Given the high cost of home ownership, mortgage loans have become the go-to option for financing home purchases. That said, a mortgage can be a long-term obligation that puts a strain on finances. This is why borrowers often look for ways to pay off their mortgage early. While this may not be the perfect solution for everyone, it can help certain borrowers achieve financial stability and save more money by reducing interest payments.
Tips for paying off mortgages early
1. Increase regular payments
Increasing payments (by whatever amount is feasible) is one of the easiest ways to pay off a mortgage loan early. That being said, these payments must be directed toward the principal amount and not toward interest or next month’s bill. One can choose from several payment strategies to bring this plan to action.
Dollar-a-month plan
This is ideal for those whose income increases slowly but steadily over time. Here, they can increase their monthly principal amount by just $1. For instance, if it’s $900 this month, it goes up to $901 the next, then $902, and so on. This small increase is unlikely to pinch one’s pockets but will still help reduce the term of the mortgage.
Round-up
Another way of increasing monthly payments is by rounding up the value owed to the nearest $100 amount. For instance, if the amount owed this month is $756, round it up to $800 instead.
An additional payment each year
One can make an extra payment each year to reduce the total mortgage amount. A regular increase of just one payment a year can help homeowners save thousands of dollars in interest alone.
Bi-weekly payments
If there is extra room in the budget, it may also be worthwhile to start making bi-weekly payments instead of monthly ones. This can help one pay off their mortgage loan in half the time.
2. Redirect extra income toward mortgage payments
Throughout the year, one may receive “extra” money through various sources, be it inheritance, work bonuses, tax refunds, or even gifts. This windfall amount (partially or in full) can be used to make mortgage payments. While these will not substantially reduce the principal amount like regular overpayments would, they will still help reduce the loan term.
3. Consider refinancing
If the interest rates decline over the years, one can consider refinancing their mortgage. Refinancing is the process of replacing a current mortgage with a new one that has different terms. It’s a way of reducing interest rates, consolidating debt, and accessing the equity built in a home. While this can be a good option in some instances, one must note that refinancing a loan comes with additional expenses, such as closing costs and origination fees. This may negate interest savings if one decides to move/sell their home before breaking even.
4. Recast the mortgage
This option allows the borrower to pay a large lump sum towards the principal amount. After this, the lender adjusts the monthly payments and offers a lower interest rate to match the remainder of the loan. Here, while the term period remains unchanged, the recalibration helps reduce the monthly repayment obligation and interest owed to the lender. This process costs around $250–$500, making it a much cheaper alternative to refinancing.
5. Pay off the balance in cash
This is what most people think of when they say they want to pay off their mortgage early. If one can save money, it may be worthwhile to opt for this lump sum mortgage payoff and clear the balance amount entirely. This would put an end to interest and monthly payments.
When to avoid an early mortgage payoff
While paying off the mortgage early can be an enticing prospect for many homeowners, there may be times when it is not the right decision.
When it may attract a payment penalty
Many lenders levy a loan prepayment penalty, which allows them to make all the money they were expecting via interest payments. In the event of an early closure, mortgage lenders may end up levying a fee of around 2% of the remaining closing balance. However, it is important to note that this fee is now only effective for a limited time. For all mortgage loans taken post-2014, a prepayment fee can only be levied within the first three years after the loan has been taken.
When one needs to rely on retirement funds
One must avoid using a 401(k) or other retirement accounts to pay off a mortgage loan. Not only will this reduce the funds available for one’s future needs, but it will also result in the loss of any interest these funds would accrue in the future.
When one doesn’t have an emergency fund
One must have a sizable emergency fund, which contains about three to six months of living expenses, to deal with unexpected events such as job loss or natural calamities. If one has not set aside such funds, they should not allocate more money to mortgage payments. Instead, one must prioritize building a safety net while making regularly scheduled payments.
Another priority should be paying off other high-interest debts, such as credit cards, before making overpayments on the mortgage. Alternatively, one can use the debt snowball method (paying off the smallest loans quickly and then moving to big debts) of fiscal management to handle finances smoothly.
