How to Pay off a Mortgage Early and Increase Your Equity
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Mortgages, or any debt, are a big responsibility, and they can weigh heavily on your wallet if you don't pay them off on time. But if you want to get ahead of the game and pay off your mortgage early, there are a few things you need to be aware of before you start paying extra cash each month. First, make sure you've got plenty of money coming in. Next, you'll need to write out a detailed plan and set some goals for yourself. Finally, you'll need to stay on top of your budget, so you don't overspend and derail your plan.
Keep reading to find out how to pay down your mortgage early so you can get on with your life and divert that money elsewhere.
Related: Best Mortgage Lenders for Bad Credit
In this article
Before you take the plunge
Take stock of your cash flow
Making sure you've enough money to pay off your mortgage is one of the most important steps you can take if you want to reduce your monthly payments and get a head start on paying off your loan. So, how much is "enough?" That depends entirely on your situation. Generally, you should aim to have at least 20% of the value of your home saved as a rainy day fund before even considering paying off your mortgage early. That way, you'll have a backup in case something goes wrong and you need to stop making payments for a while. And don't forget to factor in any unexpected expenses that come up along the way. Getting organized and creating a budget will help you stay on track and identify any unnecessary spending that could affect your savings.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
Engage a financial planner
Once you've built up a healthy savings account and calculated your minimum required savings rate, you can finally start working toward your goal of paying off your mortgage early. If you work with a financial planner, they can help you develop a strategy to pay your mortgage off as quickly as possible without putting yourself at undue risk. For example, you might decide to make extra payments on your mortgage each month to increase your payment amount. Or you might decide that selling your home is the best option for you and make an extra mortgage payment to cover the cost of your moving.
Whatever you decide, the most important thing to remember is to keep your finances under control and your expenses to a minimum. And remember to be patient — good things come to those who wait!
How to pay off a mortgage early
Make extra payments
This is the best way to repay a mortgage early. This method is particularly effective if you can increase your income over time, so you make more each year than you did when you first started making payments on the mortgage.
When making extra mortgage payments, you can take two main approaches: making additional lump sum principal payments or making regular payments on top of your existing monthly payment schedule. You could make biweekly payments or monthly. Each approach has pros and cons, so it's important to weigh your options carefully before making a final decision. For example, making additional lump-sum payments might be a good option if you're planning a big expense in the near future and you want to eliminate as much debt as possible before the purchase. On the other hand, making additional payments might be a better option if you want to speed up the process, but you don't have the funds to make a lump-sum payment right away.
You can also use this strategy to reduce the interest you pay throughout the loan by spreading your payments over a longer period. This option is especially useful if you have a large mortgage balance and want to reduce the amount of interest you end up paying on it. The process of you paying off your home loan is called amortization.
Extra payment means a shorter term, resulting in an early mortgage payoff. For example, if you have a $300,000, 30-year mortgage at a fixed rate of 5% and pay $1,000 extra each month, you can repay your mortgage 16 years early. With a 15-year mortgage, you'll be on pace to repay the loan 36% faster. For ease of calculation, you can look up a mortgage calculator.
No matter which approach you choose, it's a good idea to set up a savings account that can be used to save for future expenses while you pay off your debt. A financial planner can help you find the right balance between these two approaches and create a personalized plan.
Refinance your mortgage
Refinancing a mortgage simply means replacing your current mortgage with a new one that allows you to pay off your old loan faster and save money. A refinance is a fairly simple process that usually requires only a few steps: apply, sign documents, and fund the new loan. You can work with your mortgage broker to determine how much you can afford to borrow and whether it makes sense to refinance or not.
If you decide to refinance, you'll have to provide the bank with information about your home, credit history, and assets. They'll use this information to determine the amount of your new loan and the interest rate you will be charged. To find the best mortgage rates in your area, you can search online or contact a mortgage broker who can help you compare your options. Keep in mind that a lower interest rate can save you thousands of dollars in interest payments over the term of your loan amount. This can reduce your overall borrowing costs and help you repay your mortgage faster.
Related: How to Refinance Your Mortgage
Recast your mortgage
A recast is different from a refinance. The latter is just taking out a new mortgage to replace your old one. On the other hand, a mortgage recast is when you pay a large amount toward your mortgage, and the balance falls, meaning your future installment would be lower. For example, you've found yourself in possession of extra money through a tax refund or a windfall, and you decide to use this money toward your mortgage. The lender will consider this payment to calculate your monthly payments, which will come out to be lower than you were paying before the payment. Because you now have a smaller loan balance, your future payments will be smaller, and you'll pay less in total interest over the life of the loan.
Recasting is cheaper than a refinance, and you're more likely to get approved for it. However, it doesn't change the loan term or the mortgage interest rate you're being charged. For the record, Federal Housing Administration (FHA) and Department of Veterans Affairs mortgages cannot be recast.
After you've decided to repay the mortgage early
Now that you've decided to repay your mortgage early, there are a few items you should take into account before actually going ahead with it:
Prepayment penalties: Some mortgage lenders charge you extra if you decide to repay a loan early. These costs are meant to deter homeowners from repaying a mortgage early. Contact your mortgage company to ensure you don't have any such clause in your loan agreement and ask questions.
Contract restrictions: Some lenders straight up bar you from making extra payments, encouraging instead that you stay on the course. Once again, you could contact the lender to see whether extra payments go toward the principal balance or interest.
Where to park the extra money
Paying off your mortgage early can save you money in several ways. The most obvious way is that it will save you from making monthly mortgage payments for the next few years. Your mortgage payments will be lower since the total interest you'll pay over the loan will be much lower. This allows you to free up some money you can use for other investments.
You can invest the money in stocks, bonds, or other investment vehicles that will give you a return on your money. Or you can just save it for retirement or any other financial goal you might have. Since you won't have a mortgage to worry about anymore, you can also splurge and use the money to go on vacations, pay for your children's college education, or even make a down payment on a new car. Alternatively, you could also use the extra money to repay high-interest debt.
This can provide you with added peace of mind knowing that you're in control of your finances and not locked into a fixed monthly mortgage payment for years to come.
The bottom line
There are several different ways to pay off your mortgage early and save money in the process. The best option is to increase your monthly mortgage payment until you've completely paid off the mortgage. This method is particularly effective if you can increase your income over time, so you make more each year than you did when you first started making payments on the mortgage. Increasing your monthly payment by $100 or $200 per month will allow you to pay off the mortgage faster than you normally would.
Two other options are recasting or refinancing your mortgage. Refinance may allow you to secure a better rate, but it typically costs more, including closing, appraisal, and origination fees. By comparison, recasting is easy to qualify for; your interest rate doesn't change. But your payments will become smaller.
Paying off your loan increases the equity you can borrow against, meaning you can access more money through a home equity loan or cash-out refinance. You can also stop paying private mortgage insurance (PMI) once you have a 20% equity in your home. However, paying off a mortgage early means you lose out on mortgage tax deductions from your taxable income.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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