Have you ever wondered how you can pay off your mortgage early? Many corporate CFOs have been positioning their companies in the current low-interest rate regime by borrowing as much as they can afford under a fixed rate. Under the assumption that rates will not stay this low forever, it does make a lot of sense to borrow at low rates for future use. However, that may or may not be appropriate for you. Responsible individuals should take a look at their debt profile and analyze their current position.
As part of that analysis, mortgage debt is something that many Americans have. Further, over time, the bank’s amortization schedule structures it so that the overwhelming majority of one’s payment in the first decade goes to interest alone and not reducing much of the balance at all. It is for that reason that many Americans end up paying hundreds of thousands of dollars in interest over the life of a mortgage.
One of the key lessons about debt is one that isn’t all that intuitive. It is not necessarily the interest rate that you pay, it is the VOLUME of interest you pay over the life of the loan. For instance, paying 4% interest on a mortgage over 30 years can be a lot more prohibitive to your net worth than paying 7% interest over a shorter amortization schedule. There are all sorts of amortization tables available on the internet such as this one from Credit Karma Hypothetically, I used the calculator to put in a $300,000 mortgage at 4.5% interest over 30 years for a monthly payment of $1,520. What I found is that the VOLUME of money going toward interest exceeds the VOLUME of money going toward principal until year 14! That is right, it is crazy when you actually look at it. In fact, it will take this hypothetical person $547,220 in payments to pay off a $300,000 loan! Mortgages were set up for banks to profit and provide access to capital for home buyers that they wouldn’t normally have access to. It is not in the bank’s interest to have you pay down your mortgage faster so they will NOT educate you on ways to do so. If you are serious about trying to reduce the VOLUME of interest you are paying and increase the net worth in your life…read on…
How to Successfully Pay Off Your Mortgage Efficiently
Shorten Your Term
This one sounds easy and intuitive. Instead of amortizing over 30 years, amortize it over 15 years. Of course, you end up with a much, much larger monthly mortgage payment. When I shortened the term to 15 years the payment increased 51% to $2,295! For most Americans that is just not doable because of the much higher payment, but the interest savings are enormous. Instead of over 83% of your payment in year one going to interest, it is roughly 50%. Instead of paying $547,220 in the example above, this individual only made payments of $413,096…improving their net worth by over $134,000! And that is assuming this individual doesn’t earn ANY interest on that capital over the next 15 years!
Further, a 15-year loan with an extra month’s payment each year would pay off the loan in roughly 10 years!
The Bi-Weekly Mortgage
Many individuals have heard of this strategy, but still many have not. The bi-weekly mortgage payment takes advantage of the fact that there are 52 weeks in the year. By paying bi-weekly, you send 50% of your monthly mortgage every two weeks. By making this slight change in HOW YOU PAY, you send twenty-six 50% payments or 13 FULL payments instead of 12 each year. By employing this strategy, generally, you pay off your loan in 2/3 the time! That is pretty doable for most Americans. It does end up with extra money coming out of your pocket but only one extra payment annually.
The risk to this strategy depends upon who your mortgage lender is. Many lenders will not apply the extra principal until the end of the month. This negates the ability to have the extra principal applied for 2 weeks each month. Reducing the interest cost each month is the core of this strategy. There is, however, a potential workaround… Divide your monthly mortgage payment by 12 and add that amount to each month’s mortgage payment. These funds are applied directly to the amount owed. On the $300,000 mortgage example, that means, send an extra $126.66 each month and your mortgage will be paid off in 2/3 the time!
The following methods require more diligence and planning but are much more beneficial if followed correctly.
Single Payment Acceleration
If you are into your current mortgage by a few years at least, you have likely paid down your mortgage by some measure. The longer you are into the loan the more equity you have built. If interest rates are the same or lower than your current mortgage the potential for this to work is there. Additionally, if your home equity has increased you may have the potential for this strategy.
