Purchasing your own home represents the American Dream for many people. Owning your home free-and-clear though is something many people don’t accomplish until well into retirement.
Paying off a mortgage faster than the term of the loan is a positive financial goal just about any way you slice it. Being mortgage-free decreases monthly expenses in a big way which can enable you to finally give your full attention to retirement, a child’s college fund, and other big ticket savings goals.
The first few years of mortgage payments will go towards interest, so these simple tips are here to help you avoid the interest trap and work in the direction of living a mortgage-free life:
1. Opt for a 15-year fixed rate mortgage
The vast majority of home buyers choose a 30-year fixed rate mortgage because it spaces your payback out over 30 years, it will put several hundred dollars back in your pocket each month. This might be sensible for keeping to your monthly budget, but you will end up paying more in interest than the price of the property for the privilege of doing so.
∙ On a loan balance of $200,000 with an interest rate at 6% over a 30 year term, your monthly payment will be $1,199, but you will pay out over $231,000 in interest over the term of the mortgage.
∙ On a loan balance of $200,000 with an interest rate of 6% over a 15 year term, your monthly payment will be higher at $1,688, but you will only pay $103,000 in interest over the term of the mortgage.
∙ Though the 15-year term will cost more each month, you will be freed from your mortgage in a mere 180 months and you will save over $100,000 in interest payments.
∙ Another plus is that 15 year fixed-rate mortgages come with lower interest rates, because the lender is assuming the risk of default over a much shorter time frame.
2. Make additional lump sum payments
At the start of each year, make one extra lump sum payment towards your mortgage principal. When filling out the check, specify in the note that this payment should be applied to “principal only”. Most lenders will pay it toward the loan balance (with interest) if their don’t receive additional instruction.
∙ Apply your Christmas bonus or year-end budget surplus towards this extra lump sum payment. You could also set aside $25 per week and over the course of the year, you will have enough to send in an extra check of $1,300 with your first payment the following year.
∙ A lump sum payment can be made at any time of the year, but most lenders will have restrictions on how many such payments you can submit each year.
3. Write a second check each month
You can beat the interest trap by sending an extra check each month that’s to be applied towards your principal only. By doing this your first payment each month will continue to pay the interest on the loan while the second check significantly decreases the amount you owe in principal over the course of just a few years.
∙ Pay only what you can afford. Even just an extra $50/month will help if you do it consistently over time. Even though paying off the mortgage is your priority, it doesn’t make sense to dig yourself into an unnecessary financial hole.
∙ Some people send in bi-weekly payments towards principal. If your income goes down or other expenses go up, you can stop the extra principal payments at any time without a penalty.
If you already have a 30-year mortgage, refinancing your home is an option to get a lower rate or a shorter term.