How To Pay Off Your Mortgage Early
If paying off your mortgage early is right for you, here are some strategies to do it:
- Make biweekly payments. One way to get started with making extra mortgage payments is to set up a biweekly schedule. This amounts to making a full extra monthly payment each year and can reduce the time spent with a mortgage. Starting with biweekly payments can help you get ahead on your mortgage while allowing you to keep working toward other financial goals.
- Make extra mortgage payments each year. Similar to making biweekly payments, you can simply make an extra mortgage payment once a year, or pay an additional amount each month on top of what you already pay. Be sure to coordinate with your lender so that these extra funds are allocated to the principal.
- Refinance to a mortgage with a shorter term. If you stand to get a lower interest rate, refinancing to a 15-year mortgage means youll pay off the loan sooner. Keep in mind that even with a lower rate, you could be paying more each month, since your payments are now spread out over a shorter period of time.
Rates Versus Payments: Whats Your Refinancing Goal
Cash-out refinancing is not cheap, and you may not get a lower interest rate than that of your current first mortgage. However, your monthly payment is likely to be lower than that of your mortgage and HELOC payments combined. Spreading out a 5-year repayment schedule over 30 years is likely to accomplish that.
You also need to keep an eye on your total cost of borrowing: All loan charges, such as origination fees, plus the interest payments you make on the life of your loan.
Understand that in the long run, youre likely to pay more interest by stretching out your home loan repayment, even if you get a lower rate by refinancing. You are trading a lower payment today for a higher cost tomorrow. There is nothing wrong with it as long as you are aware and going into your loan with both eyes open.
Shorten Your Amortization Period:
You can also use the time to renew as an opportunity to shorten your amortization period without paying a prepayment charge. Remember, your amortization period is the time it takes to pay off your mortgage completely at the same interest rates and payment. The shorter the amortization, the quicker youll pay off your mortgage.
Keep in mind, a shorter amortization often means a higher regular payment amount. For instance, if your mortgage is $500,000 and your interest rate is 2.14%, your payment would change based on your amortization length:
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Pay The Minimum During The Draw Period
If your monthly income recently dropped, you might choose to just make the minimum payment during the draw period.
In the aforementioned example, the minimum interest-only payment is about $136. Once the repayment term starts, the monthly payment rises to $527. Over the entire 20-year HELOC term, youd pay $21,073 in interest and thats without any rate increases.
This option wont save you money on interest compared to the first mortgage, but it can put breathing room in your budget.
Lump Sums Vs The Long Term
With a home equity loan, you get one lump sum, one time. This can be useful if you have a project with a fixed cost that you need to cover upfront, like if youre replacing your roof. If youre doing a single, expensive home improvement project , it might not make sense to get a HELOC, since youll only need the money once, rather than having to continually borrow it.
A HELOC, on the other hand, is great if you have longer-term borrowing needs. For example, say youve purchased an investment property that you want to do significant renovations on. This will likely be an ongoing process with a variety of different costs, and you may not know upfront how much youll need to borrow in total. In this case, getting a lump sum with a home equity loan wouldnt make as much sense as opening a HELOC.
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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.
What Is A Heloc
A HELOC is a home equity line of credit. A HELOC is a loan, which using your home as collateral, and lets you borrow up to a certain amount, rather than a set dollar amount.
HELOCs are similar to credit cards. They have a credit limit, and you can borrow against it, pay all or part of the balance, and borrow again up to the credit limit.
The interest rate typically is variable and depends on the Prime rate.
Cons Of Refinancing With A Heloc Explained
HELOC rates are generally higher than mortgage rates, Cohn said. If the HELOC rate is higher than, or even equal to your current rate, its probably not a good idea to refinance your mortgage.
Also, the rate of the HELOC is set as a percentage over the prime rate, and it can adjust monthly, thats why HELOCs are best when you can pay the loan back quicklythey are not good long-term, Cohn said.
There are also numerous fees involved in a HELOC, including a property appraisal fee, application fee, possibly a membership, early-cancellation or inactivity fee, up-front charges like points, and then closing costs.
