Thirty years is a long time to pay down a single debt. Still, this remains a popular mortgage term as many new homeowners opt for monthly affordability over what is potentially a significant reduction of the cost of the loan (primarily, interest paid over the life of the loan) on a 10 or 15-year mortgage. In many cases, this is out of necessity due to family income at the time or other looming financial goals and obligations. With that said, just because you close on a 30-year mortgage doesn’t mean you have to be locked into paying for a full 30 years. Today, we’ll discuss some tactics you may employ to both shrink your loan term and the total amount you will pay for it.
While the amount you pay every month may be the same, the breakdown between principal and interest changes over time. As you make each payment, a progressively larger portion goes toward principal, increasing ownership in your home, with less going toward interest. As such, it is often advantageous to fast track your mortgage payments on the path to true homeownership. There are several ways to accomplish this without drastically changing your payment plan.
Add to Your Monthly Payment
One steady way of getting ahead of the repayment schedule is to tack on a little more to your monthly mortgage payment than is required. To help ensure you stay on track and on budget, simply divide your monthly mortgage payment by twelve and add this 1/12 additional amount to each monthly payment. This extra monthly payment on an annual basis can take months or even years off of the overall term of the loan, depending on your remaining balance and payment amount. But, in order for this to work, you'll need to ensure that your loan has no prepayment restrictions and that the additional amounts go to the payment of outstanding principal.
Lump Sum Pay Downs
If more frequent payments aren’t feasible, consider a “lump sum pay down” or, in other words, one large payment to reduce the principal balance of your loan. You’ll need to consult with your servicer to ensure there is no prepayment penalty or other prepayment restrictions on your loan, but it can certainly be worth the conversation. If there is little to no penalty and no other restrictions, you can look to take advantage of additional funds such as your tax refund, an inheritance or annual bonus to knock down more of your loan. Even taking a portion of any extra funds equal to a monthly payment and applying it to the mortgage balance will save on interest over time. If you decide to move forward, make sure to ensure with your servicer that the additional funds you’ve provided are to be applied towards principal.
Refinancing Versus Simulating the Effects of a Refinance
Refinancing into a shorter term loan, including moving from a 30-year to a 15-year means that while your monthly payment size increases, you’ll be paying less in interest over the long term and paying off your loan faster in the process. Another benefit of an actual refinance is that you’ll often be offered a lower interest rate. Alternatively, increasing the frequency or amount of your existing mortgage payments can mimic this effect, while still maintaining financial flexibility to drop down to your original payment amount in case an emergency arises. Life happens, and the last thing you want to do is force yourself into a higher payment than you may be able to afford if faced with a financial setback.
While there are several ways to accelerate the amortization of a mortgage without a refinance, payment guidelines vary from servicer to servicer. The first step in shortening the loan term is to verify the rules with your servicer. Additionally, lenders oftentimes offer amortization calculators that will demonstrate the potential savings from either an additional principal amount each month or a lump sum principal payment. In all cases, it is important to ensure funds are accurately applied so that any additional principal truly goes towards shortening the term of the loan.