Is having a 30-year mortgage a way of the past?
When people think about buying a house, they also traditionally think about obtaining a mortgage for the next three decades of their life. Many times they refinance at some point during the term, only to start a new 30-year cycle over. It's inefficient and it's definitely not the most cost-effective way to ultimately own your home. In fact, it's rather depressing!
It used to be that folks would enter retirement with their houses paid off. Sadly, that doesn't seem to be the current norm. You don't have to let what's normal be how you make your decisions though!
It is true that you can pay off a mortgage in 12 years or less. The best part? There are no gimmicks necessary!
It's really about being an informed consumer and making wise decisions. Are you curious how others are doing it? Read on for a simple solution to actually own your home in less than half the time as your peers.
A lot of people don't know that they have options when it comes to choosing a term for their mortgage. The most common are 30, 15, 10 and lately even a 40-year term. The longer the term, the longer the period of time that the interest is stretched out over. This does lower your payment, but it also gives you a negative compounding effect towards the interest that you end up paying on the loan.
Having the lowest payment option by choosing a 40-year term may sound good today, but don't do it! You'll waste way too much money in interest charges during that period of time -- not to mention you'll have a mortgage payment for 40 years!
Instead, try and choose the lowest term you can afford. Typically the lower the term, the lower the rate of interest that is charged as well -- win/win! For example, if you choose a 30-year term, the rate might be 4.125 percent. A 15-year term will be more like 3.250 percent (based on mid-September rates).
If you make mortgage payments biweekly, you can shave six years off of a new 30-year mortgage. For a 15-year mortgage it's more like three. This is due to you basically making one extra mortgage payment per year. This post outlines how to budget when you get paid biweekly.
For example, if your mortgage payment is $2,000 per month and you currently pay monthly, that's $24,000 per year ($2,000 x 12 payments). If instead you divide your payment in half and make a payment every two weeks, you'd be paying $1,000 biweekly. There are 26 biweekly periods per year (or pay periods in many people's cases), which would be $26,000 (or $1,000 x 26). The difference is $2,000 or one extra payment.
One Extra Payment
Of course, an alternative is to just make one extra payment at some point during the year. You can continue to make your mortgage payment monthly, but just write out a check for an extra one when you have the funds.
The downside to this, is that you might not ever feel like you have the extra money. Hence why the biweekly method makes sense for most people (plus the timing corresponds with when you get an extra check). Don't forget to make sure that your extra payment is applied towards the principal to further reduce your loan.
If you're thinking about buying a home, consider a slightly higher payment by choosing a 15-year mortgage (if you can afford it). Then make your payments biweekly or make an extra payment once every year, so you can truly own your home in 12 years or less.
If you're eligible, you could also consider refinancing your current mortgage. I think this only makes sense if you're lessening the term, the interest rate or both. It's usually a no brainer when you can do both!
Try not to increase your loan size by doing a cash-out refinance or by wrapping any applicable closing costs into the new balance. This provides the opposite effect! You also may need to have a certain amount of equity in your home to avoid PMI (private mortgage insurance) depending on the lending method (conventional, etc).
Purchasing a home is one of the biggest financial decisions you'll make. Make sure you do your due diligence and enter into this decision educated about the process and your options, with a plan and with clear expectations.
Are you on track to pay off your mortgage early?