As a homeowner, who wouldn’t want to save some money? Plus, we are talking paying potentially tens to hundreds of thousands of interest during a mortgage term. Especially during a 30 year term. Which is why many homeowners want to know how to pay off a mortgage early. Then, the saved interest can be used towards other things such as savings, college education, paying off other debts, or funding retirement. Remember, it helps to make plan before owning a home. Even though buyers may lock in a 30 year fixed rate, a plan could be put in place to prepay the mortgage early.
Key strategies to prepay your mortgage include:
- Refinance to a shorter term
- Get rid of PMI as soon as possible
- Pay extra principal each month
- Lump sum payments
- Recast your loan
Refinance to a Shorter Term
There are several advantages to getting a shorter term mortgage. Shorter term mortgages are typically considered 10 – 15 year loans. Even if interest rates are the same for all terms, just reducing the term by 10 – 20 years can make a significant savings. Yet, the rates on shorter term and longer term mortgages are not equal. So, the next advantage of a short term refinance is the lower interest rates offered. Therefore, combining a lower interest rate with a shorter term equals a lot of savings.
When considering a shorter term refinance, make sure you are very comfortable making a larger payment. Your loan officer can figure the break even point to ensure the savings exceeds to costs to refinance.
Another way to save money as a homeowner would be to cancel private mortgage insurance (PMI) as quickly as possible. Although, some home loans do not offer the ability to get rid of the PMI. For instance, PMI (called an annual fee) continues for the entire USDA loan term. Also, recent FHA loans with less than 10% equity will have PMI for the entire term. Here’s a solution! If rates drop, consider a refinance to a loan without PMI assuming there is sufficient equity.
VA loans do not charge monthly mortgage, so no worries here. Furthermore, conventional loans allow homeowners to remove PMI once under 80% of the value.
Extra Savings Tip! Once the PMI is cancelled, continue paying the old payment. The extra amount could be applied as extra principal, which pays off the loan even quicker.
Pay Extra Principal
Paying extra principal to your regular mortgage payment will reduce the balance quicker. Thus, less interest charged. Believe it or not, finding the funds to pay down a mortgage quicker is easier than you think. Got a raise at work? Just paid of a debt? Refinanced your mortgage to a lower payment? Then use those new found savings and apply it to the principal! Keep in mind, that paying extra to the principal lowers the balance but not the monthly payment.
Remember if paying extra, instruct the lender of your intentions! So, state that the extra amount should be applied to the principal. If there is a goal of paying off in a certain time frame, ask your lender how much extra should be paid.
Make Lump Sum Payments
So, we have discussed applying extra funds on top of each monthly mortgage payment. But, something that can make a huge difference is applying a lump sum to the balance. Lump sum funds may come from tax refunds, inheritance, selling an asset, bonus or commission income, and saving up funds for a while. The advantage of paying a lump sum is that the principal loan balance decreases all at once. Since the mortgage payment stays the same, more of the monthly payment gets applied each month to the principal. Resulting in a lower balance immediately as well as accelerating the balance downward. But, what if you want that lump sum to lower your payment?
Recast Your Mortgage Payment
Recasting your payment is also called re-amortizing the loan. So, when a borrower applies enough funds towards the balance, the lender may allow the loan to be recast. Rather than extra funds only lowering the balance, the borrower may also lower the monthly payment. Basically, the interest rate and term stay the same. When you apply that to the new re-amortized balance, the required payment is lower.
- Ask your lender for the recasting procedure
- There may be a fee to recast
- Great strategy for lowering the payment after selling a prior residence
Should I Pay Off My Mortgage Early?
Many think this is an easy one, but there’s more involved than you think. Before the 2018 tax reform, losing the mortgage interest deduction would be a downside to paying off early. Now with the much higher standard deduction, a much smaller percentage of homeowners can itemize and use this deduction. Therefore, paying off the mortgage early does not negatively affect as many in the income tax area.
But, an area that needs to be addressed would be comparing extra funds being applied to a mortgage balance or something else. Typically, mortgages are cheap money. Meaning the interest rates are low. So if there are other debts with higher interest rates, it may be better to pay those off first. Another school of thought is to invest the extra funds instead of paying down a mortgage. Investment options may include retirement accounts, rainy day , savings, college education, or buying another property like a second home or rental property.
Not sure what to do? Speak to your financial adviser, CPA, and/or mortgage loan originator.