How-to Monday: Paying off your mortgage early
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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.
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Comments
Has anyone tried Bills' new debt help quiz? All of these things certainly factor in.
Posted by: erik | June 30, 2008 1:34 PM
I don't think paying a mortgage off early makes sense for most people. The last point that Ewing makes is right on: for every dollar extra you put toward you mortgage you are buying that much more of your house. For most people this doesn't make sense because a huge portion of their personal wealth is already invested in the local real estate market (in their home). Any left over savings should be put towards retirement or a taxable account where the money can be accessed more easily if something bad were to happen. I doubt you'll be able to get a home equity loan if you can't work and need the money tied up in your house to live. Why would a lender lend money to someone who can't earn money and pay them back on a regular basis?
Cash and liquidity are king. Keep the cash out of the house and you'll enjoy the benefits of leverage as well as a subsidy from Uncle Sam. Or, think of it this way: once you pay off your mortgage the only way to get that money is to sell your house. But, what if prices are down when you want to sell...like now?
Posted by: Jamie | June 30, 2008 3:03 PM
Thanks for the comments, folks. (Nice to see another Jamie here!)
Posted by: Jamie Smith Hopkins | June 30, 2008 3:07 PM
McBride is skeptical and I was too. But some of his premises are wrong and there is more to understand about why the Money Merge Account is SOOO much more efficient than anything else available today. Ernst & Young just gave the company an award and more and more experts are praising the program. $3500 is a spit in the bucket if you are saving tens of thousands or hundreds of thousands of dollars. Visit www.ownitoutright.com to learn more and see what it can do for you specifically. It has been a true blessing to my family. Bonnie
Posted by: Bonnie Clark | July 1, 2008 11:52 AM
With all the uncertainty in the housing market, Doesn't it really behoove lenders to get borrowers to pay off more of their loans. Particularly if they have Option ARMs?
Like what Wachovia did yesterday.
http://www.coffeeforclosers.org/
Posted by: Matt Johnson | July 1, 2008 6:03 PM
There is nothing wrong with paying off your mortgage if it will make you feel better, but it won't make you wealthier. You can make more money in the long-term by putting that extra cash into your retirement account.
MMA was designed for the financially undisciplined and the mathematically illiterate. Can you challenge their numbers? You can do much better on your own. It can be shown that using MMA software will cost the average homeowner $10,000 more over the life of the mortgage. Why? The $3,500 fee and the interest cost, for starters. Then, add in the inefficient use of the home equity line of credit (HELOC) and its interest cost.
Contrary to MMA propaganda, the program forces you to make extra payments to your mortgage. Running all your income and outgo does reduce your monthly HELOC balance, but not enough to make a difference. There is no "leverage". Of course, in this interest rate environment, you don't need MMA to save money using a HELOC. Just wait until the interest rates go back up to fight inflation then what do you do?
Posted by: Jimmy | July 7, 2008 1:06 PM
We obtained a 7% 30 year home loan in 1999. We paid an extra $100-200 per month in principal and we will have our loan paid off next summer. Calculating the interest we will save over the life of this loan is astronomical and outweighs any so called tax benefit of paying mortgage interest. Also, we can now put more money into nest egg retirement plans. I wonder how many of you are getting 7% return on your investments this year? That's what I thought. Pay it off early folks, it's the best kept secret in the banking industry.
Posted by: Trevor | July 13, 2008 5:20 PM
Trevor, congrats on paying off your mortgage 20 years early. You now will have to refinance or sell your home to get to that money. My guess is you now have a huge percentage of your personal wealth tied up in your home. In other words, not diversified portfolio. I hope nothing happens to you financially that you lose your job, can't work, and need cash. If so you won't be able to get a loan because you won't have income to pay the bank so you'll be potentially forced to sell your house in a down market. Cash in the bank is king, cash tied up in your home is for illiquid jokers.
Posted by: JamieT | July 16, 2008 5:10 PM
What if you have saved up 3-6 months of your personal expenses? That way if something happens you can have yourself covered till you can find another job. Plus you're able to put that money you would of paid towards your mortgage and then save it or do anything you want. It's called FREEDOM!
Posted by: Stew | July 17, 2008 2:37 PM
Jamie,
Just because Trevor pays off his mortgage early(smart man) doesn't mean he has no money saved for emergencies. Soon he won't be paying 7% interest and socking that money to other investments. So what if real estate is down. His home is paid for, emergency fund is in place, and his principle and interest payment now work for Trevor. My home will be paid off early and and I have 3-4 months of expenses in cash now. I'm on my way to FREEDOM!!!
Posted by: Kenny | July 19, 2008 10:07 PM
Hi all, I live in Canada, were we don't receive any tax back from the government on mortgage payments or interest. For me, owning a home outright has been an obsession since I starting looking for my first home about 7 years ago. It is possible to pay more, to pay off, and to be debt free. You just have to set it as a paramount priority.
The best advise I ever got was to buy a home with rental potential, like a basement suite. I've been putting the rental income onto my mortgage religiously for 5 years, and I am proud to say that I have under a year of payments, and I'm done.
I understand the view that liquid assets are king, but a paid-in-full roof over your head counts for a lot. If times get tight you can always rent out a portion of your home, or get a HELOC. In Canada HELOC's are cheaper than mortgages, so it's a great asset to have more equity in home.
For those of you starting out... only buy what you need. Remember, things may change, and its better to own a smaller home, than be paying for 30 years on a grand estate that is too much to heat and cool, a pain in the arse to clean, and source of familial conflict due to money issues.
For those of you in serious debt, looking for a home. Check out the "snowball" approach to debt payment, always use a mortgage broker and negotiate rates, and lean towards variable rates.
Cheers for beers!
Posted by: Sandra G. | July 30, 2008 7:51 PM
I thought I heard it pays to make weekly payment equal to a quarter of the monthly credit line payment amount. Is there any truth to this?
Posted by: Paul | August 23, 2008 11:29 PM
Hi, Paul -- are you talking about making a quarter of your mortgage payment every week? The effect would be along the lines of biweekly payments, just somewhat more so.
Posted by: Jamie Smith Hopkins | August 24, 2008 6:46 AM
Yeah... I would like to have a fully paid off home by the time I retire. The stock Market and a plethora of investment opportunities are huge gambles.A paid off house has no drawbacks basically. It's one less large sum of money someone will not owe monthly when they retire.
Posted by: Angel | January 31, 2009 9:03 AM
Quote: "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." This statement reflects a simple lack of knowledge of how technology based mortgage acceleration works. With this particular item, effective interest rate is the key term.
The efficiency of the Money Merge Account is in fact very relevant now with so many people in homes with underwater mortgages. It is fact a life line as it effectively helps recoup lost equity much quicker... why wait for the market to recover to build up equity again? Do a Google search for underwater mortgage acceleration to find resources.
Posted by: Jack Lovell | April 15, 2009 12:06 AM