Cons Of A Home Equity Loan
- Home serves as collateral: Home equity loans and home equity lines of credit are both secured by your property. If you default on these second mortgages, you could lose your home.
- Closing may be expensive: Home equity loans may come with closing costs, though some lenders waive the fees or roll them into the loan. If you have to pay these fees, theyll add to your borrowing costs.
- Loan amounts are limited: You can typically borrow up to 85% of the equity in your home. So if you have $300,000 in equity, for example, the maximum you could borrow is $255,000. If you havent built enough home equity to zero out your mortgage, think about holding off until your home equity increases.
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Evaluate Your Financial Situation
The first step to take to pay off your mortgage early with a HELOC is to take stock of your current balances and overall financial situation to ensure a HELOC is the right choice for you. Make sure to ask and answer the following questions:
- Is your credit score the required 620 or higher?
- How much home equity do you have?
- Does your monthly cash flow exceed your expenses?
- How much positive cash flow do you have?
- How much extra can you spend to retain a positive cash flow?
- Do you have other financial priorities, such as an extra payment for your childrens college tuition or student loan?
To calculate your monthly positive cash flow, total all your monthly expenses and subtract them from your monthly income. What is left in your remaining balance in your checking account will be your positive monthly cash flow. The greater that amount, the faster you can pay off your home loan. You can also use a HELOC calculator to figure this out.
What Are The Risks
This strategy is not for the financially faint-hearted. Before you considering using a HELOC to accelerate paying off your mortgage, consider drawbacks like:
- High HELOC fees. Application fees, appraisal costs and transaction fees contribute to the overall expense of taking out a home equity line of credit and can eat into your savings.
- Variable HELOC rates. HELOC rates are often less competitive than those that come with mortgages, and they can rise over time with the market.
- Restricted finances. This strategy requires funneling the bulk of your monthly income into your mortgage, leaving little financial wiggle room for home improvements, medical emergencies or other unexpected expenses.
- Prepayment penalties. Paying off your mortgage early is less appealing if your lender charges fees for extra payments.
- Long-term commitment. It could take years of limited financial freedom to see the fruits of your labors with this strategy.
- You could lose your home. Your HELOC is secured by the property youre borrowing against. If you cant keep up with payments, you risk losing your most valuable asset.
Is using a HELOC to pay off my mortgage a good idea?
With healthy self-discipline under the right circumstances, a HELOC to pay off your mortgage ahead of schedule could save you money in the long run. But this strategy is only viable under a strict set of circumstances that include positive cash flow, income stability and considerable financial discipline.
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What Is The Fastest Way To Pay Off Your House
In the reports scenario, the original house had a $228,305 balance, which was scheduled to be paid off in 25 years, with a 4.48% fixed rate and a monthly payment of $1,266.40.
The HELOC strategy paid off the balance in 10 years and 8 months. Thats a faster payoff than the 30-year mortgage, but only if you make extra payments with the surplus of $1,233.29.
If youd kept the 30-year mortgage and made the same extra payments of $1,233.29, the house would be paid off in 9 years and 4 months. That shaves 16 months off the Velocity Banking strategy, without a new contract, higher interest rate, and riskier terms.
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What Happens To My Heloc When I Pay Off My Mortgage
When you pay off your mortgage, the HELOC would be paid off at the same time. For example, if you sell your house, then before you receive any of the proceeds of the sale, both your mortgage and your HELOC would need to be paid off first. The lenders would have first claim on the proceeds from the sale.
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Use The Maximize Cashflow Strategy
Reroute All Income Into 1st Lien HELOC
The first part of this strategy is to deposit 100% of your income into your 1st Lien HELOC. This pays down your principal balance as much as possible and immediately decreases your interest payment as much as possible. Its amazing because it lets you get dollar-for-dollar pay down for every dollar you make.
Reroute All Expenses From HELOC
Now that youve rerouted your income into your first lien HELOC you can use it like a checking account. You will then use this account to pay all your bills and expenses. In this way, your 1st Lien HELOC works like a credit card, but with a lot lower interest rates.
