wtopstaff September 26, 2014 12:00 am09/26/2014 12:00am
Some are better off using the money elsewhere, but extra payments and refinancing can do a number on your mortgage.
The mortgage burning party may have gone the way of the rotary phone, but that doesn’t mean Americans don’t own their homes free and clear anymore. In fact, about 34 percent of homeowners in the U.S. no longer have a mortgage, according to U.S. Census data.
The stories of people who pay off 30- year mortgages after 30 years in the same home are indeed rarer than they once were. But the recent foreclosure crisis did serve as an incentive for homeowners to pay off their loans sooner rather than later — and some have actually given it a try.
Jackie Beck, creator of the Pay Off Debt app, and her husband paid their $95,000 home mortgage in less than three years. To finish off the mortgage, they repeated the same tactics they had used to vanquish their credit card, student loan and auto loan debt. The secret to their success? They started earning more money but didn’t increase their expenses, plus they were careful not to borrow any more money.
For Beck and her husband, the major benefit was having more money for travel and other goals. Not having to make a house payment also meant that Beck could quit her full-time job and focus on marketing her app and running her own The Debt Myth website business.
While living mortgage-free may sound like an enviable goal, paying off your mortgage early isn’t always the best use of your money, says Todd Tresidder, a financial coach and author who publishes the website FinancialMentor.com. He was asked about the merits of paying off a mortgage early so many times by his readers and clients that he wrote up an exhaustive 5,200-word article, with charts, covering all the considerations.
The 140-character Twitter version: You might be better off putting your extra cash elsewhere, but the emotional payoff of being debt-free matters.
“The intuitive response is to get out of debt. We all want the security of owning our castle free and clear with one less expense to deal with. The prospect of making monthly payments for the next 30 years is antithetical to freedom,” Tresidder wrote. “However, there are times when intuition and finance disagree. … The correct answer is not cookie-cutter but must be custom fitted to your personal financial situation.”
If you have high-interest credit card or student loan debt, you’re much better off paying those off before making extra mortgage payments. Saving for your child’s college education and funding your 401(k) at least to the point of getting the maximum employer match — and maybe more — may also be more important than getting ahead on your mortgage.
Beyond that, you want to make sure you have enough cash on hand for emergencies because drawing from your home equity isn’t always easy. If your mortgage is underwater, or if you anticipate losing your house to foreclosure or short sale, making extra mortgage payments is just throwing money away.
The harder calculation is whether you’re better off investing your money or applying it toward your mortgage. When the market is strong (for whatever investment you’re making), you will likely earn much more on your investments than you are paying in interest on your mortgage. But if your investments lose money, you would have been better off applying that cash to your mortgage.
Many people aim to pay off their mortgages before they retire, but even that may not be the best move in all circumstances.
Having a mortgage does provide a tax break, but it’s not as good a benefit as many people think. According to an analysis of 2012 tax data by The Pew Charitable Trusts, just under 24 percent of tax filers claim the deduction. Many homeowners, even those who itemize, often find they do better on their taxes with the standard deduction.
For those homeowners who are fully funding their retirement accounts, are free of high-interest debt and have enough cash socked away for other life goals, here are eight simple ways to pay off your mortgage early.
Add something to every month’s payment. The advantage to extra payments is that all that money goes toward principal. Early in a mortgage, most of your regular payment goes toward interest. According to calculations by Bankrate.com, if you added an extra $100 to your payment of a new $100,000 30-year mortgage at 4.5 percent interest, you’d pay off the mortgage eight and a half years early and save more than $26,300 in interest.
Make a payment every two weeks. There are companies that volunteer to set this up for you, for a fee, but you can do it yourself for nothing. You’re effectively making a full extra payment each year. Paying half your mortgage payment every two weeks, on that same $100,000, 30-year mortgage at 4.5 percent, would cut just under 5.5 years off the term and save roughly $14,000, according to a calculator at The Mortgage Professor site run by Jack Guttentag. Splitting your mortgage payment into two pieces produces minimal savings.
Make extra payments whenever you can. Beck and her husband started by paying $35 extra per month, but then began making additional payments, at one point so eager to pay off the loan that they made eight payments in a month.
Make one extra payment a year. This provides about the same savings as making half a payment every two weeks. When you make the payment isn’t important. You could make it at the end of the year or wait until you get a tax refund or a bonus.
Refinance your mortgage to a lower rate, and keep making the higher payment. The amount this will save depends on the exact figures, but it should shave years off your mortgage and save you thousands in interest.
Refinance your mortgage to a shorter term. This cuts the amount of interest you pay significantly as well as getting you out of debt sooner.
Contribute funds from another source. Designate money from a bonus, odd jobs or freelance work toward paying of the mortgage. If your income is variable, rather than making regular additional payments toward principal, make one big payment when you can.
Cut expenses and put the savings toward your mortgage. Change to a cheaper cellphone plan, cut the cable cord or otherwise cut living expenses and devote that extra money to extra mortgage payments. Living a frugal lifestyle may be difficult in the moment, but it’s worth the struggle if your ultimate goal is to be debt-free.