Should I Pay Off My Mortgage in 2021?
Paying your mortgage off early can save you a load of interest. But is it always the best choice? That depends on how much money you have to work with. And what else you might need to spend it on. To pay off your mortgage early, you can make extra principal payments, refinance or recast the loan and do a lump sum buyout.
Consider too how much longer are you planning to stay in your house. Paying down one loan just to take out another doesn’t make as much sense. If you know you’re moving, save that money for the new down payment. Very few people these days stay in the same house for the term of their loan.
The proximity to retirement is also a factor. If your income will drop once you leave the workforce, ridding yourself of your monthly mortgage payment makes sense. But you’d need to have the money to do it. Paying off the principal early or refinancing are long-term methods, not a quick fix.
Sometimes the death of a spouse or partner will prompt a lump sum payment. A life insurance payout may be enough to cover the balance. This makes the most sense if the homeowner is unable to meet the payments alone. One of the biggest advantages of paying off a mortgage is the increase in money for living expenses.
Mortgage interest was a much-used tax deduction. But changes in tax law affected the ease of claiming it. To write off mortgage interest in 2021, you have to itemize your deductions. With the large increase in standard deductions, itemizing has become less appealing.
What About a Reverse Mortgage?
A reverse mortgage will relieve you of mortgage payments, but it isn’t a get-out-of-jail-free card. You have to pay off the mortgage, but usually through a lump sum payment at the end of the loan. A reverse mortgage comes to fruition if you sell the home or aren’t living in it for 12 consecutive months.
These loans have a term and accrue interest. If you took a 15-year loan, that’s when it comes due. A reverse mortgage is not a true vehicle to pay off your mortgage early. It is an option for older homeowners struggling to meet their payments.
Questions Before Paying Off Your Mortgage
It sounds great – to take back your home from the bank. But paying off the mortgage means finding and spending the money. Should it be your first priority? Here are some points to consider before making the call.
- Do you have other debt with a higher interest rate?
If the interest rate on your mortgage is low – between 3 and 4%, what other debt are you carrying? Credit card bills – even using “introductory offers” are the first debt you should clear. No matter how low the interest rate when you first get the card – it will go back up. Car loans and student loans are next, home equity loans or credit lines to follow. This is just good financial hygiene. Your mortgage will be here when you’re done. Once all that other debt is cleared away, paying your mortgage down will be even easier.
- Do you have a sufficient emergency fund?
What would happen if you suddenly lost your job or were injured in an accident? How long would you be able to survive on your savings? If you haven’t set up an emergency fund or don’t have much in it – that’s a bigger priority. You may be surprised how much it takes to keep your family afloat. Total up your monthly nut for 6 months. At minimum that’s what you need.
- Are you maximizing your retirement accounts?
Are you making the maximum contribution to your 401k? These accounts are how you’ll maintain your standard of living once you leave the job market. Maximizing your contributions. especially if your employer has a match. If you’re self-employed, get a SEP and/or look at setting up a Roth IRA. Paying off your mortgage early won’t feel so good if you can’t afford to keep the lights on.
- Do you have big expenses coming up?
If your daughter wants a destination wedding in Costa Rica, that money has to come from somewhere. Do you have other expenses planned – like a college fund or elective medical procedure? Unless you’re independently wealthy, that’s a lot of money to layout all at one time. Planning for a new roof probably takes precedent over knocking down the mortgage.
- Would you be better served investing the money?
Time to take a look at your investment portfolio. If you don’t have one, the money you use to repay your mortgage might be better spent. A long-term investment in the market historically delivers a high return. If you had an extra $500 a month to invest for 10 years, according to CNBC:
- At a 4% rate of return: You’d make $73,625
- At a 6% rate of return: You’d make $81,940
- At an 8% rate of return: You’d make $91,473
The question to ask yourself is what impact would that extra $500 have on your mortgage? Does it make sense to hold off and invest?
We’re not suggesting you shouldn’t pay off your mortgage early. It’s more about the timing of the process. Real estate – your home – is not a liquid asset. If you put all your money there, it’s not easy to get out. The only way to pull cash out of a house is to sell it or take out a loan against it.
5 Ways to Pay Your Mortgage Off Early
If you want to get your mortgage paid off, these are five ways to get the job done. Most are progressive – in other words, not instantaneous. But every opportunity to cut the duration of your term – and the interest it accrues, is a big win.
1. Extra Principal Payments
Every mortgage comes with an amortization schedule. Don’t let the term intimidate you. It’s just a breakout of the installment payments you’ll make over time. It should break out what you pay in interest vs principal.
