How Quickly Should You Pay Off Your Mortgage?
Extra payments on your mortgage don't have to be regular, and they don't have to be for the same amount each time. If you have some extra money at the end of the month, add it to your mortgage payment. The mortgage payment above is $658.50. If you rounded that up to $675 every month, you'd be adding $16.50 per month, or $200 more per year to principal (in other words to the mortgage loan), probably without even thinking much about it. If you in-creased the payment to $700 every month, you'd be prepaying $41.20 each month, or $500 per year. You'd be surprised at how that extra money would cut the payment time on your mortgage and save you some big bucks in the long run. Prepaying doesn't have to be anything formal or planned in advance. But you do need to make sure the lender realizes that the extra money is a prepayment on your principal (so state the extra amount in a note with the check), not extra money to be put into an escrow account for taxes.
How Much Extra Do I Have to Pay?
Dollars and Sense
Some mortgages in-clude prepayment penalties that could force you to pay 2 or 3 percent of your total loan if you pay it off early. Be sure to ask whether your mortgage includes this. It's something that might just slip by and could end up costing you thousands of dollars.
You don't have to pay a great deal extra to make a difference in paying off your mortgage. Adding just $25 a month to a $100,000, 30-year, fixed-rate mortgage at 8 percent will save you $23,337 in interest before taxes over the life of the loan. If you can swing $100 extra a month, you'll save $62,456.
You can see that it makes sense to pay extra. So how can you do it? You can easily spend $25 a week on extras. If you cut down and apply the saved money to your mortgage, you'll see a big difference in the long run. Or you could designate a bonus or your income tax refund as an extra payment.
What About Biweekly Payments?
Nearly all biweekly mortgages are set up through banks, savings and loans, or credit unions. That's because these types of institutions have access to your accounts and can make automatic withdrawals from them. Mortgage companies normally can't make these withdrawals, so they're unable to offer biweekly mortgages.
Let's have a look at how biweekly mortgages work. Instead of paying 12 large monthly installments each year, you pay half of your monthly payment every 14 days. It's not as painful as it sounds, because the money is deducted automatically from your checking or savings account. Because you pay every 14 days, you end up making 26 payments a year, not 24.
For some people, the primary benefit of a biweekly mortgage is that it's deducted automatically, saving them the task of sending the payment to the lender. Another potential benefit is that you make smaller payments more than once a month rather than having to come up with the funds to make one large monthly payment.
By making biweekly payments, you can pay off a 30-year mortgage in a little less than 23 years, and a 15-year mortgage in less than 14 years. That's the good stuff on biweekly mortgages. The downside is that not all lenders offer this option, so if you're sold on it, it could limit from whom you can get your mortgage.
The following table shows the savings in in-terest paid and when the mortgage term is decreased. It sure is interesting to see how paying extra cuts down the interest paid over the term of the loan.
$100,000 loan @ 6 percent
|15 year (180 months)||$ 843.86||$ 51,895|
|15 year biweekly||421.93||45,144||$ 6,751||1.33 years|
|30 year (360 months)||599.55||115,838|
|30 year biweekly||299.78||91,260||24,578||6.83 years|
Critics of the biweekly mortgage say it's of little benefit to the consumer, but of great benefit to the lender. There's often a fee to switch your payment plan over to the biweekly system, and it can be quite hefty. A fee of between $250 and $400 is not unusual. There can also be a transaction fee of $3 or $4 for every payment you make, in addition to the one-time charge.
You should be able to find financial institutions that provide biweekly mortgages but don't charge a fee. High fees defeat the purpose of prepaying your mortgage, so just say “no” to lenders who charge them.
Be wary of critics of the biweekly payment plans. Is the information they provide influenced by their not being able to offer biweekly plans? Comparison shop at several financial institutions before you choose the payment format that is best for you.
Multiply a $4 transaction fee by 26 payments, and you'll find you're paying $104 a year for the privilege of having a biweekly payment. If you save that money instead of spending it on fees, you could apply it to your mortgage!
If you decide to go with biweekly payments, make sure that the payments are credited to your mortgage when they're deducted from your checking account. There are biweekly payment plans that withdraw the funds but hold them aside until the mortgage company has one month's total mortgage payment, at which time they make the payment. While withdrawing funds biweekly and holding them until you have a full payment from your checking account is easier to manage than one monthly withdrawal, it's more advantageous to have the money turned over to the mortgage company whenever the funds are withdrawn from your account. Paying on your mortgage every two weeks is better than paying only once a month.
Critics also say that telling people that paying biweekly reduces the interest payments over the loan is confusing. It makes consumers believe they're getting a better interest rate on their mortgage, when the interest rate doesn't change. In the end, they say, you'll do just as well by making one extra payment a year on your own, without the benefit of the bank's biweekly mortgage plan.
That sounds good, but we all have a lot of places we could spend our money. What happens if it's time to make your extra payment, but you've just surprised your wife with plane tickets to Italy to celebrate your fifth wedding anniversary? If you don't think you have the discipline to put aside the extra money for the payment, it probably makes more sense for you to add some extra money to your payment each month.
More on: Family Finances
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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