If You Can, Avoid a Mortgage Altogether
Commonly, people see their ideal starter home as a 3-bedroom, 2-bath house in a nice neighborhood with great public schools and safe sidewalks. But perhaps you want a nice condo or apartment in a hip urban area or a ski lodge in Tahoe. Regardless of the type of house, you face one of two choices to acquire it: either take out a mortgage to finance it or buy it entirely with cash. As you can imagine, many more people opt for the former than the latter. Why? Because not many people have hundreds of thousands of dollars (depending on where you live) earmarked in their bank accounts to make an outright purchase a reality. So I ask, how will you ever learn how to save money and get the most out of life? Your best option involves walking into a bank, talking to a nice person behind a desk and presenting yourselves for the financial equivalent of a physical in exchange for a mortgage. If you’d like to avoid this process, you’ll need that pile of cash I mentioned earlier. A pile of cash accumulated through saving a high percentage of your income over an extended period of time while eschewing much of life’s activities along the way. Certainly a possibility, but a mortgage can be an easier, though cumbersome path. Once you sign those papers to put the house in your name, you’re strapped with debt. If you’re looking for a quicker way out than your 15- or 30-year payment schedule, consider the 5 simple ways listed below to pay off your mortgage faster.
How to Pay Off Your Mortgage Faster
In many cases, a home is a family’s largest asset. It can make sense to move quickly toward owning it outright. But paying off a mortgage early can be a daunting task. Some lenders can assess prepayment fees or block your attempt to pay off your mortgage ahead of schedule. Make sure you check your terms before proceeding with any of these methods. Nationally, the median monthly mortgage payment is $1,100 according to the latest American Housing Survey by the U.S. Census Bureau. This is up only slightly from 2011 when the median amounted to $1,015. Also according to the Census, the national median outstanding mortgage balance was $126,000 in 2017. Despite the slight growth in median payment amount, you still want to explore options for paying off your mortgage faster and reaching financial freedom. As a note to the methods discussed in this article, I used a 30-year 5% fixed mortgage with a $186,500 balance.
1. Switch to Bi-Weekly Mortgage Payments
Reduces 30-year mortgage by 4 years and 9 months. By cutting your monthly mortgage payment in half and opting to pay every two weeks, you can ease your financial burden in two ways. First, this spreads out the cash flow demand needed to pay your monthly bill and second, this also slips in one extra monthly-equivalent payment per year. For example, if a person pays $1,000 per month every 12 months, they pay $12,000 per year towards their mortgage. If a person chooses the bi-weekly method, they pay $500 every two weeks 26 times per year, amounting to $13,000 per year. This extra $1,000 per year can amount to serious savings down the road. If families can swing this in their budget, it can reduce their time spent paying for a 30-year mortgage by almost 5 years. For my mortgage example, the borrower will pay $32,381 less in interest over the shortened life of the loan. Also of note for this method, make sure to tell your lender to apply the extra payments directly toward your principal balance- not to the following month’s payments.
How to Set Up a Bi-weekly Mortgage Payment
- Locate the principal and interest portion of your payment on your monthly statement and simply divide the number by two. For example, $1,000 per month turns into $500 every two weeks.
- Make sure to include the tax and insurance portion of your payment each month.
- Check how your lender handles bi-weekly mortgage payments. Some lenders process them while others refuse to accept partial payments at all. Regardless, do not pay a fee to initiate a bi-weekly mortgage payment plan.
