Paying off your home loan early can save you thousands of dollars in interest.
In some cases, paying off your mortgage early may not be a wise move. Speak to an independent financial adviser before making extra payments toward your loan.
Ways to pay off your mortgage early include switching to a biweekly payment schedule, making one extra payment per year, paying in large lump sums, refinancing, and tapping into your home equity.
If you can afford to pay off a home mortgage early, you should investigate the option.
The numbers speak for themselves.
Let’s say you buy a home for $300,000 and make a 20% down payment ($60,000). If you took out a loan for the balance of $240,000 at a 3% interest rate over 30 years, you’d pay a total of $124,266 in interest by the 30-year mark. That’s in addition to the $240,000 you originally borrowed – and doesn’t factor in other expenses such as property taxes or homeowners insurance.
If you pay off your mortgage before the end of the term, you can save thousands and even tens of thousands in interest.
You should only consider paying off your mortgage early if:
You have enough money for emergencies: You should have several months’ worth of living expenses in liquid cash before even thinking about paying off your home loan early. Taking money out of your home is a lot harder than withdrawing cash from a savings account.
You don’t have other, higher-interest debt: Student loans, credit card debt and different loan types often carry higher rates and accrue interest faster than mortgages. Chances are you’ll save more by paying these debts down than if you were to pay off your mortgage early.
Your mortgage doesn’t carry a prepayment penalty: A prepayment penalty is a fee some lenders charge if you pay off your home loan prematurely. As a result, you could end up paying the same or similar amount to what you would’ve paid in interest anyway. Lenders will typically lift a prepayment penalty a few years into the mortgage.
You don’t have a significant expense coming up: If you’re planning a vacation or a wedding, or your child will be going to college, it’s better to take care of these expenses first.
You’re not neglecting your retirement account: In general, prioritize putting money into your 401(k) or individual retirement account (IRA) over paying off a mortgage prematurely.
If you want to pay off your mortgage early, consider the following:
1. Make a 20% down payment
Putting at least 20% down when taking out a mortgage reduces the principal and saves thousands in interest over the loan’s lifetime. Lenders also won’t require you to pay private mortgage insurance (PMI) during the first few years, further ramping up your savings. If you’re already paying PMI, focus on getting the loan balance to under 80% of your home’s value and then apply to remove the PMI.
2. Switch from monthly to biweekly payments
A once-a-month payment schedule equals 12 payments a year. If you split the payment amount in half and pay it in two biweekly installments, that’s 26 installments or 13 full payments per year. That one extra payment may not severely impact you, but it can save you thousands in interest over time.
3. Make one extra payment a year
The average American receives around $3,536 in tax refunds and $1,800 in holiday bonuses. You can use windfalls such as these to make one extra mortgage payment every year. You will knock years off the loan term and save thousands in interest if you do this consistently.
Make sure to tell your lender that you want any additional payments to go toward the principal. Otherwise, the lender will direct extra payments toward the next monthly minimum, which won’t reduce the total interest.
4. Pay off your mortgage in lump sums
A mortgage recast is a large lump sum payment toward the principal. Note that this doesn’t reduce the loan term, so you won’t necessarily pay off your home loan earlier, but your monthly payments will decrease.
5. Refinance your mortgage
When you refinance a loan, you replace your current mortgage with a higher loan amount and better terms, such as a lower interest rate or a more favorable term. You may consider refinancing when interest rates are falling, and you plan to live in the property for a long time.
However, remember that refinancing comes with new fees and points and restarts your loan’s amortization. Be sure to compare the life-of-loan costs of your existing and any prospective mortgages carefully before taking out a new loan.
6. Take out a home equity loan or home equity line of credit
Home equity loans (HELs) and home equity lines of credit (HELOCs) enable you to borrow against the equity you’ve built in your property. If the HEL or HELOC has a lower interest rate than your mortgage, you could pay off your mortgage with the HEL or HELOC funds, then make payments on the HELOC instead.
This could reduce your overall payment, and help you to pay off your mortgage early.
With a home equity loan, you receive a lump sum upfront and repay it after the end of the term. HELOCs give you access to a rolling line of credit. You borrow as much as you need and only repay that amount.
To qualify for a home equity loan or line of credit, you need:
At least 15-20% equity in your home
A credit score in the mid-600s
A maximum debt-to-income (DTI) ratio of 43%
7. Consider a home equity agreement
One major downside to HELs and HELOCs is that your property serves as collateral. If you don’t repay the loan, you could lose your home. In addition, you may not meet the credit score and income requirements. This applies to mortgage refinancing as well.
This is where home equity agreements (HEAs) come in. HEAs aren’t loans. There are no monthly payments, interest rates, or high credit score requirements. The income requirements are also more flexible than with debt-based products.
When you sign a HEA, you receive a lump sum upfront. In exchange, the HEA provider gets a share of the proceeds when you sell your home at the end of the term. In the meantime, you continue to live in the property as usual. You can also buy the provider out if you don’t want to sell.
With a HEA, you may be able to pay off other debt you have, improve your credit profile and be eligible for a refinance, HEL or HELOC – with all the benefits discussed earlier.
Learn more about home equity agreements from Unlock Technologies.
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