How Quickly Should You Pay Off Your Mortgage?
Mortgage payment periods vary. Some people pay off their debt over 15 years; others take 30 years. There's no right way or wrong way to pay a mortgage; you just have to decide what makes the most sense for you. While the two most common mortgages are 15-year and 30-year plans, less common types are 10-year, 20-year, and 25-year mortgages.
Equity is the net value of your house. It's the market value, less the balance of your mortgage and any equity loans or lines of credit. If your house is valued at $100,000 and you have an $80,000 mortgage, you have equity of $20,000 in your home.
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Collateral is the assets pledged as security for a loan. It's something that the lender holds as assurance of payment.
An amortization schedule is the schedule of repayments you're required to make to your lender over a specified period of time.
One thing that most financial experts agree on, though, is that, if you can, paying off your mortgage early makes sense. If you make extra payments, you'll reduce what you'll pay over the life of the loan, and increase the equity in your home all that much sooner. Increasing the equity in your home means you'll have more money to invest in your next home. Not everyone agrees, mind you. Some experts would tell you it's better to take the extra money, find yourself a good investment with a potential for big returns, and go for it. That's the way to go, they say, especially if you'll get a tax break, as with a retirement account. Decide what is right for you, invest or prepay. Calculate the total return of both scenarios, and then, do it!
If you do decide you want to pay extra on the mortgage, there are several ways you can do it. You can pay a little bit extra every month, or you can make periodic lump-sum payments. Most financial experts agree that if you're going to prepay your mortgage, it's better to do it sooner, rather than later. For instance, instead of making a lump-sum payment once a year, make smaller monthly payments. Why? Because the more you pay on your mortgage, the more interest you save, and the more equity you have.
Home equity is important for several reasons. It's collateral you can use for a car or other loan. If you ever want to get a home equity line of credit, this line will be based on the amount of equity you've built up in your home. The more equity in your home, the more money you'll get to keep if you sell the house, giving you a larger down payment if you decide to buy another house.
When you first get your mortgage, the lender will give you an amortization schedule. The schedule will show the amount of your mortgage month by month based on regular payments, with no prepayments. If you pay exactly what is required each month, you'll stay on the schedule. You pay interest on your mortgage, which is calculated each month on the remaining balance of the loan. Every time you pay extra on your principal, you're reducing the amount of your loan and the amount of interest you'll have to pay.
Once you start paying off your mortgage, you'll make the payments according to the amortization schedule your lender will provide. The following is an example of an amortization schedule:
|Mortgage Amount||Interest Rate||Monthly Payment|
|Payment Number||Interest Payment||Principal Payment||Principal Balance|
|2||$ 412.71||$ 245.79||$ 74,509.77|
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Excerpted from The Complete Idiot's Guide to Personal Finance in your 20s and 30s © 2005 by Susan Shelly and Sarah Young Fisher. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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