Why Pay Extra Toward Mortgage Principal?
There are many reasons why people pay off a mortgage early. They may want to be debt-free, for example. They may want the house paid off before retirement.
From a strictly financial point of view, you will want to pay down or pay off the mortgage if you expect the after-tax returns on your investments to be less than the effective rate on your mortgage.
The effective rate includes any realized tax benefits from the mortgage interest deduction. A mortgage with a stated rate of 4.5 percent might have an effective rate in the mid-3 percent range depending on your tax bracket and your ability to fully utilize the deduction.
It’s the American dream to own your own home and dreamers will go to any lengths to accomplish this even if it means borrowing thousands of dollars to be paid back over a 30 year period. It’s quite an obligation to make 360 payments month after month with the bulk of the money going toward interest, at least in the beginning.
The interest on an average home over a 30 year period can account for twice the cost of the home. Interest is working against you 24/7/365. Wouldn’t it be wonderful if you could pay off your debt years sooner and save thousands of dollars?
You can. It just takes discipline and perhaps a little budget adjusting. It’s no secret that paying the mortgage twice a month, instead of only once will save you thousands and pay off your debt years sooner. Some call it the bi-weekly mortgage plan.
For example: Let’s say you paid $80,000 for your home and got a 7% loan for 30 years. If you divide the payment in half and pay it every two weeks you should save $25,000 in interest payments and reduce the term by 8 years.
Not bad for a little extra work. Of course, the higher the loan and interest, the more you save. You’re paying less interest and more on the principal. The extra payments bring down the principal and interest faster.
Can just setting up a shorter mortgage term in the beginning accomplish the same thing? Essentially yes. But many people cannot qualify for a shorter term mortgage because of the higher payment. With the bi-weekly plan, you can take control yourself and enjoy the flexibility.
There are many companies who will set this up for you for a fee ranging from $100 to $400. Or, some will do it free but charge a transaction fee each time you make a payment.
Can you do it yourself? Yes, but talk to your lender and read the fine print in your contract. You may have a pre-payment penalty for paying off the loan ahead of time. Some lenders also tack on a service fee each time you make the extra payment.
Banks can also provide you with a bi-weekly calculator to let you determine how much you would save and how soon you would actually own your home. You’ll also save on private mortgage insurance (PMI) by paying off the loan early.
By paying bi-weekly, you’re actually paying one extra payment a year and that makes the difference. You can accomplish the same thing by making an extra payment whenever you can of any amount. When you do this, write a separate check with a note that states the money should be applied to the principal and not the interest.
Most financial institutions are happy to help you with saving money on your mortgage but it’s up to you to get the financial ball rolling. For about the cost of dinner and a movie for you and your family each month you can be debt free years sooner and save thousands of dollars.