- If your lender doesn’t allow a bi-weekly plan, set aside your bi-weekly payments into a separate account and use that money to make your full mortgage payment on every second deposit.
| Year # | Standard | Biweekly |
|---|---|---|
| 1 | $183,748 | $182,687 |
| 2 | $180,856 | $178,680 |
| 3 | $177,816 | $174,468 |
| 4 | $174,620 | $170,041 |
| 5 | $171,261 | $165,389 |
| 6 | $167,729 | $160,498 |
| 7 | $164,017 | $155,358 |
| 8 | $160,116 | $149,956 |
| 9 | $156,014 | $144,278 |
| 10 | $151,703 | $138,311 |
| 11 | $147,171 | $132,038 |
| 12 | $142,407 | $125,446 |
| 13 | $137,400 | $118,517 |
| 14 | $132,136 | $111,234 |
| 15 | $126,603 | $103,580 |
| 16 | $120,788 | $95,535 |
| 17 | $114,674 | $87,079 |
| 18 | $108,248 | $78,192 |
| 19 | $101,493 | $68,851 |
| 20 | $94,392 | $59,033 |
| 21 | $86,928 | $48,714 |
| 22 | $79,082 | $37,869 |
| 23 | $70,835 | $26,470 |
| 24 | $62,166 | $14,489 |
| 25 | $53,053 | $1,897 |
| 26 | $43,474 | $0 |
| 27 | $33,405 | $0 |
| 28 | $22,821 | $0 |
| 29 | $11,695 | $0 |
| 30 | $0 | $0 |
| Bi-Weekly | |
|---|---|
| Original term | 30 Years |
| Annual interest rate | 5% |
| Additional principal payment | $1,000 per year |
| Normal payment (P&I) | $1,001 |
| Accelerated payment (P&I) | $501 (x26) |
| Total scheduled payments | $360,423 |
| Total accelerated payments | $328,042 |
| Interest savings | $32,381 |
| Mortgage shortened by | 4 years, 9 months |
| Total payments saved | $57,057 |
2. Make an Extra Monthly Payment per Year
Reduces 30-year mortgage by 4 years and 8 months. This produces a similar effect as switching from the monthly to the bi-weekly payment amount shown above. This has one extra monthly payment made per year and reduces your interest paid by $31,511. Table 3 shows the standard mortgage amortization schedule compared to the extra yearly payment mortgage amortization schedule while Table 4 shows summary information about the extra annual payment method. Table 3 – Loan Amortization with Extra Payments Table 4 – Summary Information about Extra Yearly Payment Method
| Extra Annual Payment | |
|---|---|
| Original term | 30 Years |
| Annual interest rate | 5% |
| Additional principal payment | $83 per month ($1,000 per year) |
| Normal payment (P&I) | $1,001 |
| Accelerated payment (P&I) | $1,084 (x12) |
| Total scheduled payments | $360,423 |
| Total accelerated payments | $328,912 |
| Interest savings | $31,511 |
| Mortgage shortened by | 4 years, 8 months |
| Total payments saved | $56,056 |
3. Refinance into a Shorter-Term Loan
Reduces your 30-year mortgage by however long remains on your 30-year mortgage and the 15-year mortgage. Do you have a 30-year mortgage and extra room in your budget? Refinancing into a 15-year mortgage could allow you to pay off your balance faster. Doing this will also grant you a lower interest rate compared to a contemporary 30-year mortgage (shorter loan terms are paired with lower interest rates) and have you pay significantly less in interest. Consider your available refinancing options and compare them to your current mortgage cost. If you find refinancing to save a considerable amount of money and you plan to stay in the house for a longer period of time, you should pull the trigger. For comparison in our example, taking out a 15-year mortgage compared to a 30-year will result in monthly payments of $1,356 but lifetime interest of $57,629 compared to the 30-year’s $173,922. That amounts to $116,293 in interest savings.
4. Place any Windfalls into your Mortgage
Reduces your mortgage depending on how much you pay toward your outstanding principal balance. During the year, you might find yourself with excess funds you don’t know how best to put to work for you. Some examples include a tax refund, a bonus from work, and an inheritance. If you choose to use these funds to make a lump-sum payment toward your mortgage’s balance, you can make serious progress toward paying off your mortgage. If you receive a raise from work, make sure to place some of it in your IRA, 401(k), or other tax-advantaged investments to make full use of those annual limits. Another use of your raise could be placing the extra income into your mortgage. You can also add supplemental income from having the house pay for itself through hosting guests. This way, you leverage unused space in the house and have others pay down your mortgage faster. Or, you could choose to use my favorite method for paying off your mortgage faster by using the next way detailed below.
