One of the topics we get asked about all the time relates to paying off mortgages. For most of us it’s our biggest liability and getting it over and done with is a fair want. Here are some effective techniques to accelerate your mortgage payoff and achieve financial freedom faster without sacrificing investing and saving for other competing financial goals:
1. The Power of Split Mortgage Payments
One of the most effective ways to accelerate your mortgage payoff is by splitting your monthly payment into two halves and paying them semi-monthly or bi-weekly if your mortgage allows for it. This strategy leverages the power of compounding. This will lead to your mortgage being paid off sooner as less interest is compounding each month. In addition, bi-weekly payments effectively adds one extra full payment per year, directly reducing your principal balance and shortening your loan term.
“This works well for salaried workers who get paid bi-weekly as opposed to twice a month, especially if their lender offers it as an automatic payment.” – Dean Curtis, NMLS#5649, Branch Manager, loanDepot.
It's essential to distinguish between bi-weekly and semi-monthly payments. Semi-monthly payments, where you pay half your monthly payment twice a month (e.g., on the 1st and 15th), only result in 24 payments per year, not the extra payment that accelerates your payoff. Bi-weekly payments are the key to this strategy.
2. The Extra Payment Advantage
Even if your lender doesn't offer a formal semi-monthly payment option, making one extra mortgage payment per year can still make a difference. This additional payment goes directly toward your principal balance, reducing the amount of interest you accrue over the life of the loan and shortening your repayment term.
· Important Note: To ensure your extra payment is applied directly to the principal, clearly specify this to your lender. Otherwise, the extra funds might be applied to your next monthly payment, delaying the impact on your principal balance.
3. Recasting Your Mortgage
“If you come into a large sum of money, such as an inheritance, bonus, or investment gains, some lenders allow a mortgage recast, which lowers your monthly payment while keeping the same interest rate and term” – Rich DeSimone, Sr. Loan Officer & Team Leader, Quintessential Mortgage Group.
Recasting involves making a large lump-sum payment toward your principal and then having your lender re-amortize your loan based on the new, lower principal balance. This results in a lower monthly payment without changing your interest rate or loan term.
· Recasting vs. Refinancing: Recasting is different from refinancing. Refinancing involves taking out a new loan, which comes with closing costs and other fees. Recasting typically involves a smaller fee (often around $300) and simply adjusts your existing loan.
· Strategic Use of Recasting: Recasting is most advantageous when you can make a substantial principal payment. The larger the payment, the more significant the reduction in your monthly payment will be.
· Important Note: If you feel you are likely to recast your mortgage – discuss this with your broker as not all loans allow for recasting and you want to make sure you are provided one that does!
4. Larger Monthly Principal Payments
For lenders that don't offer bi-weekly or semi-monthly payments, you can still implement a similar strategy by making additional principal payments each month. For example, if your monthly mortgage payment is $4,800, you could set up an automatic payment of $400 on the 15th of each month, in addition to your regular payment on the 1st. Ensure that these additional payments are clearly designated as principal-only payments.
Key Considerations:
· Consistency is Key: The most important factor in accelerating your mortgage payoff is consistency. Whether you choose bi-weekly payments, extra annual payments, or additional monthly principal payments, or all of the above - the key is to stick to the plan.
· Budgeting: Make sure these extra payments fit comfortably within your budget. Don't overextend yourself financially.
· Lender Policies: Contact your lender to understand their specific policies regarding extra payments, bi-weekly payments, and recasting. Some lenders may have restrictions or specific requirements.
“Avoid Payment Holidays. Some mortgages allow for breaks or ‘holidays’ in payments but avoiding these will keep you on track to pay off the loan faster.” – Sebastian Chica,Loan Officer, Absolute Home Mortgage Corp.
By implementing these strategies, you can take control of your mortgage and achieve your goal of homeownership faster. The savings on interest can be large enough to free up your finances for other important priorities.
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