Your house is probably the most expensive purchase you’ll make in your lifetime. So it’s no wonder if you dream of the day that monthly mortgage payment is gone for good.
If you have the extra cash, should you go ahead and pay off the loan ahead of time? Maybe. Here’s what to consider before paying off your mortgage early.
Can You Pay Off a Mortgage Early?
Because mortgages tend to be large loans that last for a couple of decades or longer, paying off the loan early can save you tens of thousands of dollars in interest. Not to mention, it feels good not having a monthly mortgage payment to worry about.
When you send in your monthly check to your mortgage lender, the payment is split between principal and interest. Early on in the loan, a large portion of that payment is applied to interest. As time goes on, more of the payment goes toward paying down the principal. This is known as amortization, and it allows the lender to make back a larger portion of their money within the first several years of repayment.
The key to paying off your mortgage early is by applying extra payments to the principal.
Should I Pay Off My Mortgage?
Just because you can pay off your mortgage early doesn’t necessarily mean that you should. Of course, it would feel great to rid yourself of a huge financial burden like a mortgage. But if you really want to know if it’s a good decision, you have to look at the math.
There are pros and cons to paying off your mortgage early. Whether the pros outweigh the cons will depend on your overall financial situation.
Benefits of Paying Off Your Mortgage Early
- Save money on interest. By reducing the length of time you spend making mortgage payments, you’ll cut down the amount of interest you pay over the life of the loan. Depending on the loan amount, interest rate and original term, paying your mortgage off early could result in significant savings.
- Free up money for later in life. The typical mortgage lasts 15 to 30 years. That’s a long time to be saddled with loan payments. By paying off your mortgage early, you’ll free up cash to spend on more exciting things when you’re a bit older, such as travel.
- Increase home equity. Paying off your loan will increase the amount of equity in your home, which you could tap into with a home equity loan, home equity line of credit (HELOC) or cash-out refinance.
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Disadvantages of Paying Off Mortgage Early
- Less money for higher-interest debt. If you have credit card or student loan debt, funneling your extra cash toward paying off your mortgage early can actually cost you in the long run. This is because these other types of debt likely have higher interest rates.
- Less money for savings. Putting all of your money toward your mortgage can also cut into what you can set aside in savings. If you’re going to focus on paying off your home loan early, it’s a good idea to make sure you have an adequate emergency fund first. It’s usually recommended to save up enough to cover three to six months’ worth of expenses so you can manage any unexpected costs without having to go into debt.
- Could miss out on higher returns from investing. If you have the opportunity to invest your money for returns that are significantly higher than your mortgage rate, you’d be better served doing that than missing out on compounding earnings to get rid of your mortgage faster. For example, if your mortgage rate is 3.5% and your portfolio earns an average of 6% per year, you’d lose money by using extra funds to pay off the loan early.
3 Key Questions to Ask Before You Pay Off Your Mortgage
Before you decide to pay off your mortgage early, ask yourself these questions:
- Do I have an adequate emergency fund of at least six months’ worth of expenses?
- Am I on track to save enough for retirement and other major financial goals?
- Do I have little-to-no high-interest debt, including credit cards?
If you can answer yes to all three, paying your mortgage off early may be a good financial move. Just keep in mind that some lenders charge a prepayment penalty; if yours does, be sure to factor in that cost, too.
How to Pay Off Your Mortgage Faster
Here are the five best ways to pay off your mortgage faster, with the numbers to prove it.
1. Create Room in Your Budget
One of the most effective ways to pay off your mortgage faster is to pay more than the monthly amount due. That might seem obvious, but you might not realize just how far a little extra money can go.
For example, say you took out a 30-year fixed-rate mortgage of $250,000 at 5% annual percentage rate (APR) and have 25 years left on the loan. That would mean you owe $1,342.05 per month. Now imagine that you tack on just $20 extra to each payment. You’d shorten the repayment period by eight months and save $5,722 in interest. Use a mortgage calculator to help you do the math.
