As I research real estate topics, I often see homeowners asking if it would be best to pay off their 30-year mortgage in less than 30 years. There are pros and cons to paying down a mortgage in less time -- your financial situation will be a major factor in determining whether or not it's worth it. Consider the following before trying to pay down your mortgage quickly:
- Will you be able to live comfortably as you pay extra $ towards the mortgage each month?
- Would the extra $ you're paying towards your mortgage make more of a difference in your retirement account?
- Should you wait until you're more financially stable before paying more towards your mortgage each month?
- Should you refinance to save $?
- Would you be better off investing the $?
- Does your mortgage include pre-payment penalties?
One of the most important factor to consider when thinking about paying more than your monthly mortgage payment, is whether or not it's going to affect your day-to-day living. In other words, are you going to have enough money left over to be able to pay for unexpected car repairs, a weekend trip to see family, your heating bill, groceries, etc.? It may sound crazy to think you won't have enough money to pay for food, but it can happen.
Before paying extra on your mortgage each month, consider the state of your retirement saving account. According to a recent Fidelity report, the average employer 401K contribution in Q1 of 2019 was 4.7%, a record high. In this case, your money would go further in your retirement account, helping to secure your future, than it would as an extra mortgage payment. If your employer doesn't offer a retirement plan, talk to a financial adviser to get one set up. Paying your mortgage off quickly (ex. 22 vs. 30 years) doesn't make sense if you don't have money saved for retirement.
You might consider refinancing your mortgage when interest rates are low instead of simply paying more toward your 30-year mortgage each month. This may be the best way to save money on your mortgage AND pay it off faster. For example, if you've got a $300,000, 30-year mortgage at 4.75% interest but have an opportunity to refinance at 3.25% on a 15-year mortgage, you would save a lot of money over the life of your loan. You might be more financially stable at that point in your life too, making it easier to pay extra towards your loan and pay it off in less time.
Keep in mind, a 30-year mortgage will have a lower monthly payment than a 15-year mortgage, regardless of the interest rate. If you are paying extra each month on your 30-year loan and get into a situation where your finances are tight, you can cut back to the minimum required payment and not get into a financial pickle. If you refinance to a 15-year mortgage, pay the higher required monthly amount and you get into a situation where your finances are tight, you will not have the flexibility to pay a smaller monthly payment.
You might want to consider where you'll get the most bang for your buck when it comes to the extra money you plan to put toward your mortgage. Paying more toward your mortgage payments might help you pay it off a bit sooner but it also leaves you with no access to that money (unless you sell your home). Investing the extra money makes it accessible because you can withdraw it (and earn interest). Depending on your financial situation, take time to evaluate where you money will be best utilized -- investing the money or paying down your mortgage faster.
Did you know you can be penalized for paying off your loan too early? Most lenders will not allow you to pay more than 20% of the loan balance each year. This does not apply to every loan, but you'll want to read the fine print before you sign the mortgage papers. If associated with your loan, they are listed as "soft" or "hard" prepayment penalties. Prepays vary by lender but most last 1-3 years so, unless you plan on selling or refinancing quickly, you probably won't have to deal with them.
With a soft prepayment penalty, you will be penalized if you decide to refinance your mortgage. With a hard prepayment penalty, you will be penalized if your refinance your home or sell it while still paying on the mortgage.
If you want to sell your house shortly after buying it and have a prepay penalty that charges 80% of 6 month's interest (the interest-only portion of your mortgage payment), you're going to owe a lot. For example, if you pay $2,400 in mortgage interest each month, you would pay $11,520 as a penalty ($2400 x 6 mos. x 8%).
When you're considering whether or not you should quickly pay down your 30-year mortgage, start by taking a look at the details of your loan and your overall financial situation. Maybe you would be better off waiting to refinance at a lower rate and switching to a 15-year mortgage. Maybe the extra money you were going to pay on your mortgage would make more of a difference if applied to your retirement fund. Most importantly, if you pay more toward you mortgage each month and it puts in you a position where you cannot afford to live comfortably day-to-day, stick with the minimum monthly loan payment. Owning a house is a long-term investment. If you wish to pay it off in less than 30 years, make sure the decision doesn't negatively affect other areas of your life.