The 30-year mortgage was created to make buying a home more affordable. With repayment spread over 30 years, you get monthly payments that fit your budget. However, spreading the loan over 30 years means you end up paying a lot in interest—sometimes hundreds of thousands of dollars in interest, depending upon the size of the loan and interest rate. Luckily, there’s something you can do about it—you can pay your mortgage off early.
Mortgage repayments are structured so that each month you pay interest on the money you owe (the principal), plus a portion to reduce the principal. Early in the loan period, most of the money you pay goes to interest. Each month a slightly larger portion goes toward the principal, reducing the amount of interest on the next payment. To speed up payment, you need to reduce the principal faster.
Before you jump into prepaying your mortgage, however, make sure there isn’t a prepayment penalty. When a mortgage has this penalty, it’s usually in effect during the early years of a loan and it will be disclosed in your loan documents. Often the disclosure is called “Addendum to the Note,” according to the Consumer Financial Protection Bureau. Paying off your mortgage early boils down to paying more toward the principal as soon as you can. Use a mortgage calculator to see how regular or one-time extra payments will affect your payoff period.
Now let’s look at some ways that you can chip away the amount you owe to pay off your mortgage sooner.
1. Refinance to a 15-year loan
If you have a loan for 15 years instead of 30 years, you pay about half as much interest, or possibly less because 15-year loans usually have a slightly lower interest rate than a 30-year loan. If you’ve had a 30-year loan for 5 years and switch to a 15-year loan, you end up paying off your house in 20 years and save a good deal of interest.
If you like the certainty of knowing exactly when your house will be paid off and how much you’re going to pay every month, a 15-year mortgage might be good for you. However, there are some drawbacks to this method for speeding up payments. First, refinancing isn’t free. You’ll have to pay all of the fees associated with taking out a loan, such as the application fee, closing costs, and an appraisal. That’s money you could be applying to the principal of your loan. You’ll also be locked into the higher monthly payment that a 15-year loan requires.
2. Pay more every month
Another way to fast-track your mortgage is to simply pay more every month. If you get a raise and have an extra $100 each month in your budget, add that amount to your monthly payment and mark it “apply to principal.”
This is a no-fee, flexible way to speed up repayment. If you have an unexpected expense one month, you can skip the extra payment. If you get another raise, you can increase how much you apply to the principal each month. Paying an extra $100 each month will cut four years off the repayment of a 30-year, $250,000 loan at 4% interest (if you start as soon as you get the loan). You’ll also save nearly $28,000 in interest.
3. Pay biweekly
The idea behind a biweekly payment is to pay half of your monthly payment every two weeks. Because there are 52 weeks in a year, you end up making 13 payments instead of 12 each year, and the 13th payment can be applied completely to the principal. This may be particularly appealing if you’re paid every other week.
However, most lenders don’t accept biweekly payments, and services that offer to do this charge high fees. But you have options. If you want to make the equivalent of an extra payment a year, divide your current payment by 12 and add that amount to your payment each month. For example, if you pay $1,800 a month for your mortgage, you would add $150 each moth.
If you’re paid biweekly, half of your monthly mortgage payment could be direct-deposited in a dedicated account with each paycheck. Make your regular payment in months when you get two paychecks. When you get a third paycheck in a month, add the additional half-payment amount that’s sitting in your account to your regular mortgage payment. This eliminates the need to do any math and allows you to make the payment only when you have the money on hand, thanks to the third paycheck.
4. Pay more annually
If you’d prefer to make one large payment rather than 12 small ones, send an extra payment annually to your mortgage lender. This is another no-cost, flexible way to shorten your loan term.
If you like the biweekly-payment goal of an extra mortgage payment a year, that can be the amount you send annually. Or you can set a goal, like $2,000 a year, and set up automatic deposits into a savings account so you’ll have the money in the bank when you send it to the lender.
5. Use a windfall
Maybe you’re sticking to a budget without a lot of extra money to apply to a mortgage payment every month. You can still shorten the payoff time by applying “unexpected” money that comes your way. When you get a tax refund, make some overtime pay, or get a rebate, apply that money to your mortgage.
Making sporadic extra payments doesn’t allow you to target a specific date to pay off your mortgage, but it will still shorten the time and reduce the amount of interest you pay. The earlier in the loan you can pay down the principal, the bigger effect it will have overall.
6. Invest now, pay later
Paying off your mortgage early reduces the amount of interest you pay during the life of the loan, but it doesn’t increase your money. To increase your money, you have to invest it. If you have a specific date when you want to have your mortgage paid off, you can use any of these “pay more” strategies to work toward that goal. Alternatively, you can take the extra money you’d put into the mortgage and invest it for the same period, then use it to pay off the loan.
Ideally, your investment will have grown large enough to pay off the house and more. The drawback is that investments aren’t guaranteed. In addition to the ups and downs of the stock market, you may also face investment fees and income taxes on the gains you realize, so you need to weigh the pros and cons.
7. Have your house pay for itself
Could you do a short-term rental of your house to raise money to apply to the principal? You could try doing this regularly if you have an in-law suite available, or you could rent out your home while you’re on vacation for a week or two each year.
Many homeowners in Augusta, Georgia, famously leave town and rent their homes out to golf fans during the Master’s Tournament each year. The rental rate for the week sometimes covers several months of mortgage payments. If you’re in an area that attracts tourists or business people for a particular season or event, this option might provide funds to help shorten your mortgage.
Other considerations
While paying off your mortgage sooner is a noble goal, financial advisers suggest that your mortgage shouldn’t be your biggest concern. If you have credit card debt, a car loan, or student loans, they likely carry a much higher interest rate than your mortgage. It would be wiser to put any extra money toward paying off those debts rather than your mortgage.
There may be other expenses you should be saving for, as well, including retirement or a college fund for your children. You should also have an emergency fund or savings account to cover unexpected expenses. While your home is your largest investment, it’s also one that’s not easy to tap when you need extra cash. Putting all your money into your home, then having to take out a home equity loan to cover an emergency completely defeats the purpose of paying your loan off early.
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Kimberly J. Howard, CFP® Blog 