How to Repay your Mortgage in Half the Time and Save Thousands
Buying a home is an part of the American Dream and 90% of home buyers finance their purchase with a 30-year mortgage because it offers the lowest monthly payment.
What you might not realize, is that you can make extra payments on your 30-year mortgage and save over $100,000 in interest on your home loan. In many cases, your additional payment won’t be significantly more, which means you save lots of money repaying your mortgage with even the smallest amount of disposable income.
You Can Almost Buy an Entire House After 30 Years of Interest
With home mortgage rates at historic lows, some people will tell you to only make the minimum payment and invest your extra income. While the historical market return supports this viewpoint, you are still responsible for making a monthly house payment for the next 30 years.
If you’re on a tight income, eliminating that monthly payment sooner than later can be more rewarding. Even if you want to diversify how you build your net worth, repaying your mortgage faster by even one year can be extremely beneficial.
Before you learn how you can repay your mortgage sooner, let’s first see how much interest you will pay on your 30-year mortgage by only making the minimum monthly payment for all 360 months.
The median mortgage balance request in 2016 was $300,000, so we will base all calculations on that number.
Assuming you finance a $300,000 mortgage with a 3.86% interest rate, you will pay $207,000 in interest over 30 years! You’re $100,000 short of buying your home a second time by the time you make your last payment.
While historically low mortgage interest rates are some of the cheapest debt around, even contributing an extra $50 a month saves you $14,000. Even if you currently invest most of your extra income to earn a higher yield, a small additional payment is a win-win proposition for your net worth.
By pursuing one of the mortgage repayment methods mentioned below, you might only pay one-third of the interest you will pay with a traditional 30-year mortgage.
The table below can help you quickly determine the best repayment option for you. All figures are based on a $300,000 starting balance with a 3.89% fixed APR. Escrow and property taxes are not included in this table.
A 15-Year Mortgage Isn’t the Only Alternative to Pay Off Your Mortgage
After loan interest rates dropped in the Great Recession, many 30-year borrowers refinanced their remaining balance for a 15-year term.
With a 15-year term, you can usually get a lower interest rate but your monthly payment is higher. On a $300,000 loan with a 3.89% interest rate, you will only pay $2,198 compared to $1,408 before escrow and taxes. That’s only 56% more payment ($790) that slices your total interest charges in half.
My wife and I opted for a 15-year mortgage because we could afford the higher monthly payment and still invest while in debt to begin earning long-term passive income while we work towards becoming debt-free. Knowing we would pay half the interest and be debt-free in half the time was the primary reason we applied for a 15-year home loan once we crunched the numbers.
Start with an Extra $50 Payment for Fast Mortgage Payoff
If you’re not sure you can afford the whole extra payment thing, start paying an additional $50 a month towards your mortgage. By paying an extra $600 a year, you can save $14,768 and pay the loan off nine months sooner.
If you need help figuring out where to find an extra $50, these tips will help you save $7,500 a year when you make some simple changes to your daily routine.
If you can contribute more than $50 a month, do it; the more you pay today means the less you pay overall.
Biweekly Payments Are the Most Affordable Mortgage Option
Can you afford one extra monthly payment a year?
If the answer is yes, you need to hop on the budget-friendly biweekly payment plan immediately. In most months, you won’t pay more than your typical monthly payment. How’s this possible?
You divide your monthly payment in half and send your half-payment every two weeks. If your regular monthly payment is $1,408, you will send a $704 payment every two weeks 26 times a year. About once every six months you will need to send a third half payment; this gives your six months to come up with another $700.
In addition to nearly saving $33,000 in interest with biweekly payments, you will also repay your mortgage five years early.
If you prefer simplicity and have the extra cash on hand, you can also make a single lump sum payment each year and enjoy similar savings.
My Favorite Way to Fast Mortgage Pay-Off
One of the most common misconceptions between a 15-year and 30-year mortgage is that a 15-year monthly payment is double the size. That’s simply not true.
As you saw earlier, a 15-year mortgage is only around 50% more for the typical borrower.
If you’re motivated to become debt-free as soon as possible, this last option is the most motivating. By making double payments, you can transform your 30-year loan into a 10-year loan. You will also save $139,086 in interest in the process.
Double payments are not always the most popular for three reasons:
- Not every borrower can afford a double payment
- Other forms of debt are more expensive
- A good stock investment earns more interest than you pay each year
If your mortgage rate is below 5%, it can be more profitable to make the minimum monthly payment on your mortgage and find an investment that can earn 8% or more on a consistent basis. As long as you out-earn your mortgage interest rate for the year, you profit.
Even if you can’t afford a full double payment today, you can always work towards one as you pay off your more expensive debt or your salary increase.
Avoid These Two Mortgage Repayment Methods
There are two times a repayment strategy can backfire and end up costing you more money.
The first example is a variable rate and adjustable rate mortgages where interest rate hikes can increase your monthly payment on a quarterly or yearly basis. Unless you can repay your mortgage within a few years, you risk paying more in interest on a long-term loan. Since mortgage interest rates are “cheap debt,” this additional risk isn’t worth the potential reward for most borrowers.
A second time you need to stick with your current mortgage terms is when the refinancing costs offset the interest you will earn. When the housing market crashed in 2008, many “underwater” borrowers had to wait several years for their home’s market value to be greater than their outstanding mortgage balance. By the time this happened, all the refinancing fees canceled out any potential savings of having a lower interest.
While it's not really a way most people use to repay their mortgage faster, a lot of seniors are persuaded into reverse mortgage loans as well. I'd add these to the list of loans to avoid for most people because there are much better options that cost a fraction of the price.
The beauty of making extra payments is that the bank can’t charge you any additional fees on the loan you already have. Just make sure you specify that your extra payment is applied to the loan principal and not next month’s payment to maximize your savings.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.