Want to know how to pay off a mortgage early? You are smart to learn how to do so, as your mortgage is likely the biggest financial burden you will ever have.
There are legitimate, legal ways to pay off your mortgage early that almost anyone can accomplish. In the process, you will learn how to save yourself time, and money.
I will explain to you what a mortgage is, how lenders make their profits from your mortgage, and some techniques to pay off a mortgage early.
You can benefit from this information if you currently have a mortgage or if you are shopping for a mortgage. (Scroll down for how to pay off a mortgage early)
What is a Mortgage?
A mortgage is a loan from a lending institution, or a bank to provide financing for the purchase of a home, or other property type.
The mortgage allows the lending institution or the bank to use your home as collateral for the loan.
This means if you don’t pay back the loan according to the terms set forth on the mortgage, also known as defaulting, the bank or lending institution can foreclose on the home, and take ownership.
There are several types of mortgages.
The most common mortgage is the fixed rate mortgage. A fixed rate mortgage means that the interest rate is fixed or stays the same throughout the entire length or term of the mortgage.
The interest rate is the agreed upon percentage that the bank or lending institution charges for the priviledge of borrowing their money.
Other available mortgages are the ARM or adjustable rate mortgage. An ARM has a changing or floating rate of interest depending on various economic factors.
The ARM is considered more risky than a fixed rate mortgage due to the fact that the interest rate can rise causing higher monthly mortgage payments.
Two-step mortgages will have the initial period of time at a certain fixed rate percentage, and the second period of time at a different fixed rate percentage.
Combination mortgages or combo mortgages combine a certain period of time at a fixed rate percentage, and an additional period of time with an adjustable rate. The percentage rates, and time periods can vary depending on the lender.
Balloon mortgages normally have a fixed interest rate for a particular period of time, usually with lower monthly payments, and a loan balance, and with a considerable amount or balloon amount due at the termination of a preset loan period.
How Lenders or Mortgage Institutions Profit from your Mortgage
Banks and mortgage lenders profit from your mortgage in different ways, and perhaps more than you realize. Profits are realized by mortgage lenders by the many fees they charge.
These fees are called origination fees, which is what is charged for the processing of the loan.
The origination fee normally is figured at about 1% of the amount of the loan. These processing fees may cover notary fees, document prep work, and the lender’s attorney costs.
Underwriting fees are charged for the analyzation of the mortgage application, which determines the riskiness of approving the loan.
There are other fees such as escrow fees that are normally charged at closing. There are also appraisal fees that are charged by the lender.
PMI or Private Mortgage Insurance is another fee or charge you will incur if you are putting less than 20% down on your home purchase.
This is insurance provided by a private insurer that protects the bank, should you default on your loan, yet you the borrower have to pay for it.
Pretty sweet deal for the lender to have you buy insurance to protect them from loss. You can also purchase additional insurance called an owner’s policy to protect yourself against default.
Lenders also make money from your mortgage based on the difference in the interest rate you agree to pay, and the amount of interest they were charged when they secured the loan.
So, if the lender charges you 5% interest rate, and they paid 4%, they would profit the1% difference.
In addition, lenders often package, or bundle their mortgage loans and sell them to other lenders, and investors in the secondary market. The lender’s normally make an extra 1%-3% by selling these bundled loans.
Keep in mind that for the first time period of your loan, you are paying back mostly interest, and very little principal when you make your monthly mortgage payment.
In other words, because you are not paying down much principle in the first 10-15 years of your loan, assuming you are in a 30 year fixed rate loan, you will not have a lot of equity built up until the later part of the loan term, unless of course you had a large down payment.
Early Mortgage Payoff Techniques
1. Shorter Loan Term Mortgage
The easiest, and cleanest way to pay off your mortgage early is instead of taking out a 30 year fixed rate mortgage or longer duration mortgage, take out a 15 year mortgage or 20 year mortgage.
Chances are, if you qualify for a 30 year mortgage, you can also qualify for a shorter term mortgage such as the 15 year or 20 year.
In many cases, the monthly mortgage payment does not go up commensurate to the drop in loan duration, in effect giving you a discount on the monthly payback amount. You may be surprised at the affordability of utilizing a shorter term loan.
So, if you can qualify for a shorter term loan, and you can afford the higher monthly mortgage payment without strapping yourself in, this may be the way for you to go.
If you already have a mortgage you may want to consider refinancing your loan at a lower interest rate for a shorter time duration or term.
You have to be careful with the refinance though as you may be charged additional fees, and you may be forced to roll back to paying off more interest than principle with your new mortgage payments.
The bi-weekly is a payment structure where instead of making a mortgage payment once a month you are making a half mortgage payment every 2 weeks.
This allows you to make an extra full mortgage payment per year as there are roughly 4.3 weeks in an average month. The extra payment goes toward the principle of the loan.
Thousands of dollars can be saved by implementing a bi-weekly payment structure, and you can pay off your mortgage close to 8 years early on a 30 year fixed rate loan with this technique.
As a result of this simple method, you are reducing the amount of interest charged over the span of the loan.
In order for this technique to work correctly, the lender must credit the payment to the loan’s principle right away instead of waiting until the end of the month to do so, or until two payments are received in order to do so, or until the end of the year to do so.
There will be fees charged. Be sure that these fees are reasonable and you understand how they are charged. Always ask questions, and read the fine print before signing on the dotted line.
3. Make an Extra Principal Payment
You can make an extra payment every month over and above your regular monthly mortgage payment that will be put toward paying down your principal. This amount can vary and be for pretty much any amount you would like to add.
Doing so can cut years off the term of your loan, and save you many thousands of dollars of interest. Obviously, the more often, and the larger the amount of the extra principal payment, the sooner your loan will be paid off, and the more money you will save on interest.
4. Home Equity Line of Credit or HELOC
Based on the amount of equity you have in your home, equity is determined by the amount of appraised value of your home minus the amount that is still owed on the mortgage, you can utilize a home equity line of credit.
The idea is, you can use the amount of the home equity line of credit to pay down the principal of your mortgage.
Normally the interest rate you will pay on the HELOC is slightly more than what your mortgage interest rate is.
By paying back the HELOC amount in a year, you can then use the same strategy again, and continue to do so every year until the mortgage loan is fully paid off. It is possible to pay off your mortgage loan in under 6 years using this strategy.
By doing so, you can drastically shorten the number of years that you will have to pay on your mortgage, and not only save many mortgage payments, but also save many thousands of dollars in interest.
There are some risks using this strategy as the HELOC is a variable interest rate ‘loan’, so the rate can rise. Also, some HELOCs may have a balloon component, which can force the entire amount of the loan to be paid back in full instead of over time.
Best to check with a financial advisor, and do your research and due diligence before employing any of these strategies.
Know how to pay off a mortgage early
A mortgage is a loan from a lender to provide financing for a home purchase. Types of mortgages are fixed-rate, adjustable rate, , two step, combination, and balloon.
Lenders or mortgage companies profit from your loan from fees, points, interest, and bundling your loan with others and selling them.
Early mortgage payoff techniques are, a shorter term mortgage(less than a typical 30 year note), bi-weekly, making an extra principle payment, and the HELOC, or home equity line of credit strategy.
What is your favorite how to pay off a mortgage early strategy? Do you have another early payoff strategy that you like or use? If so, I would like to learn about it.
Feel free to leave a comment, or question below.
Thank you for reading.