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For many people, their mortgage is the longest-term—and biggest—debt they’ll ever have to manage. Even though a mortgage gives you access to a very valuable asset, many homeowners often feel "house rich, cash poor" as they the cost of homeownership eats up most of their monthly budget. So it comes as no surprise that many people want to pay off their mortgages early.
Here are five tips to help pay off a mortgage early:
- Make extra payments
- Refinance your mortgage
- Make biweekly payments
- Rent out part of your home
- Put unexpected cash toward your mortgage
Read on to learn more about how to pay off your mortgage early, along with some benefits and risks of doing so.
Can You Pay Off Your Mortgage Early?
In most situations, yes, it's possible to pay off a mortgage early, usually with no early payment penalties. However, lenders may charge a prepayment penalty, which is essentially a fee to incentivize homeowners to pay back their mortgage loan over the life of the loan—so the lender can collect more through interest payments.
It’s always best to double-check with your lender about whether you can pay off a mortgage early and if there is a provision in the mortgage agreement for prepayment penalties. That said, these five strategies could help you pay down your mortgage faster.
1. Make Extra Payments
Making extra payments is very effective and one of the most common ways of paying off a mortgage early. With each mortgage payment, some of it pays for your interest and the rest goes toward the principal balance. The interest is what you pay the bank to borrow its money, and the principle is the actual amount you borrowed. When you make extra payments, 100% of the additional payment can go toward the principal.
For example, you could make one extra payment a year by tacking on one-twelfth of your overall payment each time you pay your mortgage (which adds up to an extra payment, if you're making 12 payments a year normally). Another option is making a 13th payment at the close of the year.
2. Refinance Your Mortgage
The goal of refinancing a mortgage is almost always to save money on monthly mortgage payments. When you secure a lower interest mortgage rate loan and reduce your monthly payments during refinancing, this can make it easier to pay extra every month. This extra cash will go toward your principal, reducing that element of your obligation. This speeds up the process of chopping your principal down to zero.
Note that refinancing does involve closing costs, so take these costs into consideration as well.
3. Make Biweekly Payments
Some homeowners choose to make biweekly payments, which means making half of your monthly payment every two weeks, totaling 26 payments a year. By the end of the year, you will have made one full additional payment. This reduces your principal quicker because you chip away at it in small increments throughout the year and get closer to the mortgage finish line sooner. You'll also pay less interest overall when you have less mortgage payments left.
For example, suppose a homeowner's monthly mortgage payment is $1,600 a month, or $19,200 a year. If they switch to biweekly payments, they pay $800 every two weeks for 26 payments. That essentially ends up being an extra mortgage payment annually, or $20,800 per year. You can pay down the principal faster and save on interest.
4. Rent Rooms in Your Home for More Income
Not everyone has extra cash lying around to dedicate to extra payments regularly. So some homeowners decide to rent out a room or portion of their house to get a little extra income. You can look at having a long-term tenant, or even short-term renters through platforms like Airbnb once you research local ordinances. Even if you only rent a room during certain times of the year, like summers or winter holidays, it could help you make an extra mortgage payment here or there.
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5. Use Unexpected Funds for Your Mortgage
Whether it's in the form of a big bonus at work, inheritance money, a bonus from a new credit card offer or a big tax refund, these extra funds might go a long way toward paying down your mortgage. Depending on your situation, you might make a one-time lump sum payment or put a little extra toward your monthly principal for several months.
Benefits of Paying Off Your Mortgage Early
There are several benefits to paying off a mortgage early, particularly when it comes to one's long-term financial trajectory.
Pay Less in Interest
A big benefit is that homeowners end up paying less in interest if they pay off their mortgage early. The fewer payments you make, the less in overall interest you'll pay your lender. This can translate into tens of thousands of dollars, or even more, depending on the value of your loan. Just be sure to clarify with your lender that you are putting your extra payments toward your principal rather than in interest payments.
Reduce Long-Term Debt
Many mortgages last 30 years—or longer in some cases if a refinance is involved. While your current income may be sufficient in handling their mortgage payment, that may not always be the case if your job changes or you retire. Not having to worry about paying off a mortgage during retirement when income is substantially less can be a big benefit.
In addition, someone thinking about passing on their assets to their heirs may prefer to pay off their mortgage early. This way, instead of passing on additional debt payments to beneficiaries, they can provide a valuable asset.
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Improve Chances of Getting Another Loan
Having a mortgage doesn’t damage your credit score if you’re paying it on time. But if you're looking to secure a large loan in the future, you might benefit from paying off your mortgage early because that reduces your debt-to-income ratio.
Debt-to-income ratio measures the amount of debt you have in relation to the amount of money you have coming in. If the amount you owe is too close to your income, lenders may think twice before granting another loan.
Risks of Paying off Your Mortgage Early
While paying off a mortgage early does have a lot of positives, there are also a couple of downsides and risks to consider.
Potential Drain in Cash Reserves
By paying off your mortgage early, you may be dipping into your cash reserves or emergency fund and find yourself even more cash poor. If an emergency arises and have little to no cash reserves to pay for the emergency, you could end up taking on additional—and more expensive—debt through other loans.
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Cash Might Have Earned More in Investments
It may be tempting to pay down your mortgage with a lump sum of cash, but you should first take into consideration the opportunity costs associated with draining your cash reserves. The money used to pay down a mortgage early might have grown in value through other investments.
Whether it's starting a business, investing in someone else's business venture, stocks, commodities or other investments, the potential payoff could be worth more than what was saved by paying down a mortgage. However, as with all investments, there is no guarantee.
Is Paying Off Your Mortgage Early Worth It?
Paying off your mortgage early is worth it for many people because it often frees up more money for other financial goals, like retirement or not having to worry about debt. In some situations, however, it may be better to not pay off a mortgage early. For example, if you managed to get a record-low mortgage interest rate, there may be no rush to pay it off since you're not paying a lot in interest each month. Or, if paying off a mortgage early means tapping into cash reserves that will leave you without an emergency fund, that may be a risky move.
Whether or not you decide to pay off a mortgage early depends on your financial situation, and it's always a good idea to consult a financial advisor first.
Paying off your mortgage early does have its benefits, including freeing up your monthly budget and paying less in interest charges. But also consider the disadvantages, such as how much money you could have made by investing instead. Assess whether it's more important to have the extra cashflow and to save on interest or if you prefer to maximize the use of your cash through other ventures.
This depends on what is more important to you and what stage of the mortgage you're in. If you're at the beginning of the loan and far from retirement, it might make sense to pay a little extra so you can pay less in interest. But if you are close to retirement and nearing the end of your mortgage, you may gain more benefits from focusing on saving for retirement instead.
Many homeowners choose not to pay off their mortgages early because it would pose a financial hardship, as not every household has the cash reserves for an early payoff. Also, some people prefer to commit their extra money to other investments, while others may feel their monthly mortgage payments are affordable enough so they are not in a rush to make the extra payments.