Will All Your Cash Be Tied Up In The Mortgage
Before taking a large chunk of your wealth and using it to pay off your mortgage early, dont forget to look at liquidity. Your home is considered a non-liquid asset because it can take months or longer to sell the property and access the capital.
If you start paying down your mortgage too fast, you risk depleting your liquidity, says Amanda Thomas, CFP, a client advisor at Mission Wealth in Santa Barbara, California. The kind of liquidity you have is important, too.
One approach is to have an emergency fund, as well as assets like stocks, mutual funds, U.S. Treasuries, bonds and marketable securities available in a taxable investment account. That way, in addition to having money tied up in tax-advantaged retirement accounts and your home, you still have some liquid cash or other investments that are easy to convert to cash in a pinch.
Bowen suggests maintaining a cushion that protects you for at least six months before you consider using a large portion of your liquidity to retire your mortgage early.
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Paying Down Your Mortgage With A Heloc Could Be Smart Or Dumb
Getting out of debt and becoming debt free is a goal which everyone should have. Becoming financially free from the bank will allow you to live the life you want and deserve.
Depending on your mortgage interest rate and your HELOC interest rate, using your HELOC funds to pay off your mortgage could be a good idea, or a bad idea.
Since HELOC interest is not fully tax deductible anymore, there is less incentive to use HELOC for arbitrage. It is still possible to find interest rate arbitrage opportunities, but just more difficult.
If your HELOC interest rate is lower than your mortgage rate, you can make money. If your HELOC interest rate is higher than your mortgage rate, then you will lose money.
For you, thinking critically about your personal finance situation will lead you to the right answer.
How Heloc Repayment Works
HELOC is an acronym that stands for home equity line of credit. Its a form of second mortgage, meaning youve put your home up as security for the loan. And you could face foreclosure if you default.
There are many types of HELOCs with varying loan terms 15 years is a popular one. The loan will have a draw period, followed by a repayment period.
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Replace Your Mortgage Replacing One Form Of Debt With Another
The HELOC strategy is at its heart a debt strategy. Youre using a credit card and a HELOC to pay off your mortgage. In the short run at least, that means replacing long-term debt with short-term debt.
The only way to truly get out of debt is by paying it off out of your income or other assets. Using debt to pay off other debt has the real potential to go in an unexpected direction. For example, if after five years of using strategy your $200,000 mortgage is paid down to $100,000, but you now have $100,000 in credit card and HELOC debt, you will have accomplished nothing constructive.
Need help paying off credit card debt? Consider a 0% APR balance transfer credit card.
Talk To A Lender About Your Mortgage Today
If you have questions about your mortgage or how you can make your savings work better for you in Rockland or Bergen County, contact the team at Palisades CU. You can also visit any of our convenient locations in Nanuet, New City, and Orangeburg. Were here to make your finances more effective for your goals. Get in touch with a financial representative today for help in finding the right savings, lending or payment strategy thats right for you.
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Examining A Potential Mortgage And Heloc Arbitrage Opportunity
To get rid of PMI, Im about $25,000 of principal away. Thinking about using my HELOC to finance this debt reduction, I would still need to put up some cash. However, If I used all of the $21,000 credit line to pay off my PMI, I would free up $144 of cash flow a month, and accelerate my mortgage amortization.
After this payment, I would have interest-only payments on the HELOC of 7.6% on $21,000 for $133.
Looking at this, Id be saving $11 a month without doing anything, and Id speed up my mortgage amortization . If I kept paying the minimum on my mortgage , it would take 29 more months to get rid of PMI.
Therefore, I calculated the rate of return at the 29 month mark to find the profit potential:
Over 29 months, Id make $1,651 on my $21,000. This equates to an annualized return of 3.25% created for free from this potential arbitrage opportunity.
The $1,651 return on investment from this HELOC debt payoff strategy could even be added as extra mortgage payments to help pay off my mortgage debt even faster.
At the same time, it can be pretty risky to use debt to pay off other debts.
Also, if I was just using the HELOC to pay off mortgage principal, I would lose over $2,500 over the 29 months due to the difference in interest rates. The example above only works since Im still paying off private mortgage insurance.