Step 1: If You're Loan Shopping, Choose a 15-Year Mortgage.
Let's say you have a $300,000 mortgage with a 6% interest rate. Paying it off in 30 years will cost you $647,515, and $347,515 will be interest.
But if you have a 15-year fixed mortgage for the same amount, you would only pay $155,683 in interest -- a savings of roughly $192,000! Of course, your payments would be $733 higher with the shorter term ($2,532 a month vs. $1,799), but that will pay off for you big-time in the long run.
Step 2: Pay Off Your 30-year Mortgage Early.
I know that, especially these days, most people simply can't afford to make the higher monthly payments that go along with having a 15-year fixed mortgage. But that doesn't mean there's nothing you can do to speed up the day when you will own your home debt free.
The problem with a 30-year mortgage is that it's designed to make you spend 30 years paying it off. If we stick with our $300,000, 30-year fixed mortgage example, that means you're paying the bank nearly $348,000 in interest! But what if you were to take that same mortgage and make the payments on a biweekly-instead of a monthly schedule? This simple change can cut the total payment time by six years and save you $72,000 in interest payments.
It's not a trick. Here's how it works. All you do is take your 30-year mortgage and instead of making the monthly payment the way you normally do, split it down the middle and pay half every two weeks. In the beginning, paying every two weeks probably won't feel any different from paying once a month. But as you should know, it's not really the same thing.
A month, after all, is a little longer than four weeks. Therefore, over the course of a year you gradually get further and further ahead in your payments, until by the end of the year you have paid the equivalent of not 12 but 13 monthly payments. Best of all, because it is so gradual, you will hardly feel the pinch.
The impact of that extra month's payment is awesome. Depending on your interest rate, you will end up paying off a 30-year mortgage somewhere between five and seven years early, and a 15-year mortgage three years early. You will be debt free years ahead of schedule, saving you tens of thousands of dollars in interest payments over the life of your loan.
If you'd like to figure out how much you could save on your own mortgage, visit finishrich.com. First, click on the Free Stuff tab then select See All Calculators under the calculator section, then click the Get a biweekly mortgage payment plan" calculator under the mortgage section. You can then plug in your own numbers and quickly see how much you could save by switching to a biweekly payment plan.
Step 3: Set Up An Automatic Biweekly Payment Plan with your Lender.
These days most mortgage lenders offer programs designed to totally automate the process I've just described. To enroll, all you need to do is phone your lender or go to its website. Many banks also offer this service for free to customers who do all their banking with them. Those that don't usually refer you to an outside company that runs the program for them. These companies generally charge a set-up fee of between $200 and $400. In addition, there's a transfer charge of $2.50 to $6.95 that's assessed every time your money is moved from your checking account to your mortgage account.
A lot of companies now provide these services. To be sure you're dealing with a reputable firm, you should probably use one that is referred to you by your bank.
Step 4: Do the Same Thing Yourself for Free.
Why spend hundreds of dollars when you could just as easily use your bank's online automatic bill-paying service to schedule biweekly mortgage payments for yourself? Unfortunately, it's not that simple. The problem is that if you split your monthly mortgage payment in half and send it in to your mortgage lender every two weeks yourself, the lender will simply send it back to you because they won't know what to do with it. Or worse, they'll stick the money in an escrow account and just let it sit there.
What you can do is add 10% to your regular mortgage check each month and have the money applied toward the principal. The effect will be the same. That's my suggestion. Add an extra 10% per month -- and make the payment automatic. Make a point of asking your bank to make sure that this extra payment is credited toward your principal -- and then check your monthly statements to make sure they did it correctly.
Step 5: Get the Right Kind of Mortgage.
My early pay-off plan won't work unless you have the right kind of mortgage -- a 15- or 30-year fixed mortgage with payments you can afford. So, if you plan to be in your home more than five years and you have anything but a 15- or 30-year fixed mortgage -- say, one of those adjustable-rate deals that have gotten so many people in trouble -- then you should refinance NOW. Rates are at historic lows as I write this -- but this won't last forever.
First, go to a website like lendingtree.com, quickenloans.com or bankrate.com and see what mortgage lenders are offering. Then call your current lender and ask if they can match the best deal you found online.
Lending standards are much tighter than they used to be, but if you can meet the requirements, most banks will be happy to refinance your mortgage. The three basic criteria are:
- Your debt-to-income ratio, or DTI. Mortgage lenders want your DTI to be less than 38%. That is, your monthly mortgage payments shouldn't total more than 38% of your monthly income.
- Your loan-to-value ratio or LTV. Most lenders want it to be less than 80% -- meaning the total amount you owe on your house should be no more than 80% of what the house is worth. (For example, if your house is worth $200,000, they will not refinance a mortgage of more than $160,000.)
- Your credit score. You'll generally need a FICO score of at least 620 to even be considered for a loan and at least 740 to get the best interest rates.
Refinancing only makes sense if the savings you enjoy from lower interest payments more than cover the cost of closing the new mortgage. If you're going to be in your home for more than another three years, you'll generally come out ahead as long as your new interest rate is at least one full percentage point lower than what you are currently paying. Have your bank run a "break-even analysis" for you, they can tell you,
Yup, the cost of refinancing will be paid off in 28 months [or whatever]. You need to know this before you pull the trigger.
It's time to go back to the basics of homeownership: buy less house than you can afford and pay off your home as fast as possible. A debt-free home is really a nice home to live in and it's absolutely worth striving for! For more tips on paying off your mortgage faster, visit me online at finishrich.com.