How to Pay Off My Mortgage Early
By Brandon Cornett | © 2014, all rights reserved | Duplication prohibited
Reader Question: "I want to pay off my home loan early, but I don't know the best way to go about it. How do I pay off my remaining mortgage balance early? Is it as simple as making extra payments each month?"
Yes, it's as simple as paying more every month. That's how to pay your mortgage off early. But first, you need to determine (A) how much extra to pay each month, and (B) what type of penalty you might encounter for the early payoff.
You also need to think about what else you could do with that extra bit of money you'd be spending each month. If you could put it toward an investment that will get you a higher return (than the amount you'll save by paying off the loan sooner), then you might want to think twice about it.
So the first thing you need to do is find out how much money you could save on interest by cutting down the term of your loan. Depending on how much extra you pay each month, this could be a significant amount of money.
For example, let's say I have a 30-year mortgage loan for $250,000, with a 6% interest rate. If I paid an extra $225 per month (starting early on), I could pay off my loan early by roughly eight years. More importantly, I would save nearly $100,000 by paying less interest for fewer years.
Remember, during the first few years of your mortgage payback period, the majority of your payment goes toward interest. By making extra payments each month, you would start reducing the principal faster and sooner. This could add up to large savings, as shown in the example above.
Of course, all of this depends on the terms of your loan. If you want to pay off your mortgage early, you need to start by reading your loan documents. Some lenders don't allow this kind of thing, or else they charge you a penalty for early payoff of the loan. You have to factor this into your decision-making process.
Good and Bad Reasons for Early Payoff
Why do you want to pay off your mortgage early, anyway? What are your long-term financial plans? What else could you do with that extra bit of money you'll be applying to your balance each month? These are all questions you need to answer before making a final decision.
In some cases, an early payoff doesn't make sense. For example, if you're going to incur large penalty fees for paying it off sooner, then you might want to think twice. Additionally, if you're already stretching your monthly income to the limit, it might not be the best time to increase the size of your monthly payment.
Here's a scenario where an early payoff might make sense. Let's say I'm planning to retire in a few years. I'm gainfully employed right now, so I have extra money left over each month (after paying all of my bills). But when I retire, I'll be living on a reduced income. In this situation, I could pay off my mortgage early to reduce my monthly expenses during my retirement years. I have the money to do it now -- but I won't be able to do it later. If I can still make contributions to my retirement account, while making those extra monthly payments toward my principal, it's even more sensible.
On the other hand, if you're planning to sell the house and move within the next few years, it doesn't make sense to increase your payments. This might seem obvious, but you'd be surprised how many people try to pay off their mortgages early, only to end up moving a few years later. I had a friend who refinanced into a 15-year loan and started doubling up on his payments. He was obsessed with the idea of an early payoff, for whatever reason. Long story short, he eventually changed his mind and sold the home two years later. Of course, by then, he had paid two grand in closing costs and thousands more in monthly payments.
Here's the bottom line: If you're thinking about paying your mortgage off early, you need to consider your long-term plans. You also need to think about the other uses for your money, and what you might get in return. The answer lies somewhere in between.
How Much Extra to Pay Each Month
So how much extra do you need to pay each month, in order to pay the balance off sooner? To determine this, you'll need to use an extra payment calculator. You can find plenty of these calculators online, just by doing a Google search for that phrase.
Most financial experts recommend that you include a separate check with your monthly payment, in addition to the regular payment you're currently making. They also advise you to write "FOR PREPAID PRINCIPAL" in the memo line, along with a note to that effect. You want the additional payment to be applied to your principal.
Just remember to read all of the fine print in your mortgage paperwork, to find out how your lender handles this sort of thing. You can probably find it in the FAQ section of their website too.
Disclaimer: This article explains how to pay off a mortgage early, but it's intended for a general audience. The information in this article may not be relevant to your situation. You should always read your loan documents to find out how your bank handles early payoff / payments.
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