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For an extra $20 per month, you’d simply need to cut out one fancy coffee a week or a couple of takeout lunches. Obviously, putting even more money toward extra payments will result in even more savings.
Just keep in mind that you don’t want to go overboard here and sacrifice other financial goals to pay down your mortgage faster. Mortgages are some of the cheapest loans out there, so be sure you’re paying off other higher-interest debt and investing before you start cutting back in other areas of your budget.
2. Schedule Extra Payments
Maybe you aren’t able to come up with the extra cash to make additional payments each month (or don’t want to). That’s OK—a couple of well-timed extra payments throughout the year can be even more effective.
Perhaps you receive an annual bonus from work or tax return each April. If you were to take $1,200 per year and apply it to that same mortgage example above, you’d cut your loan down by over three years and save over $25,000 in interest.
If you do decide to make extra payments toward your mortgage, be sure to check with your lender that the extra funds will be credited toward the loan principal. If you don’t specify how you want these payments applied, the lender will likely use them to prepay interest owed on your mortgage instead.
3. Refinance to a Shorter Term Length
It’s common for mortgage borrowers to opt for a longer repayment term in order to keep monthly payments low—typically 30 years. However, as time goes on, your income may increase or your lifestyle may change to free up more cash flow.
If that’s the case, you may be able to refinance your loan to a shorter term. Since the repayment period gets crunched into a shorter time period, the monthly payments will likely increase. However, this is an effective way to pay off your mortgage much earlier and save a ton of money on interest, especially if you also qualify for a lower interest rate.
Take a look at this comparison of a $250,000 loan with a 30-year, fixed-rate term versus a 15-year, fixed-rate term:
As you can see, it’s possible to save $84,655 in interest and pay off your mortgage in half the time by refinancing from a 30-year to a 15-year term.
Something to consider before refinancing, however, are mortgage closing costs, which typically total 2% to 3% of the loan amount. You’ll want to make sure that closing costs don’t negate the interest savings; otherwise, it may not be worth it.
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4. Recast Your Mortgage
You’re probably familiar with refinancing, but you may not have heard about mortgage recasting. When recasting, you make one large lump-sum payment toward your principal balance. Usually, at least $5,000 is required to recast. The lender then reamortizes the loan to reflect the new balance.
Recasting a loan accomplishes a few things. For one, your monthly payment will decline. You’ll also save money on interest over the life of the loan. And if you apply those savings toward larger monthly payments, you’ll also pay off the mortgage early.
There is usually a fee required to recast a loan, though it’s typically just a few hundred dollars. Also keep in mind that not all loan types can be recast, including Federal Housing Administration (FHA) and U.S. Department of Veterans Affairs (VA) mortgages.
5. Pay Biweekly
One way to pay off your mortgage early that doesn’t require coming up with any extra payments is to split your monthly payment into two smaller payments and paying biweekly.
Here’s how it works: Most mortgages require a monthly payment, or 12 payments per year. If you switch to bimonthly payments, you end up making 26 payments per year—in effect, one extra payment. This not only quickens the pace of your loan payoff, but also saves you money on interest over the life of the loan.
Wondering how effective this strategy really is? Consider this: On a $250,000 30-year fixed-rate mortgage at 3.5%, you’ll pay off your mortgage four years early and save more than $20,000 in interest.
Not all lenders allow biweekly payments, though many do. If you want to switch to this payment method, contact your lender and double-check that they don’t charge a fee to do so.
What Happens When You Pay Off Your Mortgage?
Let’s imagine that you did pay off your mortgage early (a hypothetical congratulations to you!). What are the final steps for officially ridding yourself of the loan?
You’ll receive several mortgage release documents that show your loan is paid off and the bank doesn’t have a lien on your house. That will likely include a statement that shows your mortgage is paid in full, as well as a canceled promissory note.
It’s also common for the lender to notify the city or county recorder that you are the official, outright owner of the property. In some cases, however, you may have to take care of this yourself. If there are any funds left in your escrow account, your lender will send that money back to you, and you’ll be on your own when it comes to handling property tax and homeowners insurance payments going forward.