The bubble burst. The folly of interest only, negative amortization, and option arm mortgages have been exposed. Americans are fleeing from short term questions--"What's my monthly payment?"--to long term questions--"How can I pay my mortgage off sooner?" It's easier than you think.
How to Pay Off Home Mortgage Sooner
The word mortgage comes from the French. It means until death. In feudal times peasants were not allowed to move freely or own land. Once peasants were given legal rights, French landlords, no longer allowed to bind peasants to the land, became bankers, giving peasants land in return for monthly payments, payments intended to last until death. Things have progressed since feudal times. Homeowners now are only enslaved for 30 years.
I'm not sure when 30 yr. mortgages became the norm. Someone thought that 15 years of enslavement was not enough. Lenders are now pushing 40 and 50 year mortgages. The recent housing boom and subsequent bust was fueled by lifelong interest only and negative amortization loans, loans in which the balance went up monthly. It's time to take a stand.
The good news is knowing how to pay off your mortgage early is simple. Doing it? Easier than you think.
How to Pay Off Your Mortgage Early: Budgeting
King Naaman in the Old Testament was a leper. He consulted with Elisha the prophet who responded by telling the king he could be healed by bathing seven times in the River Jordan. The king initially refused to obey, considering the method too simple to be effective. A wise counselor convinced him otherwise; Naaman did as he was told and was healed.
Consumers yearning to be debt free are much like King Naaman: looking for complex solutions for their problems while disdaining the actual remedy. I'm not suggesting you bathe seven times in the river. I'm just advising you to budget better.
A 30 year mortgage, if paid monthly, is about 60% paid off in 24 years. If the borrower makes one extra monthly payment per year on a 30 year mortgage, the entire mortgage is paid off in 24 years. That's six years of vacations, helping your children with college, or bolstering your retirement accounts.
To understand this, let's look at how your mortgage payment is determined. We'll use a $200,000 mortgage at 6.0% for our example.
- The monthly payment would be $1199.10.
- The interest payment is $200,000 * .06 = $12,000/ 12 months = $1000
- The principal payment would be $199. That's right. After one month you will have paid $1199.10 and your balance will have gone down $199.
- A lower principal balance = a lower amount of interest. Each month the amount of interest paid goes down and the amount of principal paid goes up.
- Anything extra
But who has an extra $1200 to make that extra payment? You do.
The Secret? Bi Weekly Payments
The easiest way to pay off your mortgage early is to change the payment schedule. Instead of making one payment monthly, make 2 half payments every other week. This is especially easy if you get paid weekly or bi-weekly. By the end of the year you will have made 26 half payments or 13 full payments. It can be set up with your lending institution (some charge a small fee. Don't pay it) or automatically through your bank. Make sure you notify your lender that you want the extra amount applied to principal immediately.
If your lender reamortizes daily instead of monthly, your principal amount will decrease more quickly. The only bank I know of that reamortizes daily is Citicorp Trust Bank (ironically, a subsidiary of Citigroup, the king of toxic mortgages).
But how does this work?
- Take your monthly mortgage amount and divide it by 12. This is how much extra you will pay per month.
- Using our above example, take $1199.10/12 = $100.
- The monthly payment has gone up to $1299.10. For $100 extra per month, you will have your home paid off seven years sooner.
If you're not sure you can do this, make a list of all the things you waste money on each month. I'm guessing it's a lot more than $100.
- If you get paid twice monthly, divide the 1299.10 by 2, and make that payment after each paycheck. That's $50 per paycheck for seven years of freedom.
If you're still not convinced this is a simple way of how to pay off your mortgage faster, take a portion of your income tax return and make an extra payment once per year.
- Still not convinced--You will have paid $231,676.38 on a $200,000 loan at 6% interest by making the standard 30-year monthly payment. On a bi-weekly schedule or by making an extra monthly payment per year, you will save over $50,000 on interest.
Uncle Trentie's Basic Financial Advice
Hey! It's Uncle Trentie. Here's some basic financial advice.
- How to Pay Off Your Mortgage Early
- FHA 2010 Mortgage Guidelines
- Common Federal Income Tax Deductions