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Everything You Need to Know Before You Start Paying Off Your Home Early (Part 1)

Everything You Need to Know Before You Start Paying Off Your Home Early (Part 1)

“I’m in debt. I am a true American.” -Balki Bartokomous

It’s true. Just about every person in American (and much of the world) is in debt.

We are so used to it that we even consider ourselves to be debt-free when we still have a mortgage.

You know how it goes…

“Yeah, I’m debt-free…well, except for my house.”

If you have a mortgage you are not debt-free.

But you can be…

There is a lot to know before you start paying off your home early…

First, make sure you should be buying, not renting.

Second, you need to understand why it isn’t dumb to pay off your mortgage early.

Now, if you’re still reading, you’re in the right spot…

This Series

This is an ongoing series on paying off your mortgage early.

A mortgage is generally the biggest debt you have, so it’s not quite as simple as paying off everything else.

Small Home

You could always buy a smaller house. No? Well, it was worth a try.

In this series, I will explain multiple ways to lose the mortgage early.

You can even apply many of them simultaneously.

First, let’s discuss the different types of mortgages…

Types of Mortgages

There are many types of mortgages, but really, only a few apply to the savvy home-buyer.

Fixed-Rate Mortgages

Fixed-rate mortgages have a fixed interest rate for the entire life of the loan. This means that you will pay the same interest rate until it is paid off (or until you refinance). Fixed-rate mortgages are predictable since the interest rate remains the same. The standard loan is 30 years (in America), but it’s also fairly standard to see a 10, 15 or 20 year fixed-rate mortgage. The shorter, the better. Under no circumstance should you ever take out a fixed-rate loan for over 30 years. If you need a 40 year loan, you can’t afford that house!

Adjustable-Rate Mortgages (ARMs)

Adjustable-rate mortgages (ARMs) have an adjustable interest rate. Usually the rate is fixed for a certain amount of time, but after that time it fluctuates with the market rates. ARMs are unpredictable since interest rates fluctuate. They can go lower, but they can also go much higher. This makes an ARM much more risky than a fixed-rate mortgage. To keep it simple, I would just say: don’t do it!

Other Mortgage Types

Other mortgage types include interest-only mortgages, interest-only ARMs, balloon mortgages and other types of “creative financing”. There are also several variations of ARMs. These types of loans are very risky and should never be used by the average home buyer. In my opinion, they should never be used, period.

Decisions

Decisions, Decisions…not really. If you’re unsure, go for the fixed-rate mortgage.

A fixed-rate mortgage is the safest and most predictable type of mortgage. Unless you are experienced with creative financing, stick with a fixed-rate. I recommend refinancing if you have anything but a fixed-rate.

It All Comes Down to One Thing

No matter which type of loan you may have, there is one very important thing for you to know right now when you are attempting to pay off any mortgage early.

It’s all about making extra principle payments.

I have probably heard 100 different ways to pay off a mortgage early and every single one of them equated to paying extra principle payments in one way or another, but that doesn’t mean that they aren’t all effective.

There are different reasons for the different strategies.

These strategies are not magic, but they work. And they set you up to be able to make extra principle payments, even if you don’t think you can afford to.

Related: 3 Powerful Strategies to Pay Off Your Mortgage Early

Pre-Payment Penalties

Everyone likes to talk about pre-payment penalties.

I have actually heard this as an excuse for not paying off a mortgage early.

Many loans don’t even have them. You need to contact your mortgage company if you are unsure and figure out if your loan has pre-payment penalties.

Even if you do have pre-payment penalties that doesn’t mean you shouldn’t pay off your mortgage early.

Yes, the bank would love for you to make payments for the entire length of the mortgage, 15, 20 or 30 years. That’s why pre-payment penalties exist, but don’t let them scare you!

Bank of Cali

Don’t pay it off early. Keep paying us interest. -Sincerely, The Bank

These penalties generally only apply to the extra principle payments you make, not to your regular payments. Even if you have a penalty, you will almost always benefit from making extra principle payments.

Keep Going

There is still much to know before you begin paying off your mortgage early…

Continue reading with part 2 here.

Connect with me on Twitter, Facebook and Google+ to share your ideas for paying off you home early.

And as always, you can simply share in the comments…

Have you started paying off your home early?

What have you learned so far?

Share in the comments!

Photo Credit: Jose Maria Cuellar, Nebojsa Mladjenovic, Julia Manzerova, Roger


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14 Comments

  1. In part I think of making extra mortgage payments the same way I think of buying stocks, bonds, real estate, etc.: as an investment opportunity. Making a payment against your mortgage is exactly like making an investment with a guaranteed, risk-free, pre-tax return equal to the mortgage’s interest rate. In today’s investment environment, making extra payments on even a low rate mortgage appeals to me.

    Reply
    • Hey Kurt,

      I couldn’t agree more! There may be higher return investments, but nothing is as great as having a paid off home. Like you said, you are making a huge investment, but on top of that, it frees up so much cash to invest once it’s paid off.