What you do is the following:
- Refinance your current mortgage to your original terms, (AMOUNT AND LENGTH). By doing so, you should free up some cash.
- Let’s say you had a $250,000 original mortgage for 30 years and you are now 20 years into it. Your balance owed is roughly $166,666. Instead of refinancing the $166k you would refiance the original $250,000 for 30 years again, but…..
- Along with your first month’s mortgage payment on the new loan, make a one-time principal reduction payment. With this additional lump sum payment, you have just reset your amortization to the term left on your original loan!
Just run the numbers either on your own or with your mortgage broker to check out the possibility.
The HEAP method (Home Equity Acceleration)
This more advance strategy uses a Home Equity Line of Credit (HELOC) and a mortgage. If done correctly, it can reduce your payment period from 30 years down to 10 or even less! Are you kidding me? Why isn’t everyone doing this? First, not too many know about the strategy. Second, not too many are disciplined enough to follow it. Remember, it is not in the bank’s interest to tell you how to pay down your loan faster…
Here is the strategy:
- Obtain a HELOC (the largest line the bank will allow), with interest-only payments and the interest charged is compounded daily.
- Immediately pay down your 30-year mortgage with a portion of the HELOC.
- Direct your paycheck into the HELOC account every pay period.
- Take out less than you deposit every month from your paycheck and transfer to your checking account for bill paying.
Well, that sounds really simple. How does this actually work? Spending LESS than what is deposited each month is the key to this strategy. You are in essence applying “savings” to your mortgage in a systematic way and reducing the ways your funds “leak” out through the year. The reason this works so well is that the remaining money from your paycheck is not sitting in a random bank account doing nothing for you, with this model it’s actually paying down your loan balance. Not surprisingly, if you try this and then spend even more than you are depositing it will backfire. If however, you actually do spend less than what is deposited you may be able to pay it off even faster.
By depositing your paycheck into your HELOC you are cutting out the middleman or at least reducing it. The time that your funds are applied to the HELOC reduces the VOLUME of interest you pay over time because the daily interest compounding is temporarily reduced. Doing this consistently adds up over time. With this strategy, you stop lending YOUR money to the bank to use for free. You are borrowing the bank’s money to reduce YOUR mortgage. This is the concept of OPM. Using other people’s money.
Further, this strategy can potentially work using credit lines other than a HELOC if you have excess savings or excess cash flow. I have seen it done with credit cards, other unsecured lines of credit or business loans. In general, HEAP is more complicated but a much more efficient to reduce your debt than just paying more to the mortgage each month. It all has to do with how the bank computes the amortization. Unsurprisingly, the amortization tables are some of the most confusing tables there are and are buried within all the pages of your mortgage paperwork.
Even without using the HELOC, here is another hypothetical using the example of the $300,000, 4.5% mortgage with a $1,520 monthly payment.
- If you have the available cash flow and planned to pay an extra 1/12 each month for a total of $1,619.92 over 12 months, pay it all up front at once with your mortgage payment and reset the amortization schedule. Do this annually and you will reduce the volume of interest paid and improve your net worth faster.
- Whether the funds come from a “savings” account or from a HELOC really doesn’t matter. What matters is getting idle “savings” working for you rather than sitting in a bank doing nothing for you but providing the bank capital.
- If you have an extra $20,000 sitting in a bank savings account earning meager interest, but have access to a $20,000 credit line you may want to consider putting the $20,000 immediately toward the mortgage and then using that line of credit as your emergency fund.
All of these strategies above can be incredible ways to improve your net worth and pay off debt in an efficient, accelerated way. It is important to remember these strategies require discipline and thinking about your finances differently. While DEBT is a four letter word, it doesn’t have to be treated like other four letter words. Use your cash flow, access to capital and savings efficiently and your situation could be greatly enhanced in the next five to ten years!
The information above is not considered educational and not specific investment advice. If you would like to learn more about paying off your mortgage early and how to apply these strategies to your specific financial situation please send me a message via http://celestialwm.com/contact