5. Fastest Way to Pay Off Your Mortgage – Invest Extra Payments
Reduces 30-year mortgage by 7 years. Instead of making extra payments on your mortgage, you can put these funds into a low-cost, passive index fund which could have a higher expected return. This allows the stock market to build your wealth and compound your returns at a higher rate than paying off your mortgage earlier through making additional payments. Also, you don’t need to decide between whether to pay off debt or invest because this method allows you to do both. You should hold your index fund investments until they have reached a level above your remaining principal, plus capital gains you would recognize on the sale. At this point, you can sell your investments to pay off your mortgage sooner. The historical annual average return on the S&P 500 has been roughly 10% since the 1920s. Realizing not every year has this return, but has on average, we can model what this scenario looks like. Also note this example excludes the effects of dividends and their tax implications. Table 5 shows the investment appreciation of your monthly contributions compounding at 10% annually over 23 years. Table 5 – Investment Appreciation of a Low-Cost Index Fund
| Investing the Difference in an Index Fund | |
|---|---|
| Original term | 30 Years |
| Annual interest rate | 10% |
| Normal Payment | $1,001 |
| Monthly Contribution to S&P 500 | $83 |
| Balance after 23 years, compounded annually | $83,454 |
| Capital Gain (20% LTCG), Gains = $60,546 | $12,109 |
| After-Tax Proceeds Applied To Mortgage | $71,345 |
| Total accelerated payments | $360,423 |
| Total payments made | $276,276 |
| Interest Savings | $13,264 |
| Mortgage shortened by | 7 years |
| Total Payments Saved | $84,098 |
| Item | Amount |
|---|---|
| Investment Balance | $83,454 |
| LT Capital Gains | <$12,109> |
| Net Proceeds | $71,345 |
| Net Proceeds | $71,345 |
| Mortgage Balance | <$70,835> |
| Net Proceeds After Pay Off | $510 |
Can You Afford to Pay Off Your Mortgage Faster?
Knowing whether to pay off your house or invest is an important decision you will need to make and one many struggle with. Before making your decision, I caution you to consider whether it is the best idea for your situation. Life happens. Emergencies can present which drain your funds and cause you cash flow shortages. Know your financial circumstances and proceed prudently. With the exception of refinancing into a shorter-term mortgage, these simple ways allow you to avoid biting off more than you can chew. They offer financial flexibility with your funds and do not commit you to an overly onerous path to financial freedom.
Why We Aren’t Paying Off Our Mortgages Faster
My wife and I have two mortgages we’re currently carrying, one for my rental condo and another on the multi-unit house we currently call home. On the other side we have long-term tenants and an AirBnB on the backside of our part. We are likely to sell the condo in the coming year to raise money for the down payment on a house we plan to buy together to start our family. The rates on both loans are attractive (4.50% on the condo and 3.675% on the double) and not cumbersome given the cash flow earned from our tenants. The low rates and the steady rise in interest rates since the election have made refinancing less appealing to us. Because we are likely to sell the condo, it doesn’t make sense to begin paying off the mortgage early. Nor does it make sense to refinance if we plan to sell the condo in the coming year. When we move out of our double, we will likely continue normal payments on the mortgage because the rate can’t go any lower. We’ll also rent out our side in addition to the other in order to produce positive cash flow. However, if the double becomes a burden financially and a headache to manage, we may elect to sell it down the road as well. But as of right now, both properties are low-maintenance and producing income while appreciating in value. Therefore, we won’t be paying off our mortgages faster than necessary. Further Reading: 9 Self-Employment Tax Deductions to Optimize Your Tax Return
