right. Here are some important considerations:
- Will you incur penalties for overpaying your mortgage?Some mortgage lenders have prepayment penalties or other loan terms designed to prevent you from prepaying. Make sure to contact your lender and read the fine print in your mortgage contract to determine if this applies to you.
- Do you have credit card or any other debts? Many other types of debt, like credit card debt, have higher interest rates. Its usually more advantageous to pay off any consumer debt before you pay off the mortgage.
- Have you set aside a sufficient emergency fund? Its generally a good idea to set aside money in an emergency fund to cover expenses that are not included in your budget or to protect from a rainy day. Build a solid financial foundation first!
- Is your debt oppressing you? Some people feel debt rules their lives. If debt is stressing you out, use the Mortgage Payoff Calculator to calculate how much extra money you need to put toward your mortgage every month to get out of debt sooner.
Once youve determined that youre ready to pay off your mortgage, its time to start reaping the benefits!
Pay Your Mortgage Faster And Pay Yourself While You Do It
Did you know that the interest you pay on your mortgage can double the cost of your home? It seems shocking, but think about it: youre paying 30 years worth of interest on a six-figure loan. No wonder its so hard to afford a place of your own.
But theres a simple way to take a machete to that massive pile of interest and potentially put tens of thousands of dollars back in your pocket. Just make modest but regular extra payments toward what you borrowed , especially in the early years of homeownership.
We know what youre thinking: Pay even more every month? But wait until you see the math! Youll build equity and own your home free and clear faster, of course. But whats really impressive is how much you get back in interest. Every extra payment on principal is like making an investment with a guaranteed return.
Read on, and well explain how it works and show you how making payments on principal can easily double your money. The key thing to understand is your loans amortization schedule.
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How Much Will A Prepayment Penalty Cost Me
Generally, mortgage lenders are prohibited from imposing prepayment penalties on most home loans under the Dodd-Frank Act.
If your mortgage is the exception to the rule, a prepayment penalty can only be assessed in the first three years. Its capped at 2 percent in years one and two, and 1 percent in year three. So, if your outstanding loan balance in year two is $295,000 and you pay your mortgage off, the lender could charge a prepayment penalty of up to $5,900.
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Pros And Cons Of Paying Off A Mortgage Early
You’ll pay less in interest over time
You can reduce your long-term foreclosure risk
You can free up more income for other goals
You’ll take money away from other goals
You could strain your monthly budget
Your credit score can be negatively impacted by a closed account
You’ll lose the ability to deduct interest payments at tax time
Pitfalls Of Paying Off Your Mortgage Early
Many homeowners think that they should pay off their mortgage early to get out of debt, but does it always make sense?
You do not want to pay off your mortgage and end up low on cash. It’s much easier to take cash out of a checking account when needed than it is to refinance by pulling it out of your home loan.
Ask yourself if you’ll need liquid cash in the near future. If the answer is yes, you’re better off putting your extra money in savings not toward your mortgage.
Always have a small savings buffer to help you pay for immediate expenses.
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How To Calculate Mortgage Payments
Zillows mortgage calculator gives you the opportunity to customize your mortgage details while making assumptions for fields you may not know quite yet. These autofill elements make the home loan calculator easy to use and can be updated at any point.
Remember, your monthly house payment includes more than just repaying the amount you borrowed to purchase the home. The principal is the amount you borrowed and have to pay back , and the interest is the amount the lender charges for lending you the money.
For most borrowers, the total monthly payment sent to your mortgage lender includes other costs, such as homeowners insurance and taxes. If you have anescrow account, you pay a set amount toward these additional expenses as part of your monthly mortgage payment, which also includes your principal and interest. Your mortgage lender typically holds the money in the escrow account until those insurance and tax bills are due, and then pays them on your behalf. If your loan requires other types of insurance like private mortgage insurance or homeowners association dues , these premiums may also be included in your total mortgage payment.