How to Pay Off Your Mortgage Early
Regardless of what you owe, zeroing out your housing costs is a smart money move. This story will show you the best ways to do it.
If you're in the market for, say, a four-bedroom Colonial just about anywhere in America, you're in luck. Home buyers haven't had it this good in years: Sales prices have plummeted as much as 50 percent since 2006, and interest rates are at historic lows (at press time, about 3.5 percent for 30-year fixed loans). As a result, many people can buy a home today without taking on a mountain of debt.
Experts agree that it pays to reduce debt in all areas of your life—and, in an ideal world, to eliminate it completely. So if you're financially secure (meaning you're free of high-interest credit-card debt, you're investing in your retirement, and you have an emergency savings account that will cover 6 to 12 months' worth of vital living expenses), paying off your mortgage makes sense—yes, even though interest payments are tax-deductible. Meeting this criterion and eliminating your debt completely may be unrealistic for you, but reducing your debt isn't. Here's how to get it done.
5 Smart Strategies to Reduce or Eliminate Your Debt
1. Refinance to a lower interest rate. Despite rock-bottom rates, millions of creditworthy Americans have not yet refinanced. And that's a shame: Borrowers who refinanced during the second quarter of 2012 lowered their rate by an average of 1.5 percent. For a $200,000 home loan, that translates to savings of about $2,900 in interest payments over the next 12 months, according to Freddie Mac. (To calculate how much you could save, use the refinance calculator at Money.CNN.com, which, like Real Simple, is owned by Time Inc.)
If you plan on staying in your home for at least three more years and your mortgage is at least $100,000, with an interest rate of 4.75 percent or higher, ask your current loan servicer or lender for its best refinancing rate. Then compare that with rates at banks that you already have accounts with. Or you can opt to work with an independent mortgage broker to find the lowest rate, says Keith Gumbinger, the vice president of HSH.com, a mortgage-information site. If you can reduce your current interest rate by .75 to 1 percent, go ahead and refinance.
To help the process go smoothly, gather the following paperwork: proof of income (two recent pay stubs), copies of asset information, your tax returns for the previous two years, and proof of investments and other income. Additionally, be prepared to offer explanations for any recent income irregularities, credit inquiries, or job gaps. "Lenders question these situations because they could be an indication that you can't afford your current loan," says Gumbinger.
2. Refinance to shorten your loan's time frame. It's becoming increasingly popular for home owners—even those on tight budgets—to refinance their 30-year fixed-rate mortgages to 20- or even 15-year ones. Today's low rates allow you to do this while keeping your monthly payment fairly close to the current amount, says Erin Lantz, the director of Zillow's Mortgage Marketplace, a real estate–valuation website. Say you've been making payments on a 30-year, 6 percent fixed-rate mortgage of $200,000 for five years. If you refinance to a 15-year, 2.87 percent fixed-rate loan (typical at press time), for example, your payments will increase by less than $80 a month. Yet you would pay off the loan 10 years earlier, build equity faster, and save an astonishing $130,477 in interest.
3. Make a lump-sum payment. Did you receive a tax refund? An inheritance? Or come across a small stash of cash? Consider applying some or all of this money to your principal balance. "This is one of the best strategies you can employ, because you're not required to make a higher monthly payment," says Gumbinger. "And you didn't count on having the money in the first place, so you won't miss it." Making a single $5,000 payment on, say, a 30-year, 4.5 percent fixed-rate mortgage of $225,000 would save a home owner more than $13,000 in interest and reduce her repayment term by 15 months.
Take note: Call your lender to verify that your mortgage doesn't have a prepayment penalty. If it does, you could be hit with a fee—usually 1 percent of the loan amount.
4. Switch to biweekly payments. Simply by making half your monthly payment every two weeks, you will chop off almost six years off a 30-year mortgage, says Greg McBride, a senior financial analyst at Bankrate.com, a personal-finance website. Not to mention that you'll save tens of thousands of dollars over the life of the loan. All you have to do is contact your lender to change your payment schedule (be prepared to pay a onetime setup fee of $250 or more). Remember that twice a year, you'll be making three payments a month instead of two, so be sure that there are enough funds in your bank account.
5. Round up your payment. Every little bit—even if it's just $20 or $50 a month—that you pay toward your principal is less that you'll ultimately pay in interest. For instance, maybe you have a monthly mortgage payment of $954.83. If you round up the payment to $1,000 by putting in an extra $45.17, you'll pay off your debt two years and five months early. (Use the round-up repayment calculator at HSH.com to calculate your savings.) "This is a great option for anybody with a little additional cash, especially someone who has already refinanced or who doesn't qualify for refinancing," says Gumbinger.
Special Series: Cut Your Debt in 2012
This year, Real Simple has been helping you gain control of your wallet with easy-to-follow action plans. If you missed parts one through three (which cover why you take on debt, college debt, and credit-card debt), go to realsimple.com/debt.