Should You Speed Up Your Mortgage Payoff?
Homeowers today are building significant equity during the first few years of homeownership.
Home values are increasing by more than five percent per year nationwide, according to a recent Federal Housing Finance Agency report. That’s like getting a check in the mail each year for $13,000, just for living in the typical U.S. home.
However, homeowners don’t build much equity by paying down loan principal the first few years of their mortgage.
On a $250,000 home loan, the homeowner reduces her principal by $400 each month during the first year, assuming current mortgage rates.
If the mortgage were a stack of playing cards ten feet tall, each payment would reduce its height by only one-fifth of an inch — the equivalent of 17 cards.
Thankfully, principal reduction picks up speed after a few years, and homeowners who choose a 15-year loan start paying big chunks of principal immediately.
But it’s no wonder most new (and experienced) homeowners want to speed up the process.
Making extra payments toward your mortgage makes a lot of sense — sometimes. But for some, holding onto cash is actually a bigger priority.
Click to see today’s rates (Sep 16th, 2016)
Reasons To Pay Down Your Mortgage Faster
Most homeowners would love to stop paying their monthly mortgages as soon as possible. However, it’s often hard to justify spending more money today to be mortgage free in 25 years.
Fortunately, there are more immediate and important concerns when deciding to accelerate your mortgage repayment.
1. Increase net worth
For many American households, home equity still makes up the bulk of their wealth. Researchers at Harvard’s Joint Center for Housing Studies concluded that paying a mortgage forces families to save money that they would not otherwise.
The 2013 report concluded that homeowners experienced sizable gains in net wealth associated with owning, while renters saw few gains.
In other words, prepaying your mortgage speeds up your wealth-building goals.
Making regular payments on a mortgage is participating in “forced savings” — money you have to invest, but that you will likely receive later.
Additional payments adds to the amount of future returns.
2. Reduce interest expense
It might take years before your monthly payments make a dent in your mortgage balance, but you can kick start that process with extra payments early on.
Your interest due each month depends on your principal balance. Reducing that number can significantly drop your lifetime loan costs.
For example, if you borrow $200,000 at four percent you’ll pay nearly $145,000 in interest over thirty years.
By adding one hundred dollars per month to your payment, you save $27,000 and become mortgage-free almost five years sooner.
Click to see today’s rates (Sep 16th, 2016)
3. Reduce “debt stress”
For many, the most compelling reason to make additional payments is purely psychological.
Having no mortgage, or a smaller one, causes many homeowners to feel more secure. Even if you experience an income interruption, the roof over your head is safe. Studies bear this out. Paying off debt can result in stress reduction, relief from fear, a sense of accomplishment, a boost in self-esteem and better physical health.
You can reduce your “debt stress” by paying down — or paying off — your mortgage.
Click to see today’s rates (Sep 16th, 2016)
Reasons To Make Your Minimum Mortgage Payment
There are only two reasons not to prepay your mortgage, but they are pretty big reasons.
1. Opportunity cost
“Opportunity cost” is when there may be more profitable things you can do with your money.
Mortgage rates are downright cheap.
And they get even cheaper when you factor in tax savings.
A mortgage at a three percent interest rate has an effective rate of about two percent after writing off mortgage interest when filing taxes. Even if you don’t write off interest, mortgage financing is still the cheapest way to borrow.
You would pay an opportunity cost to prepay your two percent mortgage if you also had credit card debt at 15 percent.
Or if you could invest in the stock market, which has historically returned about seven percent.
It’s probably short-sighted to prepay your mortgage if you have not maxed out your 401(k) plan, which comes with tax advantages and possibly a matching contribution from your employer.
Before paying your mortgage early, then, ask yourself if there is anything better you can do with the money.
Click to see today’s rates (Sep 16th, 2016)
2. Loss of liquidity
There’s a flipside to the “forced savings” argument — the reasoning that says putting money into your mortgage forces you to save instead of spend.
You could argue that, once you’ve put your money into your mortgage, it’s difficult and expensive to get back.
Your lender won’t just cut you a check if you want your prepaid mortgage principal back. You would have to borrow it back with a home equity loan, probably with some upfront fees and possibly at a higher rate than your current mortgage.
That’s probably a good thing if the extra work and expense keeps you from a non-essential item, like buying a boat or adding to your shoe collection.
But the non-liquidity is not-so-good if you must tap into home equity for worthy causes — a child’s college education or an emergency medical procedure.
Home equity is no substitute for an emergency fund. Once you have an emergency, like a job loss, you could miss a mortgage payment or deplete your savings. At that point, a home equity loan or refinance may be impossible.
In summary, consider waiting to prepay your mortgage until you have accomplished the following.
- Zeroed out more expensive debt
- Topped up your emergency fund
- Maxed out retirement savings
One strategy that works for many is to simply direct extra funds into a “mortgage payoff” account — something you can get at in an emergency, but not too easy to access otherwise.
Quietly build up that account until it equals your mortgage balance. At that point, you can retire your home loan and throw your mortgage retirement party.
Click to see today’s rates (Sep 16th, 2016)
Use A Mortgage Refinance To Prepay Your Loan Faster
Today’s mortgage rates might allow you to make your current payment while dropping your loan balance faster.
For example, say you are paying $1,500 per month now, but your mortgage rate is higher that what is available today.
Assume a refinance drops your payment by $100 per month.
You could keep paying $1,500 after the refinance, and be making an additional $100 per month principal reduction while paying no more than you did before.
In this way, you can shorten the life of your mortgage, while keeping other savings and investment goals intact.
What’s more, today’s homeowners are finding that refinances don’t have to be difficult. The FHA streamline refinance, for example, requires no appraisal and no income verification.
This refinance option was set up by FHA to make it easier to capitalize on falling mortgage rates.
A similar program is the VA streamline refinance, a VA-to-VA loan that requires no pay stubs, W2s, bank statements, or appraisal. This is the easiest refinance type found anywhere in the mortgage market.
The Home Affordable Refinance Program (HARP) is designed for homeowners with little or no home equity. Homeowners who have not yet recovered from the housing downturn of last decade can drop their rate and payment, when a traditional refinance is impossible.
For borrowers with decent credit and home equity, a standard conventional refinance could lower their rate and make paying off the loan faster and easier.
A conventional loan can replace any loan type and even cancel the homeowner’s mortgage insurance. This expense alone can help a household save hundreds per month, or reinvest that amount into reducing loan principal.
Now is a good time to lower mortgage payments, and start reducing principal.
What Are Today’s Rates?
Low mortgage rates are making it easier to pay down mortgage balances quickly. Rates are holding near all-time lows, and homeowners are discovering new opportunities to lower housing costs.
Get a rate quote now. You need not supply your social security number to start your request, and there’s absolutely no obligation to continue if you are not satisfied with your rate.
Click to see today’s rates (Sep 16th, 2016)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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