With the housing market changes since 2007, more people are concerned with the state of the economy, the state of their financial position and want to make sure they are making wise choices about how to pay off their mortgage years early. Prior to the current economic issues a lot of people were not concerned about paying off their mortgage early since the interest is a tax break, so it did not matter so much. Of course there has been speculation that this deduction could possibly end.
Times have changed in everything financial and since mortgage financing is the largest debt one usually has; it is imperative that wise choices are made. More individuals are now seeking to be debt free and nothing could be wiser than seeking to payoff their mortgage years early. It seems many younger adults forget that one day, they will be older adults and their income stream may change and their needs will definitely change. So, with the retirement years in view; this alone is incentive enough to learn more about how to pay off your mortgage years early and save money while doing so.
Previously, when individuals inquired about paying down their mortgage, they were sometimes wrongly advised to refinance their loan and drop their interest rate; even if the rate only changed by 1.00%. They weren’t always advised to lower the term of their loan and unfortunately some could not pay the higher payment anyway. On occasions they were coached to add in other obligations to free up funds; (because this gives them additional funds to put into their mortgage, which they wind up not doing), and on top of that, add in the closing cost of the loan.
It is evident with the high numbers of refinanced loans, that a lot of people have not been advised of some alternative measures, which could actually be more advantageous in the long run. This would be pay additional principal to the balance of the loan with each payment, or amortize the remaining balance for a shorter term and pay that payment. The difference in refinancing to a lower rate/term and just simply paying more principal each month or using a calculator and amortize your remaining balance for a shorter term; is explained below. The latter is something you can do for yourself and is advised.
Scenario number 1:
If you refinance your loan, you are probably adding back (most people do) at least the closing cost of approximately 3%, in the past many time much higher.
Anytime you are adding principal back to your loan even though you are lowering your rate; it will take a number of years to catch up to where you are at the present in your equity position. For instance; let’s say that your closing cost amounts to three thousand dollars. You decide to pay off a credit card with a balance of twenty five hundred. Your total is fifty-five hundred added to your principal balance. You have already paid five years on this loan; depending upon your current interest rate and the term of your loan; you have paid approximately 19% principal and 80% +- interest of $99000 rounded. Remember that the first few years of the loan you are paying little principal.
- Loan Amount of $275000
- Rate of 6.00 %
- Payment 1649 Principal & Interest
- Term of 30 years
- Interest paid 79900 rounded
- Principal paid 19101 rounded
- Number of payments paid 60 months
- Remaining Principal Balance 255900 rounded
You have paid five years on your loan and you have been advised the above solution to pay off your loan early so you decide to pay off the one credit card and the 3K closing cost all added into your loan.
- New Loan Amount of $261399
- Rate of interest 4.75 %
- Term of 30 years
- Payment 1364 principal & interest, rounded
It will take you another 18 months to get back to your previous equity position. You are only lowering your rate by 1.25%. If you chose to lower your term to 20 years, it would take only 9 months (rounded). If you chose to lower your term to 15 years, it would take only 6 months to regain your equity position and with a 15 year, your rate would be a slight deduction from the 4.75%; possibly .25% to .50% reduction. I used 4.25% in this example for the 15 year amortization. Of course if you pay your closing cost out of pocket and do not pay off any other debt, plus lower your interest rate and lower your term; you can pay off your mortgage loan in much less time.
Scenario number 2:
You decide to not refinance your loan, but still want to pay off your loan in a shorter period of time. Here are a couple of options which might be the best solution and save you at least 3% of the remaining balance of your loan. Note that you cannot benefit substantially if you do not lower your rate by more than 2.000% points. The difference in the payment actually does not justify the action, in most cases. Most professional sometimes fail to give you these other options and this is why we have seen our current financial crisis in America and other places as well. Using the same loan features above.
- Remaining BAL 5 yrs 255900
- Remaining term 25 years
- Pay off this loan in 20 years instead
- Amortize the balance at 6.00 same rates you have
- New Payment 1833.36 *this is only $185 above current pmt
You are decreasing your term by 5 years and saving interest payments in the approximate amount of $44100 +-. If you chose and could afford a 15 year amortization payment over the remaining term; your interest savings would be substantially more.
The latter scenario means you are not adding any principal back to your loan; you are only paying the $184 more payment but saving 5 more years on your loan, but best of all you are saving the 44K interest and building net worth. The next 5 years you would be at a 15 year term and could actually amortize the remaining principal balance for 10 years as your income may have grown and your financial position could afford a higher payment.
Scenario number 3
You can also pay any amount over and above your current payment at any time you choose on a conventional loan, Fannie and Freddie Mac loans. FHA will also allow extra payments to the principal. You can add $50, $100, $200, to your payment (any amount your can afford) and specify that the additional funds should be applied to your principal balance. This saves interest without re-amortization of your loan payment to a higher payment or to a lower term.
It is important that you do not skip a payment regardless; even though you are paying extra money. Your first of the month payment is still due for the fully amortized principal and interest payment, regardless. You can pay your full payment ahead of time, yes but you cannot skip a month; this will give you a 1×30 on your credit report. If a person has a SubPrime loan, normally within the first 36 months there usually is a pre-payment penalty. Therefore it is best to wait until the pre-payment penalty is over. The best advice is to read your note and mortgage, and it will tell you what you are allowed to do and what the time-frame is.
Another option that the agencies; Fannie Mae and Freddie Mac no longer offer is the Bi-weekly mortgage. The bi-weekly mortgage will cut 5 to 7 years off your mortgage also, if your loan is eligible for this option through your lender. In the past the lender would allow this change to the borrower’s payment and if you are given this option; it is wise to consider. Normally the lender will require a draft on your bank account twice monthly and have some funds in escrowed upfront. You are paying an additional payment (13payments) each year.
Another important note about paying off your mortgage years early is: if you are paying only an additional amount as stated above and your escrow account has a shortage or you have late fees (paid after the 15th of the month, etc.) the extra amount you send will be applied to anything that is due and payable, before being applied to the principal.
By the way; congratulations on being wise and considering becoming debt free. This is one option you will never regret… Good Luck!