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January 27, 2020
This has been a hotly debated topic on this Money Tip! I first talked about this last year when talking about “velocity banking”, and it was like lighting a match. If you’re not sure what velocity banking is, you can check out this video for more info.
So, that being said, this week is NOT about velocity banking! This week I’m talking about OTHER methods to chip away at your mortgage in practical ways.
First and foremost, it’s really important to have an understanding of how mortgages work so that you can make choices that help you pay it off in a way that makes sense for you. That means we need to talk about amortization.
Amortization is the process of spreading a loan out into a series of fixed payments. Investopedia defines amortization as:
“…paying off debt over time in regular installments of interest and principal sufficient to repay the loan in full by its maturity date. With mortgage and auto loan payments, a higher percentage of the flat monthly payment goes toward interest early in the loan. With each subsequent payment, a greater percentage of the payment goes toward the loan’s principal.”
Confused? It’s ok! Looking at an amortization schedule might actually help when visualizing how amortization works (Hint:This is why when acquiring a mortgage, working with a professional who can go over a detailed amortization schedule with you is a good idea!)
Yeah, I know this seems like a no-brainer. But some people may not realize that a 30 year fixed mortgage (which is extremely common) isn’t the only option available. You can have 30, 20, 25, 20, etc. There are SO many choices, and it’s a good idea to consider more than one and really think about your long term financial goals when you’re shopping for a mortgage.
For the sake of simplicity, I’ll compare a 30 year mortgage and a 15 year mortgage, both at a 4.5% fixed interest rate, borrowing $200,000.00. The shorter loan term actually saves a ton of money in the long run! Let’s look at the numbers:
30yr Monthly Payment: $1,300.37. Total Interest paid over 30 years: $164,813.42
15yr Monthly Payment: $1,530.99. Total Interest paid over 30 years: $75,397.58
This means that the same exact loan amortized over 15 years instead of 30 saves you $89,414.84
Did your eyes bug out a little bit? Yeah, mine too! Choosing a shorter loan term can save you SO MUCH MONEY. In this example, it’s more than HALF of the money you would have been paying in interest. I don’t know about you, but I love paying 50% less!
Also something to keep in mind, interest rates for shorter terms are usually lower than their long term counterparts. So the moral of this story? Make sure to ask your loan officer to show you more than one option, and if you’re able to make a shorter term mortgage work for you, do it!!
This is by far the easiest and most practical way for someone who already has a mortgage to pay it down faster. Whether it 5, 10, or 100 dollars, putting it towards your mortgage principal makes a difference!!! I swear, every penny counts here. Every time you put extra money towards your mortgage principal, you are making dent!
Did you know that paying an extra ten dollars a month EVERY month knocks off 9-13 months of mortgage payments? That’s huge!! Ten dollars. That’s one lunch out. Or movie ticket. Or cocktail. ONE. If you can manage to put those ten dollars towards your mortgage every month, you just saved yourself almost an entire year of mortgage payments.
Want to really have your mind blown? Paying an extra $100 every month knocks off six to eight years off your mortgage. Read that again: 6-8 YEARS off your mortgage by paying an extra hundred dollars a month!
NOTE** If you’re going to do this, it’s IMPERATIVE that you mark those extra dollars for principal. This strategy only helps pay down your loan if you are putting that extra money towards principal payments. So when you are making that monthly payment, pay attention to the check boxes!!
This is an extremely common strategy. Bi-Weekly payments means that instead of making one mortgage payment every month, you actually make half of your monthly mortgage payment every two weeks. Why does this help? Because by doing this, you actually end up making one extra mortgage payment every year!
You have to be ahead in your mortgage payments to start this, AND you need to make sure that you have the option to implement this with your mortgage company. But if you can, this is an easy way to pay down your mortgage faster!
I bet by now you’re noticing a theme here: The more you pay down your principal, the quicker your mortgage is paid off! It really is that simple.
It all goes back to that initial definition of amortization. Because of that, your monthly payment always remains the same. However, if you are paying extra money towards principal, (either consistently every month, or periodically in large sums) you are reducing the debt owed, and the amount of interest being paid over the life of the loan.
So let’s say you have a large sum of money coming to you- a bonus, commission, inheritance, really awesome birthday present… if you were to put that money towards your mortgage principal, you’re again reducing the amount of money owed, which reduces the amount of time it will take you to pay it back.
Fun fact: If you had a 30 year fixed mortgage, one extra payment a quarter results in an average of ELEVEN years off your mortgage. Obviously this will vary depending on your borrowed amount and rate, but it makes it worth saving up those bonuses and applying them to your mortgage!
I’m a bit conflicted in giving this as advice. I personally think it only makes sense to refinance if you will see a significant monthly savings (more than 200 a month in payments), and/or you can drop private mortgage insurance.
If you can- great! It’s absolutely worth exploring, seeing if you can lower your rate, shorten your term, etc. BUT, it needs to be the right circumstances. Refinancing can cost you money, so you need to make sure that the savings achieved are significant enough to cover whatever cost may be associated with it.
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