If you’ve dabbled in the personal finance world, you’ll find that becoming debt free is the pinnacle of achieving financial freedom.
Yes, I’m not talking about being debt free from credit card debt – although this is liberating for those who have experienced it. I’m talking about paying off everything including your home mortgage, and live in a perpetual state of freedom from every creditor on earth! Well, not quite free, as you will still owe taxes to greedy Uncle Sam (or whatever you call the government you are a citizen of…).
One easy way to pay off your mortgage early, is to refinance your current loan. As of today, mortgage rates are at record lows so this may be the route you should take. An easy example of this is to refinance your current mortgage with 25 years remaining to a new 15 year loan. Granted, you’ll make larger payments, but your loan will be paid off 10 years early, saving you tens of thousands of dollars in interest costs – Shazam!
But what if you’re in a situation where you don’t want to refinance, or prefer not to take the risk of making that larger payment every month for years on years?
You do have some options, and they are plentiful. Below are my recommendations on how to pay off your mortgage early, yet not go through a refinance. Pay particular attention to number 6, as I believe this is the most efficient method to paying off your mortgage in a hurry (in some cases less than half the time).
1. Send a set Amount each Month ($50, $100, $200 a month)
So you’re tight and on a budget? Who isn’t? I know I am… If you’re financially scraping by, yet want to pay off that mortgage early. Sending a small set amount each month will make a huge difference in the interest you will pay and the length of your mortgage.
For example: For simplicity sake, lets say you have a 30 year fixed $200,000 mortgage at an interest rate of 5.0%, and you decide to make a small $50 a month additional payment to the principle on your loan. If you started on month one, you would decrease the length of your loan by almost 3 full years (34 months) and save yourself over $20,000 in interest. Not bad for $50 bucks a month?
How about a $100 a month additional payment? You will save over $37,000 in interest and pay off your mortgage over 5 years early (62 months).
Yes, this is the power of making even small payments to your mortgage. Just a little bit every month pays tremendous dividends in the future.
2. Switch to Bi-Weekly Mortgage Payments
How many of you out there get paid on a 2 week schedule? Aye! Aye!
Many of us in the US get paid 26 times a year or every 2 weeks. For those of us who get paid more than once a month, it is fairly easy to begin paying our mortgage on a bi-weekly payment schedule. This means that instead of making one larger payment every month, you would make a 50% payment to your mortgage twice a month.
The effect of this change is dramatic. By making this simple change with your bank, you will cut 4.5 years off your mortgage in the sample above, and save over $32,000 in interest payments. Rock On!
What if you added in that extra $50 a month from example one? It will save you 6.5 years on your mortgage and save you over $46,000 in interest payments. Now we’re talking!
Even if you can’t refinance, just making these simple steps will save you close to 7 years on a typical mortgage. It’s almost too good to pass up. (well, it is too good to pass up)
3. Make a Yearly Lump Sum Payment to your Mortgage from your Tax Return
The third option is for those who get a nice tax return every year. If you are one of those individuals who likes that large return and adjusts your W4 to achieve it, consider using some of that cash to pay down your mortgage early. This simple step will also be dramatic on length of your mortgage.
Example: Say you want to send an additional $1000 a year to your mortgage at tax time in order to pay it off early. (starting in year two) Using the figures above, you will save over $30,000 in interest payments and cut 4.25 years off your mortgage.
What if you have a little more and can sent $2000 a year at tax time. (not unreasonable, right?). By doing this every year, starting in year 2, you will save over $51,000 in interest and knock off 7.4 years from your mortgage. Wow, you’ve just reduced a 30 year mortgage to a 22 1/2 year mortgage. Not bad Padawan!
4. Change your W4 form to Receive Less in a Yearly Tax Return and make Extra Payments
You may be thinking… “What’s a W4 form”? A W4 is the IRS form that designates how much money should be withheld from your paycheck in order to pay your yearly federal income taxes. Adjusting your W4 form will increase your paycheck amount or decrease it, because it will increase or decrease your tax liability. This will also adjust your yearly tax return.
