If you find yourself with a little extra cash at the end of the month, should you put it toward your mortgage loan or refinance to a shorter term? There’s no simple answer. Risks and benefits exist when paying off your loan early or switching loan terms, so the right decision differs for everyone.
In this section, we’ll look at a few instances in which it makes sense to pay off your mortgage early – and when it doesn’t.
When Paying Off Your Mortgage Early Works
You might assume that you need to shell out hundreds of extra dollars each month to pay off your mortgage early. The truth is, a small monthly amount or a single annual payment can make a major difference over the course of your loan.
Contributing just $50 extra a month can help you pay off your mortgage years ahead of schedule. You don’t need to find a way to earn an extra $10,000 a year to pay off your mortgage.
If you’re looking for a tool that can help you understand amortization and estimate what paying off your mortgage early would cost you, try using our Rocket Mortgage® amortization calculator. It’ll help you see for yourself how a small amount can impact your loan. Your result might surprise you. Most people can manage to save at least a few thousand dollars in interest with a small monthly extra payment. This is especially true if you start paying more on your loan in the early years of your mortgage.
The best candidates for early mortgage payoffs are those who already have enough money to cover an emergency. You’ll want at least 3 – 6 months’ worth of household expenses in liquid cash before you focus on paying off your mortgage. This is because it’s much more difficult to take money out of your home than it is to withdraw money from a savings account.
When Making Minimum Monthly Mortgage Payments Works Better
It may not be a good idea to focus on paying off your mortgage early if you have other debt to worry about. Credit card debt, student loan debt and other types of loans often have higher interest rates than most mortgages. This means they accrue interest faster.
By paying these debts down, you’ll save more than you would if you put all your money toward your mortgage. It’s best to review your financial paperwork and compare interest rates of your other debts to your mortgage interest rate. If your other debts have a higher interest rate, you should pay them down first.
Understanding Prepayment Penalties
You also may want to avoid paying your loan off early if it carries a prepayment penalty. This is a fee your lender charges if you make all payments your mortgage prematurely. Prepayment penalties are usually equal to a certain percentage you would have paid in interest.
So, if you pay off your principal very early, you might end up paying the interest you would have paid anyway. Prepayment penalties usually expire a few years into the loan.
Consult your mortgage lender and ask about any prepayment penalties on your loan before you make a large extra payment. Prepayment penalties are also noted in your mortgage contract.
When Balancing Early Mortgage Repayment And Other Financial Responsibilities Works
While it’s possible to take cash out of your home equity with a refinance, this process takes time, which you may not have in an emergency. Make sure you have plenty of money set aside for emergencies before you put any extra toward your mortgage loan.
You may want to delay paying off your mortgage if you have another big expense coming up or you’d rather put money into your 401(k) or IRA. You might also want to consider diverting your extra money into a child’s college fund or into savings for an upcoming vacation or wedding.
There’s no point in paying off your mortgage if it means you might end up going into debt in the future.
If you pay off your mortgage early, you'll no longer have any mortgage interest to deduct on your tax return if you itemize your deductions. This change is most likely to affect you if you have a large mortgage, a high interest rate—or both—-and your annual interest payments are substantial.
Repaying their mortgage rather than investing the money not only saves the borrower the interest they would have paid on the mortgage, but it also frees up money that otherwise would have gone to monthly repayments.
The Dave Ramsey mortgage plan encourages homeowners to aggressively pay off their mortgages early, however. One recommendation Ramsey makes is to convert your 30-year mortgage into a fixed-rate, 15-year home loan. Not only will you pay off a 15-year mortgage in half the time, but you'll also pay much less in interest.
To O'Leary, debt is the enemy of any financial plan — even the so-called “good debt” of a mortgage. According to him, your best chance for long-term financial success lies in getting out from under your mortgage by age 45.
A mortgage paid in full will remain on your credit reports at the three national credit bureaus (Experian, TransUnion and Equifax) for 10 years as a "closed account in good standing." At the end of that time, if you haven't taken out a new mortgage, your credit scores may drop slightly because of a reduced credit mix ...
Paying your mortgage off early, particularly if you're not in the last few years of your loan term, reduces the overall loan cost. This is because you'll save a significant amount on the interest that makes up part of your payment agreement.
Should I pay off my mortgage early? There are both pros and cons to paying your mortgage off early. While you save on interest and have extra funds to use elsewhere, you will lose the federal mortgage interest tax deduction and could miss out on more lucrative investments.
If you overpay more than the limit set by your lender or pay off your mortgage early, you may have to pay an early repayment charge (ERC). This amount will vary depending on the lender. It's usually equal to several months of the mortgage's interest, a percentage of the original mortgage value or balance still owed.
As Hogan interviewed millionaires for his most recent book, he discovered a common theme: Many paid off their mortgages early or as quickly as they could instead of holding onto the loans to term.
It can mean less worry and increased flexibility. “If your mortgage payments represent a substantial chunk of your expenses, you'll be able to live on a lot more once that payment goes away. If you're intending to stay in your current home during retirement, eliminating monthly payments might be a good move.
Even with low-rate mortgages, the bulk of monthly payments go toward interest, not principal, sometimes for 10 or more years. Thus, it's not uncommon for Americans to want to pay that debt down as fast as possible. In fact, according to Census Bureau data, nearly 40% of Americans already have.
If you can demonstrate an ability to repay the loan before you're 75 years old, they will consider your application no matter your age! For example, if you needed to borrow $300,000 and were 50 years old, the standard 30-year mortgage term could be reduced to 25 years and your loan would be approved.
For example, if you pay off the mortgage within the first year, then you owe 2% of the outstanding balance; the penalty fee drops to 1% of the balance if you pay off the loan within the first two years.
Because interest is calculated against the principal balance, paying down the principal in less time on your mortgage reduces the interest you'll pay. Even small additional principal payments can help.
Introduction: My name is Van Hayes, I am a thankful, friendly, smiling, calm, powerful, fine, enthusiastic person who loves writing and wants to share my knowledge and understanding with you.
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