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Everything You Need to Know Before You Start Paying Off Your Home Early (Part 2)

Everything You Need to Know Before You Start Paying Off Your Home Early (Part 2)

Today is the 2nd and final part in this series.

If you missed part 1, you can read it here.

One of the discussions that came up in part 1 was about investing instead of paying off your home early.

It’s a common perspective that you shouldn’t pay off your mortgage early, but you should invest the money instead.

It makes sense, because mortgage rates are low right now and you can probably earn more by investing than you can save by paying off your home early, but there is actually a way to take advantage of both!

It’s not always about having the highest return, sometimes it’s simply about being totally 100% debt-free…which is an amazing feeling.

Soon I’ll be publishing an article on how to get the best of both worlds, but for today, here is part 2 of what you should know before you start paying off your mortgage…

Pay More Earlier

You will see a bigger difference when you make extra principle payments in the earlier years of your mortgage, as opposed to the later years.

As mentioned in part 1, with a fixed mortgage, your payments will stay the same over the life of the loan as long as nothing about your loans changes.

Your interest rate will also stay the same with a fixed mortgage.

You payment is made up of principle and interest.

There is also escrow in your payments for insurance and tax payments, but for the sake of this article, we are just talking about principle and interest.

This means that in the early years, your payments will be almost entirely made up of interest. In the later years, your payments will be almost entirely made up of principle.

Why? Because your payment amount stays the same and your payment always includes principle and interest. In the earlier years, you owe much more on your home than in the later years.

One Stop Mortgage Shop

Need a mortgage? Seems legit.

Once you have paid off the majority of your mortgage, you are paying much smaller interest payments and much larger principle payments. Think about it: 6% of $150,000 (when you first get your loan) is a lot more than 6% of $20,000 (after you have paid off most of your loan).

Does that make sense? Hopefully! But if you have questions, that’s what the comments are for.

It’s important to make extra principle payments in the early years in order to pay less interest overall. Once you make it to the final years of the loan, you won’t notice as much of a difference.

Some people say that you shouldn’t pay off your mortgage early, but you should invest the money since you can generally earn more by investing than you can save by paying off your mortgage early.

This is true, but it’s much more true in the later years of your mortgage.

If you are in the very first few years of your mortgage, you can make a huge impact just by paying a little extra here are there.

It can mean years off the life of your loan if you pay extra in the beginning.

What Are You Putting Down?

If you are still looking for a home, consider making a sizable down payment.

You will reduce your overall mortgage amount. You will reduce your monthly payments, which makes it easier to pay extra. And you will pay less interest!

Don’t fall for those first-time buyer 0% down loans.

Plus, there are great ways to save money for your down payment.

First, you need to determine how long it will be before you will be buying a home.

If it is less than 5 years, you should save your money in a savings account, Money Market account or possibly a very conservative mutual fund.

If it is more than 5 years, you should invest your money in a moderate to aggresive index fund until 5 years before you plan to buy, then transfer to a safer account.

If this is your first home, you can use an IRA to shelter your down payment.

Now let’s talk about something that you may have heard about, but you may not understand…

Piggy Bank

A Word About Private Mortgage Insurance

Private mortgage insurance (PMI) is basically an insurance that the lender uses as protection in the event that you default on your loan.

It’s common for loans with less than a 20% down payment, since those are viewed as a “riskier” investment by the lender.

Insurance Sign

Everyone has insurance on everyone else. Where did all the trust go?

If you are required to pay PMI, it is typically included in your monthly payments.

The thing that many people don’t know about PMI is that once you have paid 20% of your total loan, you can drop it, but don’t expect the lender to remind you about this.

If you are required to pay it, pay 20% of your loan as quickly as possible, then call your lender and kindly ask them to remove your PMI.

Final Thoughts

That pretty much sums up everything you need to know before you really start aggressively paying down your mortgage.

Don’t forget to read part 1 if you missed it.

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

You’ll also want to check out:

Have you started paying off your home early?

What have you learned so far?

Share in the comments!

Photo Credit: Jose Maria Cuellar, Mary Hutchison, 401(k) 2012, David Hilowitz

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My name is Kalen and I'm the founder and main finance writer for MoneyMiniBlog. I write short, sweet and simple articles on money and productivity. My awesome wife and I have 4 amazing children. I also serve on active duty in the United States Air Force. Feel free to ask me anything.

2 Comments

  1. You cannot always drop PMI anymore, especially with FHA. It may take a refinance. If you come in with less than 20% down, you pay it for the life of the loan.

    Pay down 20%, then refinance conventional to get rid of it.

    Reply
    • True. Good point! FHA loans have really caused a lot of issues. This is only one downside to FHA loans. Not to mention that they had a lot to do with the collapse of the housing market several years ago.

      I always appreciate your input!

      Reply

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