If you are one of the many American homeowners who have recently refinanced their mortgages and are in the fortunate position of having more expendable cash each month, you may be considering whether you should pay off your mortgage early. One common way to accelerate the payoff is to change it from monthly to biweekly. But you should first review the advantages and disadvantages of this strategy and consider your alternatives.
Setting up a biweekly mortgage payment plan can save you thousands of dollars and may cut years off the life of your 30-year fixed mortgage loan. By dividing your monthly payments in half and paying that amount every other week, you would make 26 payments per year, or the equivalent of 13 full payments, rather than the usual 12 payments. By applying these payments to your principal, you will essentially reduce the number of years you will owe on your mortgage and reduce your interest.
For example, let’s say you owe $200,000 on your 30-year fixed mortgage at a 7 percent interest rate. By implementing a biweekly mortgage payment plan, you would save more than $65,000 dollars in interest. If your mortgage was $400,000, you would save roughly $131,000. In addition, by paying an extra monthly payment per year, you would shave six years off your mortgage loan.
Paying off your mortgage early also has an immeasurable non-financial benefit: peace of mind. No one enjoys the burden and persistent financial obligation of mortgage payments. This can be a bigger weight off your shoulders if you are close to retirement.
An easy alternative to setting up a biweekly plan is to increase the amount of your monthly payments. For example, you can take one additional monthly payment, divide it by 12, and slightly increase each of your current monthly payments. For example, if your mortgage is $1,000 per month, you could simply pay $1,083.33 per month instead. This would add up to an extra monthly payment each year. It also gives you the freedom to return back to your regular payment schedule, if you lose your job or become ill.
If you set up your own accelerated payment plan, be sure to instruct your bank to apply these payments to the principal of your loan. Otherwise, they could consider the payment an early payment and apply it to the interest of the loan. You also should check with your bank or loan officer to confirm that there is no prepayment penalties associated with your loan.
Before you commit to paying off your mortgage early, make sure you also have significant savings stashed away in an account for a rainy day or an unexpected emergency. If prepaying your mortgage means you are diverting funds away from or forgetting to contribute to an emergency savings plan, you will be putting your financial security at risk. It is recommended that you set aside emergency cash of at least three to six months’ worth of expenses.
If you have the cash flow to pay off your mortgage faster, make sure you are sufficiently funding other important financial goals, such as your retirement savings or your child’s college at the same time.
Do not consider prepaying your mortgage if you are in debt. A good rule of thumb is to pay off all your debt first, starting with the highest interest rate. Consider taking out a home equity line of credit to pay off your high-interest-rate debt at lower rates. Interest rates on HELOCs are generally tax-deductible.
Kris Flammang, co-founder of LPF Financial Advisors with offices in Lakewood Ranch, is a chartered retirement planning counselor and representative of Securities America Inc. LPF Financial Advisors and Securities America are not affiliated. He can be reached at 907-0101 or firstname.lastname@example.org.