So, you want to pay off your mortgage early. By doing so, you’ll be able to save on interest, build equity faster, AND potentially shave years off your payment schedule. And though it might sound daunting, there are some pretty simple ways you can accomplish it.
Check out these three options!
1. Refinance to a shorter-term mortgage
Makes sense, right? If you have a 30-year mortgage, you can refinance to 15 or 20 years and pay it off faster.
There are two upsides to this. The first is like we just said. The sooner you pay back your loan, the less money you spend on interest. The second is, mortgages with shorter terms usually have lower rates than longer ones. The lower your interest rate, the less you pay, too. Awesome!
Tip: Check today’s rates on 15-year versus 30-year mortgages by visiting our refinance interest savings calculatorpage.
Now some important notes. One, these refinances typically come with higher minimum payments. You’ll likely haveto pay more every month, but again, you’ll benefit from interest savings over the life of the loan. And two, you’ll have to pay closing costs for the refinance.
Want to dig a little deeper?
Some decisions look easy. At first glance, refinancing your 30-year fixed rate mortgage to a 15-year mortgage seems like one of them. This refi sure does have its upsides. But there are also some things you’ll want to think about before you decide if it’s right for you.
Your rate is lower and you pay less mortgage interest
The big win with this type of refinance is simple. You save on interest, which can keep a lot of money in your pocket. Interest rates are lower on 15-year loans compared to 30-year fixed rate mortgages. Often a good bit lower. The lower the interest rate, the less you spend. You also pay less total interest because you are borrowing the money for a shorter period of time.
So figuring you’ll live in your house a while, you’ll save in the long run – and that’s always a good thing. But, like many good things in life, a 15-year fixed refi comes with a trade-off.
You may end up paying a higher principal each month
Depending on what your current interest rate is on your 30-year loan, your monthly payments could be higher when you refi to 15 years. This is because you’re paying off your principal in half the time. If you end up making a higher monthly payment, this could leave you with less of a financial cushion for other monthly costs, such as unexpected repair bills, and future expenses (e.g., college tuition).
Keep in mind: A lot of mortgages come with no prepayment penalties. This means you can pay off the loan faster than the terms require and save on interest. Have extra money this month? Great, pay more if you want. Things a little tight? No problem, just pay the minimum.
An example of savings and payments
Say you owe the lender $200,000 on your mortgage loan, you have 20 years (240 months) left to pay it off, and your interest rate is 5%. If you refinanced into 15-year loan (180 months) at 4.5% interest, how would that compare in terms of overall interest payments to the 30-year loan?
Use a refinance interest savings calculator to create a visual chart of the savings. Many bank & financial online sites can assist you with a calculator.
You can see that you would save a whopping $41,381 in interest over the 15-year life of the loan by paying an additional $210 a month. Not a bad looking deal.
Don’t forget you need to pay closing costs
While you’re looking at that deal, remember you’ll have to pay closing costs to refinance. These typically run between 2% and 5% of the loan value. In the example, closing costs might be between $4,000 and $10,000, which still leaves you with a good savings.
As a rule of thumb, the longer you plan to live in your home, the more sense it makes to pay closing costs because you’ll enjoy bigger savings over a longer period of time. Figure out if paying these costs makes sense for you.
Think about other ways you might use the money
One more thing to consider. Think about that $210 as an investment and the $41,381 as a payoff. Could you make a better investment and get a better payoff someplace else? Other opportunities might result in a higher return, but they can also come with less certainty.
It might make more sense for you to put that extra $210 in savings into your kid’s college savings account or into your own retirement account. If you have other debts with a higher interest rate than your mortgage, you might want to pay those off first.
2. Pay a little more each month (or when you can)
Don’t like the sound of refinancing right now? Fear not! You’ve got choices to pay off your mortgage early. The simplest way is to just pay more when you can. Here, there’s no paperwork or closing costs. And you’ll still save money because you’re paying back the loan faster.
Before you do, check that there is no prepayment penalty. You don’t want to be charged for paying back the loan early. (FYI: At ditech, there’s no prepayment penalty on conventional loans.) Also find out how to apply the payments to the principal – that is, to the money you borrowed and not the interest you’re paying to borrow it. Check your statements to make sure they’re right.
Don’t worry if you can’t pay that much. A little more every month can make a big difference. And the more years you have left on your mortgage, the bigger difference it makes. Many people pay $100 extra every month. Some people make 13 payments a year instead of 12. And others make biweekly payments instead of one payment each month. Find something that works for you.
3. Did you get a windfall of cash? Make one big payment
Sometimes you come into a nice little pile of money. Did you get a tax refund? Or a bonus from work? Maybe you got a gift or an inheritance from a family member.
You can make one big payment once just like you can make a lot of little payments. They both save you money. Once again, check that there’s no prepayment penalty, make sure the money goes to paying down the principal, and look at your statement to confirm everything is right.
Bonus tips! Your last mortgage payment … and beyond
When that golden moment comes, and you are ready to make your last payment, there are a couple things you need to know.
It’s got a nice ring to it, doesn’t it?
If you’ve sent in that final mortgage payment, congratulations! Go celebrate! But read this first.
Paying off your mortgage and owning your home free and clear is a huge milestone, and one that your friends will definitely be jealous of. However, there are still a couple of things you’ll need to do. We’ll fill you on those steps and provide some suggestions on where you may be able to use those extra funds.
Here’s what you can expect after you pay off your mortgage:
You’ll receive some important documents.
Once your loan is fully paid off, many lenders will return the mortgage promissory note and that you signed when you first took out the loan. The canceled promissory note confirms you’ve fulfilled the terms of the loan and no longer owe the lender any money. Recommend putting this document in a safe place. Your lender will also release the lien of the security instrument from your property by sending a satisfaction/release to the county where the property is located for recording.
Cancel your automatic deduction.
If you’ve set up automatic mortgage payments through your bank, you should get in touch with that bank and notify them to turn off automatic payments once your loan is paid off.
Make future payments of your school and property taxes and homeowners insurance.
Yes, you’re still going to have to pay for these things after your mortgage has been paid off.
If you’re like most people, your property taxes and homeowners insurance were rolled into your mortgage payment. This means they were escrowed by your lender, and the payments were made for you.
But now you’re in charge of making those payments. You’ll need to make sure you begin receiving these bills directly, so contact your local taxing authority(ies) and your homeowners insurance company. You may want to start setting aside money each month to account for these payments.
Use that monthly mortgage payment elsewhere.
No longer having a monthly mortgage payment means having leftover cash each month to do what you want with it. Keeping it in your bank account or putting it in your retirement fund may be a good place to start, but perhaps there are upgrades you finally have the extra money to make in the home, such as: renovating a part of your homethat desperately needs it, a home improvement project to boost its resale value, or making some aging in place modifications so you can live out the latter years of your life in this home.
Plain and simple: reaching mortgage payoff can give you more financial freedom to invest back into your home and beyond.
The things above will set you up nicely for this next (and probably your favorite) phase of homeownership – being mortgage-free. Ok, now go out and celebrate. You’ve earned it.
Consult a financial advisor before making decisions regarding important personal financial matters, and consult a tax advisor regarding the deductibility of interest and tax implications.
Excerpts from Ditech.com blog