- Posted by Jeffrey Hain
Paying off your mortgage early sounds like a dream, right? Well, it doesn’t have to be. You can make it a reality with extra mortgage payments. By applying additional funds to the principal, you can reach an earlier payoff date and save interest over the life of the loan.
Amortizing Your Mortgage
When you signed the multitude of papers for your mortgage, you agreed to a set monthly payment at a specific interest rate for a set number of months. This created an amortization schedule. Amortization is simply the structure of payments and length of the loan, both of which must be spelled out for you, the borrower, in clear terms.
Unlike a revolving credit card, in which you pay down the balance then borrow anew, a mortgage is planned to diminish over time. The number of years or months in the future when your home loan will end is your assurance that you have a closed-end loan. That credit card, meanwhile, is an open-ended loan. Any extra payments you make to your mortgage, at any time, will affect the amortization schedule.
Amortization, however, is only an upper limit of the length of your mortgage loan. The agreed-upon schedule does not stop you from paying more on your mortgage each month, or making additional payments. As a consumer, you are protected from having to make extra payments, but not prevented from making them. Likewise, you are protected from having an open-ended loan (one that has no predictable end date), but are not prevented from ending the loan early.
No Prepayment Penalties
Most mortgages today have no prepayment penalties, which works in your favor. If you manage to pay off a 30-year fixed rate mortgage in only 15 years, you come out ahead financially because you’ve reduced the amount of interest paid on the loan.
You can use online financial calculators to experiment with different extra-payment methods with no risk to your savings.
Deciding on an Early Mortgage Payoff
There are considerations for eliminating your mortgage early and it may not make sense for everyone. If, however, you and your financial advisor determine it is the best plan for you, we have some ideas on how you might achieve an early payoff.
Make a “13th month" Payment
We will use round numbers to provide an example. Imagine you have a $300,000 mortgage set up at 4 percent interest for a term of 30 years.* Making one extra payment every year—a “13th month" payment—will reduce the term of the loan from 30 years to 25 years and 11 months. You save more than four years of payments and interest.
Make that “13th month" payment by dividing the monthly mortgage amount by 12 and tacking that amount onto each month’s payments. For that $300,000 mortgage in our example, the amount is an additional $119.36 each month applied to principal.
One Extra Payment
Alternately, if you simply make an extra month’s mortgage payment —$1,432.25—once a year, you get the same effect on the amortization schedule! Your term shrinks by four years, 11 months. Perhaps you receive a tax refund in April, cut back on those fancy coffee splurges, or stick to a tight, necessities-only budget. You could apply those saved funds toward the extra month’s payment, bringing you nearly five years closer to full home ownership.
Biweekly payments will produce similar amortization reductions. Take the monthly payment, multiply by 12, and divide by 26. This is the amount to send in every two weeks. It makes 26 half-payments (13 full payments) in the year. Be careful, though, because you have to make sure you always meet the monthly obligation, and the payments will never exactly mesh with the months. To set up a biweekly payment, contact your servicer for assistance.
What if even that payment schedule is too much? Round up. Again, with that $300,000 mortgage example, take the monthly payment from $1,432.25 and round up to $1,500. The extra $67.75 will take a smaller bite from your monthly budget, but will bring the amortization schedule down by nearly two years. And you probably won’t even miss the money!
Have a talk with your financial advisor to determine if an early mortgage payoff makes sense for you.
*Loan and rate listed are for illustrative purposes only. This is not a commitment to lend but for illustrative purposes only.