Many people spend a lot of money on home security systems to protect their homes, but no security system will protect them from bankruptcy. By making additional payments on the borrower’s mortgage, it is possible to both dramatically reduce the amount of interest paid and also pay the mortgage off quicker - giving the home buyer a bigger margin for safety each month and allowing them to live mortgage-free sooner. The amount saved will vary based on the initial size of the loan and interest rate.
Simply by making an additional payment over the life of a 15-year mortgage for $300,000 dollars at an interest rate of 5%, amounts to an eventual savings of up to 200 dollars monthly. Hypothetically, by making a payment of $2,572 monthly, rather than the minimum required payment of $2,372, it is possible to reduce the number or required payments from 180 monthly payments, to 161 monthly payments. By doing this, the term of the loan is reduced from 15 years to 13.4 years, and drops the total amount of interest paid into the mortgage from $127,029 to $111,653. It is possible to save even more by making extra payments if the interest rate is higher.
One the most effective ways to save money on your mortgage is by refinancing at a significantly lower rate. Current borrowing rates are near historical lows for many consumers. The following interactive table highlights current rate information in your local market.
When considering the option of paying mortgages off more quickly, it is not uncommon to hear the term of “mortgage cycling” come up. Quite often consumers will see books and ads promising a solution for paying of your mortgage more quickly while saving more money. When considering “mortgage cycling”, various establishments who offer their services may be quite helpful if the borrower is less than familiar with the idea that by paying extra towards your monthly mortgage payment, the loan will be paid off in less time and a great deal of money can be saved in interest.
While appearing to be a new idea towards mortgage management, the concept of “mortgage cycling” has been used for a very long time, and is quite simple to understand. When attempting “mortgage cycling,” there are quite a few techniques that must be understood in order to do it effectively and save the most money. Some of these techniques also tend to be quite risky, such as taking out short term home equity loans in order to pay down the principle of the mortgage. If not done with careful consideration, using this technique could quite possibly end up costing considerably more in interest or even lead to a difficulty in finances that pushes the borrower into foreclosure.
By far, the technique that is the least risky is for the borrower to pay more towards the mortgage principle, by means of paying numerous, sizeable extra payments. Simply by doing this and paying a greater amount towards the principle of the mortgage, the mortgage can be paid off well before the term of the loan. Unfortunately, not all consumers have the extra funds necessary to take advantage of this technique, so what can those consumers do? Read on for further information and techniques.
Most borrowers do not believe that it is possible for them to afford to pay more towards their mortgage. Although they do not believe they have the additional funds required for this, most consumers use their revolving credit accounts to purchase luxuries such as televisions, or daily luxuries like gum or soda. Most definitely, there is absolutely nothing wrong with making these purchases, but if the consumer is seeking an early pay off of their mortgage, they might want to reconsider.
As income tax time rapidly approaches, many consumers will be expecting reimbursement for overpaid taxes or credits. For a borrower considering paying off a mortgage early, they may want to apply their refunds to the principle of their mortgage. This can also be said of any funds that aren’t already obligated, such as settlements from insurance companies, and financial awards.
The rate in which a mortgage can be paid off more quickly varies depending on the additional amount paid and when it is applied to the account. The earlier a larger extra payment is applied to the mortgage, the more the consumer will save. Just to show the effect that making an additional monthly payment can have on a mortgage, consider this:
Hypothetically, if the borrower had a 30 year mortgage for $160,000 at an interest rate of 7%, a minimum monthly payment of 1064.40 would be required. Upon taking a closer look at the second minimum payment, the consumer would deduce that the payment is comprised of merely $131.83 toward the principle and a hefty $932.57 towards the interest. If the borrower adds a minimum of $131.83 to their monthly required payment of $1064.40, an entire month of the term will be eliminated.
Simply by practicing this technique on a monthly basis, the term of the mortgage would be reduced from 30 years to 15 years. By adding the additional payment on a monthly basis, the amount of the payment that would be applied to the principle would continue to grow. After the first year, by doubling the principle, approximately $137 would be paid toward the Mortgage with each payment. As the consumer’s wages increase, so can the extra amount that they pay toward their mortgage.
When examining different methods of paying down the principle, all should be considered with caution. It is feasible for one to consider paying large sums out of their savings accounts and save many thousands of dollars in interests over the term of the mortgage. Careful consideration should be placed on this method as sometimes unforeseen expenses arise and financial security during these times can be especially comforting. Another option for the borrower would be to sell stocks and use the money to pay down the principle. If a borrower is to consider this method, they would be smart to make certain that the rate of return is balanced against the rate of interest of the mortgage. Before applying extra money to a mortgage payment, It would also be wise to evaluate paying off any revolving accounts that have high interest rates, such as credit cards.
By far the easiest method for paying larger amounts toward the principle of a mortgage is to save any additional funds through the month and use it as an extra payment. After the payment is made, any other additional funds could be applied to the payment as well. Just by make a few small adjustment and paying more towards the principle of the mortgage, the need for difficult to understand mortgage cycling would be eliminated.
Each year contains 12 months and 52 weeks. Many people get paid bi-weekly and want to align their mortgage payments with their paychecks for budgeting. A person makes 26 payments each when when making bi-weekly payments. Each of the 26 payments is half of what a monthly payment would be, thus 26 bi-weekly payments is like making 13 monthly payments. Early on in a mortgage most of the payment goes toward interest, so effectively making an additional payment each year helps reduce the principal much faster - shaving years off the loan. Another popular way to create a 13th mortgage payment each year is to add another payment which is aligned with a yearly bonus or tax refund.
If you come into a large sum of money due to inheritance, stock options, a bonus or a gift you may want to apply the sum to your mortgage immediately if you do not have other higher interest debts. The sooner debt is extinguished the less interest you will pay. You may also want to ask your lender if they are able to recast your loan if you are making a large payment to allow you to use more flexible lower monthly payments in the future. Typically conventional loans allow recasting while loans that are backed by Ginnie Mae do not. You can learn more by reading our mortgage recasting guide.
We offer one of the more advanced extra payment calculators on the web. It allows you to calculate the amortization schedule for a loan with various weekly, biweekly, monthly, annual or periodic extra payments of various amounts for set periods of time throughout the loan.
Some home loans come with prepayment penalties. If you make extra payments and your loan is nearly paid off you may need to maintain a small loan balance until the prepayment penalty period has expired to avoid paying this fee.
It is also imperative that the borrower keep in mind the tax-deductible nature of mortgage interest. Because interest on many mortgages is tax-deductible, some of the payment that the borrower is paying is actually being paid by the government. The 2018 tax law will allow interest on up to $750,000 of mortgage debt to be deducted from one's income. Previously the limit was set at $1,000,000.
Interest on up to $100,000 of second mortgage debt (HELOCs and home equity loans) was also previously tax deductible, though it no longer is unless the debt is obtained to build or substantially improve the homeowner's dwelling.
Consider this, a person having a mortgage with a 7% rate of interest will have the government paying 1.89% of the cost of interest which would be 27% of the 7% rate of interest on the loan. By use of this deduction, the actual post-tax mortgage rate would be 5.11%. Upon consideration of this reduced rate, the consumer might consider investing money in another area that might yield a higher return. Additionally, there is another advantage to this method. If money is invested rather than being applied to the principle of the mortgage, any returns received would be taxed. Investments paying an interest rate of 7% would actually have the money earned reduced because of the taxes required on the return.
If the consumer has other forms of debt which are higher interest or not tax-advantaged, it makes sense to aggressively pay those off first. Since that interest is not tax-deductable, paying off that debt guarantees a higher risk-free return than applying the money toward your home loan or many other investment options.