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Pay Off Your Mortgage Early - Save Thousands in Interest

Last Updated: July 18, 2011

Second only to the dream of buying a home is actually paying it off. It takes most of us 30 years, during which time we end up paying more in interest than we pay on the home's actual purchase price. So the sooner you can pay off your mortgage, the more money you'll save - thousands, if not tens-of-thousands, of dollars over the lifetime of your loan.

Step 1: Weigh All Your Mortgage Options Before Buying a Home

Your ability to pay off your mortgage starts well before your first payment is due; before you sign on the dotted line; even before you find the house you want to buy. If you're in the market for a home, the time is now to start thinking about paying off your mortgage:

• Live Within Your Means. If the purchase price on your home is so high relative to your income that it hampers your monthly cash flow, you won't have any money left over to make extra payments toward the principle on your home (i.e., pay off your mortgage). Look for something in a lower price bracket that will free up plenty of money, not only for making extra payments on your home, but also so you have funds available to set aside for emergency living expenses.
  
  
• Adjustable vs Fixed-Rate Mortgage. The reason buyers choose adjustable rate mortgages is because interest rates start out low. But because they're "adjustable," they can go up anytime. Buyers often talk themselves into believing that by the time their interest rates go up, they'll be making more money anyway to help cover the difference. That is rarely the case. Homeowners with adjustable interest rates all too often find themselves in over their heads. In fact, paying off their mortgage becomes the least of their worries, instead struggling to make their mortgage payments at all. With fixed rate mortgages, there are no surprises. You know your payments will always stay the same. And if rates do fall, you can always refinance to take advantage of the savings.
  
  
• No Penalty For Prepayment. Under the terms of many mortgages, homeowners are penalized for making payments early, which is imperative to paying off your mortgage (and outlined in more detail below). So be sure to choose a mortgage that does not assign penalties for early payments. Also check to see how many extra payments are allowed per year, as this too may be limited.

Step 2: Make Extra Payments

It sounds simple enough because it is - the way to pay off your mortgage is make more payments toward the principle balance. Not only does this reduce the length of the terms of your loan but, as the principle shrinks, so does the interest. The complication, of course, is figuring out how to make extra payments works for you:

• The Dollar-a-Month Plan. Let's say you have a $150,000 fixed-rate mortgage at 6 percent. By adding an extra dollar to your $900 payment each month - one dollar the first month, two dollars the next month, three dollars the next month, and so on, you will pay your mortgage off quicker and save a lot of money in interest.
  
  
• Make Bi-Weekly Payments. Instead of making one monthly mortgage payment, say $900, break that amount into into bi-weekly payments of $450 each which will be 26 payments per year. So by the end of the year, you've made one full extra payment toward your mortgage. Add this up over a 30 year period and you will have paid off your mortgage quicker and saved money in interest.
  
  
• The 15-year Switch. Since interest rates on 15-year fixed-rate morgages are generally lower than on 30-year loans, you might want to concider refinancing to pay off your loan faster. Keep in mind your monthly payment will go up so make sure this is affordable for you.
  
  

  Extra Payment Plan	Mortgage & Interest Rate	Total Interest Saved	Reduced Payments
  The Dollar-a-Month Plan	$150K at 6% Fixed	$52,000	Paid Off in 22 years
  Bi-Weekly Payments	$150K at 6% Fixed	$37,000	Paid Off in 24 years
  15-Year Switch	$150K at 5.5% Fixed	$103,000	Paid Off in 15 years

   

• Send in Lump Sums. We all want to do something special with that bonus from work, that tax refund, that family inheritance. Well, what could be more special than putting it toward ownership of a home?
  
  
• Prioritize Making Extra Payments at the Beginning of Your Mortgage. You'll be charged the most interest the first few years of your loan, as that is when your principle is its highest. So make it a priority to, one way or another, make extra payments toward the principle the first 5 to 7 years of your loan - a period of time in which you may otherwise pay in thousands, but only see a reduction of hundreds.

Step 3: Make Sure Your Extra Payments are Going Toward the Reduction of Your Principle

When you send in more money than is due for your regular monthly mortgage payment, lenders may not know what to do with it. Instead of putting it toward the principle, they may simply apply it to next month's mortgage payment. It's your job to specify, in the memo line of your check for example, that you want the extra money to go toward the principle of your loan. Then, equally important, is follow-up, making sure your extra payments are being applied accordingly.

Step 4: Determine Whether You Need to Refinance

The terms of your mortgage could make paying it off difficult. Consider refinancing if:

• Yours is an Adjustable Rate Mortgage. Refinance for a fixed rate so you're guaranteed the same payment throughout the length of your loan. As with any other expense, knowing what to expect helps you budget better, including extra payments.
  
  
• You'd Like to Switch From a Long-Term Loan to a Short-Term Loan. Over the course of a 30-year mortgage, homeowners typically pay more for the interest than the actual price of the home. If you can swing higher payments each month, you could refinance to a 15-year mortgage that would cut your overall interest paid in half. Of course, with this option you have no choice but to pay more toward your loan each month. Whereas if you opt to simply send in extra payments on an existing 30-year mortgage, there's room for adjustments depending on the dynamics of your financial situation.

Whether you're already years into a mortgage, or in the market for your first home, the time is now to take control. With a little resourcefulness and discipline, you can pay off your mortgage sooner than later - saving money and buying peace of mind.