The thought of paying off a mortgage over 30 years does not sit well with many homeowners. If you are someone who thinks 30 years is way too long to live in the burden of debt, then you’re in the right place.
If you’ve been searching how to pay your mortgage faster, chances are that you’ve been bombarded by “experts” throwing around terms like velocity banking and debt weapons.
But the truth is that all these so-called groundbreaking concepts are not all they are cracked up to be. If you really want to understand what it takes to pay off a mortgage faster, stay with me for a few minutes and I’ll share with you my 5 tips on exactly how to do that.
They are no earth-shattering concepts that are going to make your mortgage disappear over 5-7 years. The truth is you have to pay the money back...with interest. My five tips are simple steps that will help you get there a little bit faster.
How Mortgages and Interests Works
So before we get into it, it’s important to understand the basics of how mortgages and interest works. It really is just simple math. There are no illusions and the banks are not trying to rip you off.
So let’s say you take out a $300000 mortgage at a fixed rate of 4% over the period of 30 years. Now with a mortgage payment, you have two components, principal and interest. Banks use an amortization schedule where they calculate exactly how much you must pay each month over a 30-year period so that at the end of it, you have paid off the loan in full.
The monthly payment in the above case would be $1,432.25 and you’ll be paying a grand total of $515,607 at the end of 30 years. Your monthly payments remain constant throughout the entire term, however, the amount that goes towards the principal and the amount that goes towards the interest changes each month depending on how much you still owe at that time.
For example, in the image above, out of the $1,432.25 payment in the first month, $1,000 (4% of $300000/12) goes towards the interest, and $432.25 goes towards the principal. Next month, the portion of interest will reduce to $998.56 out of $1,432.25 since now, you owe them $299,567.75. This same calculation is carried all the way through.
To check out the full amortization schedule and play around with the numbers head over to this mortgage calculator here.
So if you don’t want to pay all this money every month in interest, all you have to do is owe them less money. Its simple math. Unfortunately, you need to borrow this money in order to buy the house and the only way to afford the monthly payment is to spread it over a 30 year period.
5 Ways to Pay Off Mortgage Faster
If you decide you want to pay your mortgage faster than the 30 year schedule here are 5 ways to help you move towards that objective.
1. Make Random Extra Payments Towards Principal
As simple as it may sound, making random extra payments towards your principal, whenever you can, can help you save thousands of dollars and get done with your mortgage years early.
For example, say you make extra payments of $3000 every year. Just doing that will save you a total of $61,410 in interest and you’ll be done with your mortgage in 22 years and 5 months.
If you can up that to $5000 every year would save you more than $90000 in interest and more than a decade of your mortgage.
2. Make Bi-Weekly Payments
By making bi-weekly payments, instead of making 12 monthly payments, you’re making 26 bi-weekly payments throughout the year. Which is equivalent to a full payment extra each year.
So every year, one full payment goes directly to the principal. This will help you knock years off the back end of your mortgage and you’ll be able to save up to 4 years and 2 months on a 30 year mortgage at a 4% fixed interest rate.
Not all lenders allow you to make bi-weekly payments so make sure to check with them first.
3. Pretend You Have a 15 Year Mortgage
Pretending that you have a 15 year mortgage rather than actually taking a 15 year mortgage can be a better way to go. By doing so, you get the flexibility where if you don’t have the money one month, you can make the smaller payment.
But when you do have the money and you want to make the additional payment, you can do so according to a 15 year schedule and pay off the mortgage at a much faster pace.
4. Refinance to a Lower Interest Rate
Refinancing your home loan can make sense if you can get a lower interest rate. Rates are at historic lows right now, and it’d be worth checking if it makes sense for your situation. The key here is, can you save enough on interest to make it worthwhile.
See what the closing costs are and compare them with how much you can save in interests. An important factor is how long you are going to stay in the house. You can calculate the break even point to determine how long it will take to save enough interest that it surpasses the closing costs you had to pay to refinance the loan.
If you’re gonna be in the home for a shorter-term like 3-4 more years then it’ll probably not make sense to refinance, however, if you plan to stay long-term then it could be a great option.
A great option is to refinance and keep the length of your mortgage the same. So for example, if you still have 25 years left on your mortgage then you can refinance to another 25 year loan so you do not go back to another 30 year term.
5. Use a Portion of your Emergency Fund to Pay Down the Mortgage
This is along the lines of velocity banking in that using a home equity line of credit as your emergency fund and taking a portion of the cash in your emergency fund to make principal mortgage payments.
If you’re very good with money and have six months saved up in the bank as an emergency fund that is earning next to nothing, a good strategy could be to take half of that amount to pay down the principal on your mortgage. Then get a home equity line of credit to just sit there. Don’t borrow against it, just have it there to act as your emergency fund. There is obviously more risk in doing this because you are reducing your cash savings, but considering interest rates are so low having a lot of cash in the bank might not be the best strategy.
At the end of the day, there is no magic bullet or secret technique that will make your mortgage disappear. It all comes down to making more payments as fast as you can.
Make sure to head over to www.schoolofpersonalfinance.com to learn about joining our membership program where you can work 1-1 with me and start your journey of becoming great with money!
Rich McCormack, CFP®