Do you dream of getting out from under your mortgage? For many Americans, that day takes an agonizingly long time to come. Harvard's Joint Center for Housing Studies found that nearly two-thirds of Americans aged 55 to 64 still owe money on their mortgages. Many of these people are likely to throw a retirement party before they get to throw a mortgage-burning party.
If you don't want to view your mortgage as a life sentence, there are some techniques you can use to speed up the repayment of your loan - and throw that mortgage-burning party while you are still young enough to enjoy it. Here are five possibilities:
- Refinance and repay the savings
Mortgage rates may have risen last year, but they are still about two percent less than they were at the peak of the housing boom. That difference is significant to homeowners who bought near the peak, and are just now seeing their housing values recover enough for refinancing to be an option. Those homeowners could be in for some big savings. For example, on a $200,000 mortgage balance, dropping your mortgage rate from a housing-boom-era rate of 6.2 percent to today's 4.2 percent would reduce your monthly payment by $247. Before you start thinking of ways to spend that money, remember the purpose here: to pay off your mortgage faster. Plowing that extra $247 into a higher mortgage payment would allow you to retire your loan nearly ten years earlier.
- Double up on principal repayment
Here's why repaying a mortgage takes such an agonizingly long time: in the early years of the loan, most of your payment goes to interest rather than principal. In the example above, if you refinanced a $200,000 loan balance at 4.2 percent over 30 years, you would be paying $978 a month - and in the first month, only $278 of that would go towards principal. Suppose you matched that $278 with an extra payment - and continued to do that every month. The challenge is that your principal payments gradually increase over the life of the mortgage, so matching them could become more difficult. However, if you are at a stage of your career where your earnings are starting to accelerate, this could be a good strategy. The payoff is that by doubling up on your principal payments, you could repay a 30-year mortgage in 15 years.
- Grow your savings
One risk of repaying principal ahead of schedule is that if an emergency arises, you would not have that cash available to you. This could force you to borrow against the equity in your home, which could prove to be more expensive in the long run. So, instead of plowing extra money directly into the mortgage, suppose you invested it first instead? Based on historical stock returns and current bond yields, a balanced investment portfolio could be expected (though not guaranteed) to produce an average annual return of about 6.5 percent. If you took the $247 in refinancing savings from the first point above and invested it monthly into a balanced investment vehicle, at an annual return of 6.5 percent you would amass enough to pay off your remaining mortgage balance in less than 19 years - more than 10 years ahead of schedule. In the meantime, you would have this growing pool of savings available to you in case of emergency.
- Refinance to a shorter term
Perhaps the most straightforward way to get out from under your mortgage sooner is to refinance into a shorter-term loan. For example, you could refinance from a 30-year loan with 25 years remaining into a 15-year mortgage. This would most likely entail making a higher scheduled mortgage payment, but it would pay down principal faster without you having to calculate special payments or watch over an investment account. If you can afford those higher monthly payments, the benefit is not only a shorter mortgage term, but also less interest expense. Shorter-term loans typically carry lower mortgage rates than longer-term ones, plus you would be paying interest over fewer years. This is a popular approach - one survey found that a third of LendingTree customers who refinanced chose a shorter mortgage.
- Bi-weekly payments
A subtle but surprisingly effective way of shortening your mortgage term is to divide your monthly payment in two, and make half of it at mid-month, or half a month early. This fits well with people who get paid every two weeks, and by making part of your payment a little early, you will reduce the amount of interest you are charged. On a 30-year mortgage at 4.2 percent, those interest savings would add up enough to shorten your mortgage by just over four years.
Be smart about your priorities
As enticing as the thought of paying off your mortgage may be, you may want to take care of some other financial priorities first. For example, it makes sense to pay off any credit card debt before making extra mortgage payments, because credit card debt typically carries a much higher interest rate than a mortgage. You should also have 3-6 months worth of expenses set aside in an emergency fund, something which can come in particularly handy when you are a home owner. Finally, taking full advantage of any retirement fund which has an employer match is likely to give you more bang for your buck than paying off your mortgage early.
So, your mortgage-burning party may still be a while away. But, if you start working towards it early and diligently, you can be popping the champagne at that party years ahead of schedule.