When you put in extra money toward the principal, you are adjusting the original schedule. It’s not going to pay your mortgage off tomorrow, but it will shave years of interest off your loan. There are no pre-payment penalties on modern mortgages.
A mortgage, like an auto loan, pays the interest first, then it applies what’s left to the principal. If you have a 30-year mortgage of $250,000 at 4%, you can estimate your monthly principal and interest payments to be around $1100. (Without property tax or insurance.)
Here’s how the first payment breaks out on your amortization schedule. Multiply the loan balance – 250,000 by the interest rate of 4%. That gives you the annual interest – in this case, $10,000. To find the interest for one month, divide the total by 12. When you make your $1000 payment, $ 833 goes to interest and $166 to the principal.
Throughout the loan, you’ll pay $179,673 in interest. The way to reduce the interest is to reduce the principal. If you can afford to put an extra $250 a month towards the principal – you could knock off between 7 – 9 years off the term.
Extra principal payments are made separately. Your second check should specify payment on the principal only. If you pay your mortgage online, check to see how you can add principal-only payments to your account.
One Extra Payment A Year
There are two ways to go about this. The simplest one – if you have the money – is to make 13 payments instead of 12. It’s a regular payment – not to the principal. The entire $1100 using the example above.
The second method is to pay your mortgage on a bi-weekly schedule as opposed to monthly. This method will automatically add an extra payment to your amortization schedule. But not all loan providers are set up for it. Make sure you discuss it with them to make sure there’s no confusion that could hurt your credit.
If you have a 30-year mortgage and can refinance to a shorter-term, it will save you big bucks. The $179,673 in interest referenced above drops to $82,859 with a 15-year mortgage. You’d save more than half the interest you are currently carrying.
Of course, your monthly payment would be different. If you bought at 4% with a 15-year term, it would increase to around $1850. But in a refi – we’d assume you have some equity in your home. Let’s say you’ve paid down your mortgage to by 60,000, bringing the balance to $190,000.
The average interest rate for a 15-year mortgage in 2021 is 3.1%. (Note this is a national average and rates will vary by the location.) If you refinance the $190,000 at 3.1 % interest for 15 years, your payment comes out to about $1300 a month. It’s just $200 a month higher than your original loan payment for the 30-year term. The shorter-term and the huge drop in interest is a smart choice for getting your mortgage paid off early.
Your income and credit score come into play when you refinance. An on-time payment history on the original mortgage also helps. One downside to refinancing is closing costs. Depending on where you live, closing costs can vary dramatically.
If you’re trying to avoid closing costs, this is the way to do it. But honestly, it will probably cost you more than you’d have to pay for them. Recasting is a way to keep your same loan but adjust the payment schedule. (You’ve already paid closing costs when you closed on the original loan.)
The way recasting works, you offer to make a lump sum payment on the principal of your mortgage. You need to discuss this with your lender ahead of time to see if they allow it. Most major banks over the option but not all loan providers do. If you started at Wells Fargo but they sold your loan to another provider, recasting might not be an option.
The minimum amount for most recasting deals is $5000. There’s no maximum but recasting will reduce the amount of interest you’ll pay over the life of your loan. Don’t expect lenders to cut their profit too much. You give them $5000 toward the principal.
They adjust the existing amortization schedule. Your principal is lower, so your payment has less interest to cover. Your lender will have fees for recasting the deal. They will vary but are usually a few hundred dollars.
Recasting does not change your interest rate. It will change your monthly payments. If you make some extra principal payments after you recast – you can cut the life of your loan by years.
4. Lump Sum Payoff
Sometimes paying off the balance of your mortgage is a good investment. The death of a spouse or a downturn in health can make maintaining the payments challenging.
If your spouse had personal life insurance or was insured by the job, the policy should be enough to pay off the mortgage. If you have an annuity, a second home, or investments you can sell, you can apply those to the balance.
Another option is to pull the money from a retirement fund – a 401k or IRA. You have to be eligible to pull money out of your retirement accounts. For a traditional 401k or IRA, you need to be at least 59 1/2 years of age. But remember, you have to pay taxes on the money you take out.
Depending on what you need to cover the balance, you might consider a loan from your 401. The term is 5 years with an affordable interest rate. It’s considered a withdrawal, so there are no taxes due.
5. Tax-free Buyout
If you have a Roth IRA or Roth 401k, you have some tax-free money. Roth products are paid with after-tax dollars, so withdrawals are tax-free. Your account has to be open for 5 years and you need to be 59 1/2 to pull money out without penalty.
But if you’ve hit that threshold you can buy out your mortgage without any tax liability.
Should I Pay Off My Mortgage Now?
Only you can answer that question. But a good way to get started is by adding extra principal payments and keeping an eye on options for refinancing.
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