How To Pay Off Your Mortgage Early And What To Consider
According to the National Association of REALTORS®, 87% of home buyers used a mortgage to finance their home in 2021. But mortgages can be daunting to take on, considering that they’re often 30-year commitments.
You may need to take out a loan to purchase your home, but do you want to be in debt for the next 3 decades? The good news is that in many cases, you can pay off your mortgage early. But before you decide to do that, there are some things you should know about the proper procedure.
Can You Pay Off A Mortgage Early?
Yes, it’s possible to pay off your mortgage early. In fact, doing so can help you save a great deal of money in the long term. Making extra payments, even if just in small amounts, can help you own your home outright sooner. Extra payments, refinancing or adjusting your repayment schedule can be useful methods for paying off your mortgage earlier.
Benefits of Paying Off A Mortgage Early
There are several benefits that make paying your mortgage loan off early worth it. Let’s take a look at some of these benefits.
Own Your Home Outright
Paying off your mortgage early can provide you with a sense of security. Should your financial circumstances change in the future, you’ll only have to worry about paying taxes and insurance because you’ll own your home outright. Furthermore, you’ll have equity in your home that you can use to borrow funds for future or unexpected needs, such as making home improvements or repairs.
Reduce The Amount Of Debt You Have
Mortgage debt is a significant undertaking, especially if you also have credit card debt, student loan debt, etc. By paying off your mortgage early, you’ll reduce a substantial portion of your debt and free up more funds to make your other monthly payments.
Reduce Your Interest Payments
As you pay off your mortgage, the first payments you make primarily go toward the interest on your loan. The longer that you carry your mortgage, the more you’ll have to pay in interest over time. Choosing to pay your loan off early can help you save a significant amount of money by avoiding additional interest charges. This is especially true for homeowners who had locked their mortgage into a higher interest rate originally.
Increase Your Cash Flow
Since your mortgage is a major monthly expense, paying it off will provide you with a considerable amount of money that you can put to use. With the increase in cash flow, you can grow your savings, contribute more to your 401(k) or IRA retirement savings, make improvements on your home, travel to new parts of the world or invest in the stock market. Paying off your mortgage early affords you the freedom to do what you wish with your money.
How To Pay Off Your Mortgage In 5 Years
Assuming your lender allows you to pay off your mortgage faster and that an early payoff is financially worthwhile, you’ll want to determine what the most realistic course of action will be based on your finances.
Many people who set the financial goal of paying off their mortgage in 5 years are a part of what’s called “the FIRE movement.” “FIRE” stands for “Financial Independence, Retire Early.” These are aggressive plans to achieve financial independence, but they can be useful in helping a borrower with the means to reduce their debt faster.
So, how do you pay off your mortgage in 5 years?
There are a few steps that you’ll need to take in order to meet this goal. Regularly putting extra money toward your payments will prove to be worthwhile in the long run, but this should be done strategically. Let’s take a look at the process.
1. Put 20% Down
Making a 20% down payment on a home is a helpful way to avoid extra expenses. With a smaller down payment, you may be required to pay private mortgage insurance (PMI). However, by putting 20% or more down, you’ll take out a smaller loan. And you won’t be required to pay PMI on a conventional loan. Not having to make this extra expense each month can help you make larger payments toward your mortgage loan.
2. Create A Budget And Stick To It
The most effective way to gain the funds to pay off your mortgage early and finally own your home outright is to reduce your number of nonessential expenses. Eliminating vacations, unnecessary purchases and dinners out can go a long way in helping you to reduce your personal spending.
When deciding to pay off your mortgage early, make sure you begin by developing a budget for all of your spending. A personal budget can go a long way in helping you monitor your finances and become more intentional about what you do spend. However, you don’t want to use all your available funds on your mortgage and not contribute to emergency funds and your 401(k) or IRA.
3. Make Larger Payments More Frequently
Making extra payments toward your mortgage can help pay it off faster. While some people choose to make additional payments on a consistent basis, others do so whenever they come across some extra cash. The specific way that you choose to make extra mortgage payments should be based on your budget.