      Thanks for sharing, Kurt!

      Reply
  2. Well we might agree to disagree on this but I’d rather take my money and expose it to some other investment rather than pay down my house. A mortgage is one of the few places you can get a rock-bottom interest rate and you can almost certainly do better over time by paying the minimum instead of putting extra towards your mortgage.

    With that being said, it can be a psychological thing as well. I’d be curious to hear various people’s thoughts on whether they’d rather have a 200k loan at 4% interest along with 200k cash to invest as they please, or if they would rather have 0 loan and 0 cash. It’d be an interesting study to read up on. I might have to go look and see if it’s been done before…

    Reply
    • Hey DC,

      Thanks for sharing! I wrote a little bit about the perspective you mentioned in my article: “It is Dumb to Pay Off Your Mortgage Early?“.

      I understand that side for sure. Of course, for it to work in your favor you would need to earn more in interest than you would pay on the mortgage. It’s pretty easy to earn more than 4% or 5%, so that’s not much of an issue, but here is my opinion:

      You would only be investing the extra money, which likely wouldn’t be very much per month. Over the life of a mortgage (let’s say 30 years), you will generally pay at least 1 or 2 times as much for the house by making minimum payments. So let’s say you are buying a $100,000 house and, with interest included, it ends up costing you about $250,000 once it’s paid off…as long as you were able to earn more than $250,000 with the extra money you would have put towards the house, then you’re good, if not, then paying off your home would have been the wise choice.

      Thanks for your input, I appreciate you!

      Reply
  3. Hi Kalen, this is really interesting to read. Up until recently I always thought that paying off my mortgage will be my next priority after become consumer debt free. But like DC says above, I’ve heard that paying off mortgages might not be the best way to go compared to investing a lump of cash. I wonder if you can go into the pros / cons of both routes for comparison?

    Reply
    • Hey Hayley,

      I made a couple points in my reply to DC. Like I said, it basically depends on how well you can do with investing. Mortgage rates seem low, but they will still end up costing you a lot over the life of your loan. You can find a simple calculator online to figure out how much you will end up paying for your home given your interest rate. You can also use this calculator to figure out how much you will save just by paying off your home a little earlier.

      In my experience, adding a small amount to your mortgage each month will make a much bigger impact and save you much more money than adding that amount to an investment account. I go into some detail in my article “It is Dumb to Pay Off Your Mortgage Early?“. I explain how a mortgage should really be your last priority after you have paid off all other debt, fully funded you emergency fund, maxed out your IRA and put the maximum amount that your company will match in your 401(k) (if they do).

      Another point, you don’t have quite as much risk factor when paying down your mortgage. Of course, there is always some risk when dealing with finances, but once your mortgage is paid off, you free up a huge amount of cashflow. If you choose to invest the money and put it in the wrong place, you could lose it much easier.

      Many times, when people invest rather than pay down their mortgage, they don’t calculate how much they are spending in interest over the life of their loan and they don’t earn as much in interest as they spend.

      DC does offer an alternate perspective, and it’s definitely one to consider, but history shows that doing it that way is generally only the best solution for very savvy investors that can earn high returns, and you also have some luck to factor into that. DC has a great blog and I love that he provided a different perspective.

      Thanks for the conversation! :)

      Reply
  4. Right now paying off my mortgage is not a priority for me. I have other debt and savings to take care of first but also I don’t know if I’m going to keep this house forever. Plus I have a pretty nice interest rate on my house so I rather put the extra money elsewhere.

    Reply
  5. I would love to be debt free from the mortgage, and we were set to start throwing everything at it, but I went to almost all self employed income this year, and it just makes more sense to try and max out my solo 401k and HSA before being more aggressive with the mortgage. We still pay a little over $300 a month extra toward principle and are set for 8 years until it’s all done, so I’m Ok with that for now.

    Reply
    • Hey Kim,

      That’s smart! I have always been an advocate for making you mortgage the VERY last thing. Pay off all other debt, max out your retirement accounts, then work on the mortgage.

      It sounds like you guys are set pretty nicely! In 8 years, you will be doing even better!

      Thanks for sharing.

      Reply
  6. We are paying off our mortgage more aggressively, but we are putting most of our disposable income into investments because we are able to make far more interest that we’d be saving if we paid it off.

    Reply
    • Hey Daisy!

      That’s awesome! We do something similar. I wrote about it here. Paying down a mortgage is nice, but sometimes another route makes sense.

      Reply
  7. I have also noticed that people who have a mortgage say, “We’re debt-free.” I think you are right in saying that it’s because we’re so used to debt. It has become so normalized, we don’t even see it when it’s there. We’ve paid off our consumer debt, and we’re over half-way paying off a business debt. Next, it will be the mortgage. I’m actually looking forward to taking it on.

    Reply
    • I love your attitude! Looking forward to taking it on is an awesome approach.

      It’s sad how used to debt we can be these days.

      Thanks for the comment!

      Reply

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