If you can pay yourmortgageYou save interest on your loan early. In fact, getting rid of your home loan just a year or two early can save you hundreds or even thousands of dollars. However, if you plan to take this approach, you need to check if there is a prepayment penalty, among other possible issues. Below are five mistakes to avoid when paying off your mortgage early.financial advisorcan help you figure out your mortgage needs and goals.
How to pay off your mortgage early
pay your mortgagesounds like a dream to own a home without having to make a monthly payment to a financial services provider. Before delving into the top mistakes people make when prepaying their mortgage, it's important to understand how to prepay your mortgage because there's more than one way.
The easiest method is to make additional payments outside of your normal monthly payments. As long as this route doesn't result in additional fees from your lender, you can send 13 checks per year instead of 12 (or the online equivalent of that). You can also increase your monthly payment. By paying more each month, you pay off the loan in full before the due date. Let's go into a little more detail about each method of paying your mortgage early.
- Make an additional payment per year: One way to pay off your mortgage before the end of the mortgage term is to make 13 payments per year instead of 12. You can add the extra payment at any time throughout the year and continue to make the regular monthly payments. This works well for people who receive a large sum of money at some point in the year, e.g. Like a bonus at work or a big tax refund.
- Make bi-weekly mortgage payments instead of monthly: A great option for some living on much less than they earn is to make mortgage payments every two weeks instead of monthly. This pays off your mortgage halfway through the term of the loan. This isn't a great option for everyone, but it can be a great way to speed up that loan and pay it off early.
- Refinance your mortgage into a shorter term:Another option is to refinance your mortgage to a shorter term. For example, if you have a 30-year fixed-term loan with a 22-year remaining term, you can refinance it into a 15-year loan and pay off the remaining balance seven years earlier than you would otherwise. This will also usually lower your rate but increase your monthly payments. You'll pay less for the home over the life of the mortgage than you would with the lower 30-year rate.
- Pay your balance in cash:If you can save enough money to pay off the entire loan balance, then this is an option. This is the option most people think of when looking to pay off their mortgage early, although there are many other ways to go about it.
It should be noted that whenever you pay more than is necessary for the next monthly payment, you must communicate with the lender that the amount should be counted towards the principal of the loan. If you don't, the mortgage lender will likely roll your extra payment over to the next month, and it looks like you don't owe your next payment, or not that much.
When to pay off your mortgage early
It might seem like a good idea to pay off your mortgage early once you have the right amount for it, but there's more to consider. If you have a strong financial reason to pay off your mortgage sooner than expected, it makes a lot of sense. For example, if you plan to retire sooner than expected, you don't want to take out a mortgage during your retirement years.
However, paying off your mortgage early, no matter what you decide, ties up a significant amount of cash that you can use to invest and build more wealth or save for unexpected hard times. You're also no longer eligible for some tax deductions that you can get for actively paying your mortgage.
Ultimately, the right time to repay your mortgage early depends on your personal financial situation. It has to be a time that won't break you financially and will benefit you in the long run. We recommend working with yourfinancial advisorto determine when that time is for your situation.
Mistakes to Avoid When Prepaying Your Mortgage
As mentioned earlier, it's not always the right time to prepay your mortgage. Also, you can't always do it right. Consider these big mistakes other people can make when prepaying their mortgage so you don't do the same:
1. Not considering all options
It can be very tempting when you can get some extra cash to pay off your mortgage early. However, paying off debt a little earlier may not be the most profitable choice. To illustrate this, let's look at an example.
Let's say you're considering a one-time payment of $20,000 to your companymortgage principal. Your original loan amount was $200,000, you have 20 years with a 30-year term, and your interest rate is 4%. Paying $20,000 principal at once can save you about $8,300 in interest and allow you to pay it off in full 2.5 years sooner.
That sounds great, but consider an alternative. If youinvested this moneyFor an index fund representing the S&P 500, with an average return of 9.8%, you could earn $30,900 in interest over the same 10 years. Even a more conservative projection of your rate of return, say 4%, would yield $12,500 in interest.
Everyone's financial situation is unique, and it's possible that the idea of being debt-free is so important to you that it's worth less than making the best use of your money. The most important thing is to weigh all of your options before you come to the conclusion that paying off your mortgage early is the best path for you.
2. No additional payments on the principal of the loan
Throwing in an extra $500 or $1,000 each month doesn't necessarily mean you can pay off your mortgage faster. Unless you specify that the additional money you pay should be applied to your principal balance, the creditor can use it to pay interest on your next scheduled payment.
If you write separate checks for special payments, you can note this on the note line. If you pay your mortgage bill online, you may want to find out if your lender will allow you to include a note stating how the additional payments will be used.
3. Don't ask if there is a prepayment penalty
Mortgage lenders are in business to make money, and one way they do that is by charging interest on your loan. When you prepay your mortgage, you essentially cost the lender money. Some lenders are therefore trying to compensate for lost profits by charging a prepayment penalty.
Prepayment Penaltiesit can be a percentage of the value of a mortgage loan or the equivalent of a certain number of monthly interest payments. When you pay off your home loan well in advance, these fees can quickly add up. For example, a 3% prepayment penalty on a $250,000 mortgage would cost you $7,500.
If you're trying to save by prepaying your mortgage, you could actually lose money if you have to pay a hefty penalty.
4. No more money
Putting every extra penny you have into your mortgage is an aggressive way to get out of debt. It can also backfire. For example, if you don't have anything set aside for emergencies, you could be in trouble if you get sick and can't work for a few months. In this case, you may need to use your credit card to cover your bills or try to get additional credit.
If you don't have oneemergency fund, it might be best to put some of your extra mortgage payments into a rainy day fund. Once you've saved three to six months of expenses, you can focus on paying off your mortgage debt.
5. Extension of your loan term through refinancing
refinancingIt can save you money in many ways, as it allows you to convert to a shorter or longer loan term, whichever works best for you. a term of 10 years and reduction by 10 years. On the other hand, you can opt for another 30-year term to lower your monthly payments.
However, shorter-term loans tend to have lower interest rates, allowing you to save on interest and achieve full ownership much sooner. In some cases, however, refinancing can cost you more in the long run, especially if you want to extend the life of your loan. Before you refinance, it's a good idea to crunch some numbers and find out if a longer mortgage term really makes sense.
do not forget itFinal costsany. If your lender allows you to pass these costs onto your loan, you could end up paying more money. After all, you will now be dependent on interest for a larger loan amount.
Ultimately, whether you have to pay off your mortgage early depends on how much cash you have left over, what alternatives you have, and other factors that are unique to you. But if it's something that's rightfully on your radar, you should seriously consider all of your options.
While many financial advisors are often known for their expertise in investing and financial planning, they also have knowledge of mortgages and home buying. So if you're having trouble making your own decision, think twicecontact a local financial advisor.
Home buying tips
- Afinancial advisorcan help you with important financial decisions like buying a home.Free SmartAsset toolmatches you with up to three rated financial advisors operating in your area, and you can interview their correspondents for free to decide which one is right for you. When you are ready to find an advisor who can help you achieve your financial goals,start now.
- Securing a mortgage can be a stressful and confusing process. To start, you need to find out which term works best for you, whether you want a fixed or variable interest rate and where you can get itbest mortgage rates.
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Rebecca Lake, CEPF®Rebecca Lake is a retirement, investment, and estate planning expert who has been writing about personal finance for a decade. His finance niche experience also extends to buying real estate, credit cards, banks and small businesses. She has worked directly with several major finance and insurance brands, including Citibank, Discover and AIG, and her writing has appeared online in the US. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now resides on the North Carolina coast with her two children.