If you have a mortgage loan, you’ve probably wondered whether it would be worthwhile to pay it down ahead of schedule. If so, you’re not alone. The “to pay or not to pay early” debate has been happening for years. There are advantages and disadvantages that come wither either strategy so it’s important to consider the math and the potential benefits before you decide.
You may find that you are better off investing the extra money in a Roth IRA or retirement savings than paying off your mortgage early. For example, you wouldn’t want to pay down a mortgage at 4% APR when you can earn a greater return by investing in stocks and bonds or bumping up your retirement contributions. Add in the home mortgage interest deduction you can take on your federal taxes and, some say you would be silly to prepay your mortgage and miss out on those perks.
Lastly, if you’re applying for need-based education aid for your kids, a paid-off mortgage or a lot of home equity can count against you at colleges where equity is considered money in the bank.
If, after considering the pros and cons, you still want to pay off your mortgage early, here are four ways to make it happen.
- Refinance with a shorter-term mortgage.
- Pay a little more each month.
- Make an extra mortgage payment every year.
- Throw all “found” money at the mortgage.
Refinance to a shorter-term mortgage
You can pay off your mortgage faster by refinancing into a 10- or 15-year mortgage.
For example: You got a 30-year fixed-rate mortgage for $200,000 at 4.5 percent. Five years later, you refinance into a 15-year loan at 4 percent. Doing so pays off the mortgage 10 years earlier and saves you more than $60,000 (if you exclude closing costs on the refi).
Shorter-term mortgages usually have lower interest rates than 30-year mortgages but refinancing carries closing costs. Plus, a shorter term means higher monthly payments. Keep in mind, unless the new interest rate is lower than the old rate, there’s no point in refinancing. Check out our Mortgage Calculator to run some quick calculations for your personal situation.
Pay a little more each month
You can get all the benefits of an early payoff without the extra costs of a refinance by paying a little more each month but this takes discipline, of course. Divide your monthly principal and interest by 12 and add that amount to your monthly payment for a year. In the end, you’ll make the equivalent of 13 payments in 12 months.
For example: You got a $200,000 mortgage at 4.5 percent. After five years of making the minimum payments, you add an extra 1/12 of a month’s principal and interest to each monthly payment. Doing so will help you pay off your mortgage three years and three months earlier and save you more than $18,000 interest!
But, before you start making extra payments, keep in mind the following:
- Check with your mortgage company first. Some companies only accept extra payments at specific times or may charge prepayment penalties.
- Include a note on your extra payment that you want it applied to the principal balance—not to the following month’s payment.
- Always check the next statement to make sure your payment has been applied properly.
Make one extra mortgage payment each year
Instead of paying a little more each month, make one extra monthly payment each year. One way to do this is to save 1/12 of a payment every month, and then make an extra payment after every 12 months.
For example: Let’s say you do this starting the first month after getting a 30-year mortgage for $200,000 at 4.5 percent. That would save more than $27,000 interest, and you would pay off the mortgage four years and three months earlier.
Apply ‘found’ money toward the mortgage
Did you get a bonus at work, a tax refund or an unexpected windfall? Funnel some or all of that money toward your mortgage.
For example: Let’s say you got a 30-year fixed-rate mortgage for $200,000 at 4.5 percent. Then, five years later, you can pay an extra $10,000 in a lump sum. Doing so pays off the mortgage two years and four months earlier, and saves more than $19,000 in interest.
The downside to this approach is that it’s hard to predict the mortgage payoff date. And be careful putting so much extra cash toward the mortgage that you come up short for other needs.
At the end of the day, only you can decide how to approach your home mortgage debt. If you hate debt, you naturally want to put it behind you once and for all. But you just want to be sure to make an informed decision.