With this in mind, adjusting your W4 to lower your yearly income tax return and thus increase your paycheck amount is not a bad way to pay off your mortgage early. You can then use the strategy in option 1 & 2 above. Keep in mind you will want to make sure you don’t owe a ton of money to the IRS at the end of the year by adjusting your W4 inappropriately. That could come back to bite you bad!
5. Take your Pay Raises and Send it to the Mortgage
It’s a no brainer, but sometimes hard to implement. If you’re lacking the extra money to pay off your mortgage early – don’t fret, consider designating a piece of your yearly pay raises to this goal.
Remember option 1? Just a little extra makes a huge difference, so you don’t need to send everything you make in a raise and leave yourself with no fun money. But do consider how this small decision will affect you financially down the road. Remember $50 a month can turn into multiple years of debt freedom in the future.
6. Use the Amortization Schedule and Pay it Off in a Hurry.
Ok, now what you’ve all been waiting for… This method is by far the most effective. I have a good friend who became very wealthy in real estate before the age of 30 by using this method, and he was the one who tipped me off to it.
It is actually fairly simple, and is really not a secret – it is just rarely talked about for some reason. It will also take some communicating with your bank, so they understand what you’re doing and apply your extra payments correctly.
Those I know who use this method will pay their mortgage with a letter stating their intent, but either way, I recommend a conversation with your lender on it before starting – as I imagine some lenders will resist this method.
So, what am I talking about?
I’m talking about using your amortization schedule to pay off your loan. What this means is that you will track your loan payments off of your amortization schedule, and always know the particular month you are in for payment.
But here’s the key, every time you make an extra payment, you will be applying that payment to your next months principle in the amortization schedule.
For example, if you are making a payment on your mortgage for month 5, you will also make a payment on the principle of what is due for month 6 in the amortization schedule. This extra payment must go to your next months principle on the amortization schedule and not to the back end of the mortgage – which is why my friend uses a letter to the bank with every payment.
Then the next month your mortgage is due, you have actually jumped a month in your amortization schedule and are on month 7, instead of 6! This means your regular monthly payment that you have to pay anyhow has more designated principle going to the loan, and accelerates your mortgage payoff like crazy. If you make extra payments without this designation, the extra payments go to the backend of the loan and you stay on the same amortization schedule (Thus the bank makes more interest with your regular monthly payment.)
By applying this method every month, you will pay off your mortgage in less than half the time. It’s quite amazing, and effective.
Two other benefits to this method that are worth mentioning…
- You can ramp up and still pay off your mortgage in 1/2 the time. Because the principal amounts in the amortization schedule ramp up over the first 15 years, your extra payments are very little at first. This should give you the possibility of paying extra on your loan, and not be overextended like crazy.
- Double it Up! Another option is to double up your extra payments and make extra payments on more than one future month. This is when you really see your mortgage length decrease in record speed! Just think, you could jump multiple years in your amortization schedule by making extra payments in this way.
So, what are you waiting for? Talk to your bank today!
Special Note on item 6: Due to a lot of feedback on this item, it appears not every bank will allow this type of transaction. I highly recommend you meet with your banker in person to discuss your plans on this and if they allow it on your mortgage. It may require a letter with every payment, or it may be outright rejected by the bank. If rejected, you may want to consider refinancing to a 15 year loan or using another method. My apologies if this method doesn’t work out for you. – Jason
There are really 3 keys to paying off your mortgage early. All these options above will work, but they all require you to pay more money towards the principle, start early with the extra payments, and stay persistent. If you can do all three, you are in great shape. I wish you all the best in showing that mortgage who’s boss – go ahead, pay it off early!
PS, If you’re looking for a great calculator to see how making extra payments will affect your mortgage, there is nothing better than the mortgage professional – the calculators are excellent and very easy to use.
Readers, What’s your method for paying off your mortgage early? If you’re not going to, why not?
Photo Credit: Mint.com