Just make sure that if you make extra payments, you tell your lender that you want the money to go toward lowering your mortgage principal. If you fail to make this clear, your lender could instead use the additional funds to pay off the interest.
4. Make Biweekly Payments
Dividing your monthly mortgage payments into biweekly payments is another way you can pay off your mortgage faster. Through this method, you can shave months off your mortgage term and save thousands of dollars on interest without having to make a significant change to your monthly expenses. If you’re paid biweekly, making payments biweekly may be more feasible for you anyway, as you can schedule your payments around your paydays.
This works because there are 52 weeks in a year. Paying biweekly gives you the yearly equivalent of one extra monthly payment that can go directly toward the principal.
5. Refinance Your Mortgage
Refinancing your mortgage enables you to trade in your current loan so you can benefit from different terms – maybe a lower interest rate or a different term length. Shorter-term loans usually have lower interest. So, even if interest rates haven’t dropped since you obtained your loan, you can still usually secure a lower interest rate when you refinance by choosing a shorter-term loan.
While you’ll have to pay closing costs on your refinance, they’re typically cheaper than those you pay when obtaining a loan to purchase a home. If you’re choosing to refinance, make sure to ask how much the closing costs will be, and whether your lender charges prepayment penalties.
Once you know what the closing costs look like, you can calculate a breakeven point and figure out whether the refinance makes sense. If your breakeven point is less than five years, it might make sense to refinance when on the 5-year FIRE plan.
Questions To Ask Before Paying Off Your Mortgage Early
Now that you understand the benefits of paying your mortgage off faster, you may be convinced that it’s the right move for you. But don’t get ahead of yourself – there are some questions that you must ask your lender to ensure this is a viable option.
What Are The Current Terms Of Your Mortgage?
Knowing the length of your loan term will help you determine how long it will take you to pay off your mortgage if you make the minimum payment each month. Being aware of your interest rate will tell you how much interest you’re currently paying on the remaining balance of your mortgage principal.
You should also see whether you agreed to a fixed- or adjustable-rate mortgage (ARM). If you have an ARM loan, you’ll want to know how market rates have changed since you first obtained your mortgage. If market rates are higher, paying off your mortgage early may be the right move.
Will Your Mortgage Company Let You Pay It Off Early?
When you pay off your mortgage faster, you pay less interest, and the investors who own your mortgage make less money off your loan. For this reason, not all mortgage companies permit their clients to pay off their loans earlier than stipulated in their contract. So, before you make any grand plans, double-check that your lender will, in fact, allow you to pay off your mortgage faster.
Is There A Penalty For Paying Off Your Mortgage Early?
Some mortgage companies charge borrowers with a prepayment penalty for paying off their mortgage earlier than their loan term. If this fee is set, lenders will typically charge their clients a percentage of the principal balance that would’ve remained, or the amount of interest that would’ve been paid. Prepayment penalties are used to discourage individuals from making extra payments on their loans or refinancing at a lower interest rate, which in turn allows lenders to collect interest. Rocket Mortgage does not charge prepayment penalties.
Should You Pay Off Your Mortgage Early?
Several benefits come with paying off your mortgage early. The faster you pay off your mortgage, the sooner you can gain full ownership of your home. This means you’ll eliminate the risk of foreclosure and gain equity that you can borrow against. By paying off your mortgage early, you’ll also reduce the amount of interest you have to pay on your loan, free up funds to pay off other debts, be able to save money for retirement and gain the ability to invest your extra savings.
However, it’s important not to put yourself into a situation of becoming house poor. Sinking too much money into your home can leave you with little cash for emergencies and unexpected expenses. Before committing to a stringent plan of paying off your mortgage in 5 years, ask yourself whether this financial goal is right for you.
The Bottom Line: Reduce Your Debt, But Do So Wisely
Paying off your mortgage faster can be tempting, as it enables you to finally own your home outright, get ahead of your debts and start investing your money. However, if it’s not right for you, there may be other financial options that you can consider.
Speak to one of our experts if you want more advice on paying off your mortgage early. Or, apply online if you're ready to refinance your loan today and achieve your goals!