Three hundred and sixty. In degrees, that number may not seem like much – like making a quick 360-degree turn. But measured in months, 360 can feel like an eternity, particularly for borrowers who commit to a 30-year mortgage loan. Fortunately, for those who dream of a mortgage-free future arriving sooner, there are effective ways to shorten the term of your mortgage, and save big money in the long run, too.
One of the most popular strategies is to pay down a mortgage loan early by making accelerated payments that will reduce the balance faster, which will dramatically lower the total interest paid over the life of the mortgage.
For example, say hypothetical homeowner Mike just borrowed $200,000 via a 30-year mortgage at a fixed rate of 3.5 percent. Normally, he would pay approximately $898 monthly in principal and interest. But if Mike were to chip in an extra $200 a month toward the principal starting with his very first mortgage payment, he would pay off the loan 87 months (more than 7 years) early and save $37,656 in interest.
“Another easy way to shave years off your mortgage is to make bi-weekly instead of monthly payments,” says Tom Reddin, former president/CEO of LendingTree.com and current publisher of the blog MortgageRates.us. “Take your monthly payment and divide it by two to determine your payment amount for your lender to withdraw every other week. By following this bi-weekly payment schedule, you’ll end up making 26 payments throughout each year, which is the equivalent of 13 monthly mortgage payments each year.
Reddin says this convenient approach “will cut more than four years off a traditional 30-year fixed-rate mortgage and can yield a savings of more than $20,000 in interest costs on a $200,000 mortgage, if you start with this approach at the beginning of your mortgage.”
You can set up accelerated payments by contacting the lender that services your mortgage and indicating how much extra you want to contribute toward your principal and at what frequency. Avoid any prepayment plans offered by lenders and third parties that charge you a fee for the service. Most mortgages allow you to prepay with no charges or penalties.
Another loan-shortening approach is to refinance to a shorter-term mortgage. If you have 22 years left on your loan and owe $150,000 at a fixed rate of 4.0 percent, but refinance to a 15-year mortgage at 3.0 percent, you’ll increase your monthly payment by about $181 but shave 7 years off your term – and retain tens of thousands otherwise spent in interest.
Steven Alexander, president of Private Mortgage Services in Atlanta, says you may also want to consider a “cash-in” refinance, whereby you bring extra money to the closing table to decrease your mortgage principal. Doing so makes it easier to qualify for a refinancing and a lower interest rate, which will save you money on the monthly payment. You can then reinvest the money into the loan as accelerated payments to trim the term if you so desire.
“By paying down your mortgage more quickly, you are maximizing liquidity,” Alexander says. “You do not want to end up in a position of having to consider selling your home to access your equity wealth.”
However, there are potential drawbacks to paying down your mortgage and shortening the term the loan term. First, for households that itemize deductions, the return on investment is reduced when you prepay your mortgage because of the tax deductibility of mortgage interest. For example, if you’re in the 25-percent tax bracket, the mortgage interest deduction decreases your taxes by $25 for every $100 paid in interest.
Second, refinancing can incur steep costs, including fees for the appraisal and loan origination, and that can set you back several thousands of dollars. So, be sure the interest savings will offset the refinancing fees over a reasonable length of time, especially if you anticipate remaining in your home for only a few years.
Third, you may be able to get a better return on your investment elsewhere.
“Prepaying your mortgage, although important to overall fiscal health, is usually the last thing on the list when excess funds are available,” says Keith Gumbinger, vice president of HSH Associates, a mortgage research firm in Riverdale, N.J. “Funding retirement accounts, liquid emergency accounts and children’s education accounts, purchasing health or life insurance, and paying down student loans and non-deductible higher-interest debt should all be considered first.”