Ask Stacy: What’s the Best Way to Pay Off My Mortgage Early?

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Want to get rid of the mortgage ASAP and pay as little interest as possible in the meantime? Here's what you need to know.

This week I’m answering three questions with a common thread. They’re from readers interested in ditching their mortgage ASAP.

Question No. 1:

Could you go over some different ways to pay off your mortgage early? I am retired and have a fixed income, and would like to retire the debt on this house. I make an extra payment a year, and tried to do a 15-year fixed, but the costs to get the APR down to a reasonable rate drove the mortgage back up to my original loan amount. I felt that I was starting all over again. Thanks. — Richard

Question No. 2:

I have a mortgage loan at 2.75 percent with a variable interest rate (that adjusts) every year, with 11 years remaining. I am making an extra payment of $100 every month. Can you help me lower my interest or years left? Thanks. –Fernando

And the last one:

Would it be wise to refinance a home with a 30-year mortgage to a 15-year mortgage when you have only two years till retirement? — Richard

Here are your answers, guys!

Should you pay extra on your mortgage?

In general, mortgage debt is like any other kind. You should pay as little interest as possible by paying it off as fast as possible. There’s only one way to do it: paying as much as you can.

The only exception? When you can earn more on the money elsewhere.

Figuring whether this is the best use of money is straightforward. For example, if you’re paying 4 percent on a debt and earning 5 percent on savings, you’ll be better off adding extra money to your savings rather than paying down a debt.

Mortgage debt, however, is a bit more complicated because of income taxes. If you’re in a combined 25 percent state and federal tax bracket, every dollar you deduct saves you 25 cents in taxes. Since mortgage interest is deductible for most people, when you pay a dollar of mortgage interest, after taxes the cost is only 75 cents, effectively reducing the rate you’re paying.

Example: If you’re in a 25 percent tax bracket, your after-tax cost of a 4 percent mortgage is 3 percent (75 percent of 4 percent). In this example, if your savings are growing at more than 3 percent after taxes, you’re better off paying your savings over your mortgage.

Another consideration affecting any debt: the “ball and chain” effect. The additional peace of mind you achieve by becoming debt-free is priceless, especially when you consider that most homeowners spend nearly their entire adult lives in debt. So if casting off the shackles is your main motivation, math be damned. Just do it.

For more on both the mental and physical aspects of paying your mortgage off, see my post, “Ask Stacy: Should I Pay Off My Mortgage?

How to pay off a mortgage faster

Both Richard and Fernando want to pay off their mortgages faster. As I mentioned, there’s only one way to do it: Pay more than the minimum payment and send in as much money as you can afford as often as possible.

With a mortgage, however, you’ll want to make sure you designate the additional money as principal reduction. A simple note on your check will do. If you fail to do this, the mortgage servicer may assume you want the extra money to be applied to future monthly payments.

If you haven’t already, sign up online with your mortgage servicer, and have them email you monthly when your payment is received. In the email I get, my servicer breaks down my payment into three parts: principal, interest and extra principal.

For more, see “3 Ways to Pay Off Your Mortgage Faster.”

How not to pay off a mortgage faster

There are several fee-based services out there promising to help you pay your mortgage faster using techniques ranging from biweekly payment plans to cash management software.

Hogwash. Don’t pay anyone for help paying down your mortgage. Just send in more money.

How to know whether to refinance

In order to answer the refinance question, you need three pieces of information:

  • The total cost of the refinance. You need to know every fee you’ll pay, not just for the mortgage, but the closing costs, taxes and fees assessed by your state, county, etc.  
  • How much you’ll save. If you’re refinancing to a lower rate, how much less will you pay?
  • How long you’ll stay in the house. While it’s sometimes tough to know exactly how long you’ll be staying put, estimate the best you can.

Now let’s use some simple examples to illustrate how this works. Let’s say we have a $100,000, 30-year, 6 percent mortgage and have the opportunity to reduce the rate to 4 percent.

Step 1:  The monthly payments on my 6 percent mortgage are $594.82. Using a mortgage calculator,we see that changing the rate to 4 percent drops the payments to $475.52. Savings? About $120 monthly.

Step 2: Find out exactly what the new mortgage will cost. As mentioned above, mortgage refinancing isn’t free, even when the lender implies it is.

For example, when I refinanced my Florida mortgage in 2009, I negotiated with my lender to eliminate many of its fees, and with my title company to rid myself of a couple more. But here are some of the fees I couldn’t negotiate away:

  • Title company settlement fees — $370.
  • Notary — $150.
  • Title insurance — $930.
  • Recording the deed — $246.
  • State tax stamps — $1,050.
  • Intangible tax — $600.

This isn’t all of the fees I paid, just some of the bigger ones. Still, the total is more than $3,300.

Step 3: Divide the cost to refinance by the monthly savings. The result is the number of months it will take to break even.

If my case, if my refinance cost $3,300, I’d divide that by monthly savings of $120. The result, 27, is the number of months it will take me to break even. So every month I remain in my home after the 27 months, I’m ahead by $120. If I don’t stay that long, I lose money.

Richard asks, “Would it be wise to refinance a home with a 30-year mortgage to a 15-year mortgage when you have only two years till retirement?” The answer is, with a 15-year mortgage, he’ll pay less interest. Paying less interest is always better than paying more, but a 15-year mortgage will also have higher monthly payments.

To see if it’s worth it for Richard to refinance, he should use a mortgage calculator to see what his payments will be under both scenarios: 15- and 30-year. He should also find out the cost of the refinance. Then he’ll use the calculator to see how fast he’d pay off his existing 30-year loan by making the same-sized payments he’d be making with a 15-year loan.

He might find he’ll pay off his mortgage faster by adding money to his current monthly payment, rather than paying to refinance to a 15-year mortgage. The fact that he’s retiring in two years is irrelevant, provided he’ll be able to comfortably make the payments on either loan.

Got a money-related question you’d like answered?

You can ask a question simply by hitting “reply” to our email newsletter. If you’re not subscribed, fix that right now by clicking here. The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer. Got any words of wisdom you can offer for this week’s question? Share your knowledge and experiences on our Facebook page.

Stacy Johnson

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