Your home is arguably the biggest investment you'll ever make and requires the most money you'll ever need to borrow. So it makes sense that you'd take your time paying it off, right? Wrong.
The sooner you can pay it off, the less interest you will pay over the life of the loan, says Travis Saling, a mortgage loan officer at Team Home Loans in San Diego, California. The problem is that it can be downright difficult to do this because most homeowners don't always have the cash resources to increase their monthly payments. So they don't go out of their way to make paying their mortgage off a priority.
"Many of my buyers have told me they would apply extra money to their principal each month, but rarely is that the case," says Saling. "Life happens, and they get used to the lower payment and don't follow through."
Sound familiar? Well, if you want to take steps toward being mortgage-free, how about getting a little creative about it? Here are a few under-the-radar strategies for saving money and paying down your mortgage faster.
Strategy #1: If You're Part of a Couple, Only Spend Based on the Income of the Lower-Earning Partner
Let the phrase "don't live above your means" be your guiding mantra. In fact, if you're cohabitating with a partner and you've merged money to finance your home purchase, consider budgeting the rest of your living expenses off of only one of your salaries - preferably the lower earner.
Why, you ask? Well, if you can be frugal enough to stretch one of your earnings to cover your expenses, then that leaves another full salary to use to pay off your home loan sooner. Of course, this tactic would only help you pay down your mortgage faster if one partner's salary (the one not used for living expenses) exceeds the monthly mortgage payment. If you can swing that, you'd be paying more toward the principal than on the interest over the life of the loan.
Saling warns, however, that you must be sure that you both make enough money to finance your day-to-day cost of living and monthly utility, cable, and other bills. "We have a saying around here that you don't want to be house rich but cash poor," says Saling. "You want your loan to work for you, not the other way around."
Another consideration is the trade-off between the interest rate on the loan versus the potential rate of return the money could earn if invested elsewhere, such as stocks, bonds, etc. instead), says Matt Hackett, operations manager at New York City-based Equity Now Inc. He adds that the higher the salary, the better for implementing this strategy of living off of one partner's income.
If you're unsure, it's best to consult a financial advisor, says Saling. If you're able to swing it, he adds, you must let your lenders know that the extra money you're paying should be applied toward the principal so they don't return it to you as a refund of your escrow account.
Strategy #2: Learn from the Canadians
Turns out we could all pick up a trick or two from our neighbors up north. An April 2014 survey by Scotiabank reported that 37 percent of Canadian mortgage holders are less than a decade away from paying off their home loan debt. What are the Canucks doing that Americans aren't? Well, according to the study , it's actually a lot of small things:
• 39 percent of respondents made more regular payments
• 25 percent have upped the amount of their monthly payments
• 24 percent made additional lump sum payments
So the next time you get your tax refund, a cash gift, or a bonus at work, why not throw this money toward your mortgage? The easiest changes to make are often the ones that don't affect your lifestyle too much. In that same vein, Saling also suggests rounding off your payments to the nearest hundred dollars every month.
"This is another easy way to save money long-term," he says. "Just make sure to let the lender know, or they could issue you a refund at the end of the year for your overpayment. You need to let them know you want to apply it towards the principal to save you headaches down the road
Strategy #3: Lower Your 401K Contributions and Use that Money to Make Extra Mortgage Payments
There's no doubt about it - you have to save up for retirement so you can be financially secure well into your golden years. But as older homeowners approach retirement age, they also want to pay off their home loan before they stop working. So what's a person to do?
One potential tactic may be to lower your 401K or other retirement contributions so they max out right at your company's match, then use those extra dollars that flow back into your paycheck toward paying down your home loan principal. If your company doesn't match (and not all do), it's up to you to choose an amount that you feel comfortable dividing between your 401k account and your mortgage's principal.
Saling does advise speaking to your Certified Public Accountant (CPA) before taking this leap. "Each person has a different individual situation so consult your CPA before lowering your contributions to your 401K," says Saling. "High earning individuals may need that tax write-off down the road."
According to Hackett, you need to consider the trade-off between the savings that come from paying down your mortgage and the potential growth (appreciation, interest, dividends, etc.) in a retirement account. If you think you'd be earning more in your 401K than you'd be saving in interest on your loan, then it might not make sense for you to make this move. Again, it would be best to talk to a trusted financial advisor and work through the math to see what the best option for you would be.
Strategy #4: The Refinancing Boom is Over, But it Could Still Make Sense for Some
Sure, rates are higher now than they were a year ago, which has deterred some borrowers from refinancing. However, considering that rates are still relatively low, refinancing can still be a good way to pay down a mortgage faster, says Hackett. The lower the interest rate on your mortgage, the lower the ratio of each payment that goes to interest. That means more of your payment goes to principal and that you'll pay off your loan faster. So it's a matter of simple math - if you can secure a lower interest rate, you're actually accelerating the rate at which you pay off the principal by default, says Hackett.
That being said, you do need to consider your unique home loan situation before going after the first refi you're offered. "When looking at the refinance option, you need to know how much interest you have left on your existing loan," says Saling. "There are online calculators where you can plug in your rate and starting loan amount and do a quick amortization to figure out how much more interest you have on your current loan."
Next, use the same calculator to figure out the amount of interest on the new loan (fees, etc.) you're exploring, says Saling. "So if the cost of the new loan plus the new interest is less than what you have left to pay off, it makes sense to do the refinance," he explains.
As a general rule, Saling says if the loan can save a homeowner 1 percent, it is a good time to refinance. For example, Hackett says a $300,000 30 year loan at 5 percent pays $4,426.10 in principal in the first 12 months while the same loan with a 4 percent interest rate pays $5,283.11 in principal. That's a difference of $857.01 extra going toward the principal and accruing less interest just by refinancing. But, as always, Saling says you should consult your local loan officer to have them run your numbers, and let you know how much you could save.
Strategy #5: Switch from a Bi-Monthly Payment Plan to a Bi-Weekly Plan
Switching to a bi-weekly schedule versus a bi-monthly one is a small and simple move to try, says Saling. In fact, this is one of Saling's favorite tricks to pay a home loan off faster, because it doesn't take too much thought and won't leave you strapped for cash.
"There are 52 weeks in a year, so paying bi-weekly would be 26 payments versus only 24 payments if you pay bi-monthly," explains Saling. "That really does have a large impact in the amount you pay in interest long term," he explains.
To get a sense of how much you could save, Saling advises his clients to calculate the financial impact of making that additional payment. "If you don't visualize it, you will never see the big picture," he says. "It's the best source of motivation." At mortgagecalculator.org, you can use a bi-weekly mortgage payment calculator to see just how much extra payments can pay off in terms of interest on your balance over time.
To that end, if you think you can handle putting even more money toward your mortgage, Saling says another tactic could be just to pay an extra fixed amount each month, say $200, for example.
To illustrate the power of an extra payment, Saling provided the following scenario: a $275,000 loan at 4.5 percent interest for 30 years will have $226,618 in lifetime interest. "If you could afford an extra 200 dollars a month," Saling says, "it would be paid back in 23.3 years and save you 58,093.14 in interest!"