How-to Monday: Paying off your mortgage early
Image courtesy of Stock.XCHNG
Sure, you get a tax deduction for the interest you pay on your mortgage, but that doesn't mean you aren't heartsick about all that interest. That's why paying off a mortgage early -- and cutting out as much interest as possible -- will always appeal to some homeowners.
There are various options, some better than others, experts say.
Consider, for instance, biweekly payment plans through your lender. If you make half your mortgage payment every other week, that's 26 half-payments -- or 13 full payments rather than 12, eliminating mortgage debt more quickly. But don't sign on the dotted line if the lender charges you a fee to participate, says Bankrate.com's Greg McBride.
"You can achieve the very same objective on your own," he says.
Here's how: either make an extra payment once a year or add 1/12th of that amount to each monthly payment. "Neither of those cost a dime, and you retain the flexibility to change course if money is tight," McBride says.
Ethan Ewing, president of Bills.com, makes the same recommendation. "Check your monthly statement from the lender and make sure it's being applied to principal," he adds.
You can see your total interest and principal due, and how those would change if you made extra payments, at Bankrate.com's mortgage calculator.
More complex pay-off-early plans suggest you replace your mortgage with a home equity line of credit and use that line as your savings and checking account, depositing your paychecks and withdrawing money for your bills. The idea is that your deposits lower your mortgage balance as long as the money sits there, unspent. You end up with a lower average monthly mortgage balance than you otherwise would, saving you on interest payments.
"It's good if you're cash-flow positive. If you're cash-flow negative, you're going to be in trouble," says Ewing. Spend more than you earn, and you're eating up your home equity. "We've got a negative savings rate in this country, so there are certainly a lot of people who would be cash-flow negative."
Also consider the cost to refinance and the possibility nowadays that your line of credit could get scaled back or frozen by your lender, McBride says. Remember too that lines of credit have variable rates. You can often fix the amount you borrow upfront -- the amount of your mortgage, in this case -- but any later borrowing could end up with a higher rate.
Following along? OK, here's a related concept that requires a home equity line of credit in addition to, rather than instead of, your mortgage:
Again, you deposit your paychecks and pay your bills through the line of credit. The difference? Every few months, you put, say, several thousand dollars from the line of credit toward your mortgage. In other words, reduce principal by borrowing against your line of credit, paying interest on what you borrowed for the several months it takes for your discretionary income to catch up.
Rich Leffler, a Towson-based consultant for Money Merge Account, a $3,500 program that comes with software telling you when to make the extra payments and how much the payments should be, says you'll come out ahead because your deposits lower the balance on your line of credit as long as they sit there.
"Eight to 14 years is when you could expect a typical 30-year mortgage to be paid off with this program," says Leffler, who's also a mortgage consultant. Depending on the loan, "You could save $80,000 on the mortgage by paying it off sooner and end up spending maybe $5,000 in interest over the life of the line of credit."
A variety of financial commentators are skeptical. McBride doubts the net benefit for most homeowners would be nearly that dramatic, particularly if they're starting off with a $3,500 payment for the program. With isolated exceptions, he doesn't see how it would work to your advantage unless the interest rate on your line of credit is lower than the rate on your first mortgage -- and remains lower.
McBride and Leffler agree on one point: Find out the costs and savings for you, personally, before you take the plunge.
Another thing to consider before paying down a mortgage more quickly: so-called "opportunity costs." If you're putting additional money into your mortgage, you're not doing something else with that cash. Paying down higher-interest credit card debt, for instance. Or saving for retirement. Or making investments that have nothing to do with the housing market.
"If you put $100 extra into your house, basically -- into your mortgage -- you have to consider that an additional investment into real estate," Ewing says. "My wife and I, .... we'd rather save that money and put it into other investments."
Tried any pay-off-early ideas? Have any recommendations? Chime in.