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Homeownership is still one of the biggest American dreams, but it comes with a long-term hitch — monthly mortgage payments.
Almost 40% of American homes are free and clear of all mortgage payments, according to Forbes. Homeowners of the remaining 60% may face long mortgage terms with end dates far into the future.
For that 60% facing long mortgage terms, is it worth it to pay off a mortgage early?
In this article, we’ll explore how you, as either a homeowner or real estate investor, can pay off a mortgage early, as well as the advantages and disadvantages of the strategy. Let’s get started!
Why Pay Off a Mortgage Early? 3 Reasons
There are a few incentives for paying off a mortgage faster than you need to.
#1: Free Up Cash
One of the most common reasons to do so is to free up cash for other investments. By paying a mortgage debt early, someone can use their monthly payments — plus the interest they no longer have to pay — toward new opportunities, such as in the stock market or real estate.
#2: Getting Out of Debt
Many homeowners may wonder if there’s a specific time to pay off a mortgage and other debts. According to Shark Tank’s Kevin O’Leary, it’s age 45.
“If you want to find financial freedom, you need to retire all debt — and yes that includes your mortgage,” he recently told CNBC. “The reason I say 45 is the turning point, or in your 40s, is because think about a career: Most careers start in early 20s and end in the mid-60s,” O’Leary said. “So, when you’re 45 years old, the game is more than half over, and you better be out of debt, because you’re going to use the rest of the innings in that game to accrue capital.”
Older homeowners may like the idea of entering into retirement without a monthly mortgage debt to worry about.
Advantages of Paying Off Mortgage Early
The biggest advantage when you pay off your mortgage early is that you free up cash flow. You also save money on future mortgage interest rates, so you’re putting more money back into your budget. You might even save more money on mortgage insurance that’s no longer needed.
That new financial freedom enables you to make new investments that would have been impossible, including another mortgage if you wish.
There's also something to be said for the peace of mind of total homeownership. You don't have to worry about losing your home in times of financial distress.
Disadvantages of Paying Off Mortgage Early
One potential setback is incurring a prepayment penalty.
Some lenders charge a fee if you pay off or refinance your mortgage before a certain time. But this penalty is not universal to all lenders, and if you’ve already passed the penalty date, you don’t have to worry.
But this is something to keep in mind.
Another disadvantage is that when you pay off your mortgage early, you'll wrap up more of your net worth in your home. Your assets become less liquid, and which makes it harder to draw from your home equity.
Plus, you’ll be unable to deduct mortgage interest tax on your tax return.
However, you can minimize the fallout from these disadvantages with preparation.
7 Ways to Pay Off Your Mortgage Early
If you’re wondering how to pay off your mortgage faster, here are seven ways to do just that.
Option #1: Refinance
Want to know how to pay off your mortgage faster?
If interest rates are low — according to Bankrate, in July of 2021, the average 30-year fixed mortgage rate is 3.04% and the 15-year fixed mortgage rate is 2.35% — you can shorten the term of your loan by refinancing, bringing your 30-year commitment down to 20 or even 15.
Option #2: Make Extra Mortgage Payments
Before you really explore how to pay off your mortgage in 5 years, ask your lender if they charge a penalty for early repayment.
If not, or if you decide if the fees will cost less than if you continued to pay your mortgage on time, you can make extra mortgage payments on the loan principal.
But be careful — make sure your lender knows your extra mortgage payments are for the principal rather than the interest on your account.
Also, it’s best to pre-pay when interest is highest toward the start of the loan.
Option #3: Make 1/12th Additional Payment Each Month
This simple strategy results in one added month of payments per year and is easier on your monthly budget than just paying that extra month in full.
For example, if your monthly mortgage payment is $1,200, pay $1,300.
Option #4: Round Up Your Payments
Instead of paying the exact amount due, round up your monthly payment to the next hundred. For example, $1036 becomes $1100.
This method is also easier on your budget.
Option #5: Increase Payments by $1 Each Time
This method is super simple and surprisingly effective, especially if your income rises slowly but steadily.
Just add one dollar to your payment every month.
If your mortgage payment is $850 one month, just make it $851 the next month, $852 the month after that, and so on.
Similar to the debt snowflake method, it can shave years off a 30-year term.
Option #6: Recast Your Loan
Recasting is an alternative to refinancing that doesn’t cost quite as much in closing fees.
Simply arrange to make a lump sum payment toward the principal, and the lender officially sets a shorter term. You get to keep your existing loan in place with the same interest rates.
Option #7: Use Windfalls for Lump Sum Payments
Have you come into a lot of money recently, through an inheritance or from a big sale?
You can use your windfall cash for a larger lump sum payment on your principal. This has essentially the same effect as recasting, but without the bank fees.
The Bottom Line: Should You Pay Off Your Mortgage Early?
It can be highly satisfying to pay off your mortgage early, but make sure extra mortgage payments fit into your monthly budget and support your long-term financial health.