Oct 29, 2017
If you haven't seen articles and advertisements on the Internet promoting strategies for paying off your mortgage early, you will.
By all means, pay off your mortgage as quickly as you can! But don't believe everything you read online. Adding a few extra bucks here and there will help. But it won't cut your term in half.
Here are the most common methods I see reported:
The Strategy: Round Up Payments
In my opinion, this is one of the easiest strategies to master. Simpy round your payment up! If your payment is $1,237, pay $1,300. If your paymetn is $823, pay $900. It's not going to cut your term in half! But it's not going to break the bank either.
The Results: If you borrowed $200,000 at 4.0%, your monthly principal & interest payment would be $954.84. Add an extra $45.16, making it an even $1,000. You'll shave 29 months off the term of your loan. Almost two and a half years.
The Strategy: Bi-Weekly Payments
Instead of making a mortgage payment at the first of every month (12 payments per year), bi-weekly plans allow one half of your mortgage payment every two weeks. Thus you're making 26 half-payments or 13 full payments every year. It's the equivalent of making one extra payment per year.
You can also receive a similar result by adding 1/12 of your required payment to each monthly payment.
This is the strategy where I see the most ridiculous claims. "Pay off your loan in 12 years!" "Cust your mortgage term in half!" That's hogwash. At today's interest rates, you can expect to shave about four years off a 30-year term.
Nevertheless, it's a great idea! Many people are paid every two weeks and it's easier to budget half a payment from each paycheck. It may not cut your loan term in half. But four years without a mortgage is certainly better than a poke in the eye!
After closing, you may receive solicitations from companies offering to provide you with bi-monthly payments - for small fee. Don't pay anyone to take advantage of this service! Set it up directly with your lender for free.
The Results: If you borrowed $200,000 at 4.0% and made bi-weekly payments, you'd pay off your loan in 310 months instead of 360. That's a little more than four years early.
The Strategy: Increasing Principal Payments
Here's how it works:
- Ask your lender for an amortization schedule or find one online. This document divides your monthly payment into principal (the amount being used to pay down the loan) and interest. Every month, the portion of your payment going to principal and will increase. And the portion of your payment going to interest will decrease.
- Every month, make the regular monthly payment that is due. Then make an additional payment for the following month's principal portion.
- Repeat the process each month until you have reduced the amount of time you need to pay your mortgage by half.
OK, this one really does work. By following this strategy, you will pay off your loan in (literally) half the amount of time. But you'd need some deep pockets!
This strategy calls for increasing mortgage payments every month. And you'd have to keep an amortization schedule handy because every time you make an extra principal payment, it changes the next month's distribution of principal vs interest.
The Results: On a $200,000 loan at 4.0% interest, your required monthly payment would be $955/month. Under the Increasing Principal plan, you'd add $289 to your first payment (for a total of $1,244), $291 to your second payment (for a total of $1,246), $293 to your third payment (for a total of $1,248), and so on and so forth. By the 179th payment, you'd be paying a little over $1,900/month. Total interest paid: $71,950.
Why not get a loan with a 15-year term to begin with? You'd pay a lower interest rate (usually about 1% lower than a 30-year term). In the above example, your payments would be a steady $1,381/month. Total interest paid: $48,609.
Whatever your game plan, remember if it sounds too good to be true, it probably is! And if you need help with the math, I have a variety of amortization schedules and mortgage calculators that I'm happy to share.