Ready to pay off your mortgage? Laura explains who should pay off their mortgage ahead of schedule and who shouldn't. Learn eight ways to get rid of your home loan as quickly as possible—if it’s a smart financial move for you.
Paying Off an Adjustable-Rate Mortgage Early
With a fixed-rate mortgage, paying extra to your principal doesn’t change your monthly payment, but it does shorten the term, allowing you to pay it off faster.
With an adjustable-rate mortgage or ARM, paying extra has the opposite effect: your payment goes up or down on rate adjustment dates, but your term doesn’t change. An ARM gets recalculated so that the remaining length of the loan stays the same.
So paying extra to principal on an ARM won’t decrease the term, but it will save you money because you pay interest on a lower remaining mortgage balance.
8 Ways to Pay Off a Mortgage Early
Before you make any extra mortgage payments, make sure that your lender doesn’t charge a prepayment penalty.
Before you make any extra mortgage payments, make sure that your lender doesn’t charge a prepayment penalty. Most don’t, but do your homework and double check.
If paying off a mortgage early is wise for your situation, there are many different strategies you can use. Some are easy on your pocketbook but take more time, while others may be more challenging for your finances, but whittle down your balance faster.
Here are 8 strategies to pay off your mortgage early:
Strategy #1: Make bi-weekly payments
Some mortgages offer an accelerated, biweekly payment schedule, which is a great strategy. Biweekly payments aren’t magic—they simply take advantage of the fact that there are 13 weeks in each quarter, not 12, and there are 52 weeks in a year, not 48.
By paying one half of your mortgage payment every other week, you end up making one extra full payment each year. This strategy works especially well if you get paid every other week, so the biweekly loan payments occur close to each payday.
Here’s an example from chapter 5 of my book: Christine’s fixed rate mortgage is just under $160,000 to be repaid over 30 years at 6.5% interest. Her payment is $1,000 per month or $12,000 per year. If she keeps that payment schedule, over the life of the loan she’ll pay a total of about $202,000 in interest.
But if she makes biweekly payments, she pays half the monthly payment, or $500, every other week. That means she pays a total of $13,000 per year instead of $12,000. Keeping a biweekly schedule reduces Christine’s interest expense from about $202,000 to $184,000, saving $18,000. Not to mention that she’d pay off the loan in just over 27 years instead of 30. Brilliant!
Problem is, some lenders may not offer a biweekly payment schedule because they don’t want to give up any interest income or deal with the administrative hassle. Instead of applying your payment to principal early, they may just put your money in an escrow account and hold it until they receive your full payment. If that's the case, making biweekly payments won’t do you any good.
So check with your lender about the best way to start making biweekly payments. If they make it complicated or charge a big fee, simply use another payoff strategy that I cover here.
Strategy #2: Make an extra payment each year
If you can’t get a mortgage lender to apply biweekly payments as you send them, make one extra payment a year that gets fully applied to your principal balance.
Let’s say your monthly mortgage payment for principal and interest is $1,200. Divide that over 12 months and save $100 per month. At the end of the year, you’ve got a nice extra amount to send.
As I previously mentioned, the key is to make sure that extra mortgage payments get applied to your principal, not just set aside for the next payment. Make it clear by putting “apply to principal” in the memo section of your paper check or online payment.
Or you could make the payment through an online account with your lender. Most of the big banks, such as Wells Fargo, Chase, and Bank of America, have payment portals where you can easily indicate that extra payments go to your principal balance.