MARY ANN QUINN's Blog
Most homeowners would love to be able to pay off their mortgage early. However, few see it as a possibility when they take into account their earnings and other bills.
There are, however, a few ways to pay down your mortgage earlier than planned. But first, let’s talk about when it makes sense to try and pay off your mortgage.
When to consider paying off your mortgage early
If you recently got a promotion, have someone move in with you who contributes to paying the bills, or recently got a secondary form of income, you might want to consider making extra payments on your mortgage.
However, having extra money doesn’t always mean you should spend it immediately on your home loan.
First, consider if you have a large enough emergency savings fund. It might be tempting to try and throw any extra money at your mortgage as soon as possible, but there are other financial commitments you should plan for as well.
If you have kids who will be applying to college soon, remember that student aid takes into account their parents’ finances. If your children plan on applying to institutions with high tuition, then your equity will be counted against you.
Refinancing to pay your mortgage early
Refinancing your home loan is one option if you’re considering increasing the payments on your mortgage. If you can refinance a 30-year loan to a 15-year loan with a lower interest rate, you’ll save money in two ways--your lower interest rate and the fact that you’ll be accruing interest for less time.
There is a downside to refinancing. Once you refinance, you’re locked into your new payment amount. So, if your higher income isn’t dependable, it might not make sense to commit to a higher monthly payment that you aren’t sure you’re going to be able to keep paying.
There’s also the matter of refinancing costs. Just like the costs associated with signing on your mortgage, you’ll have to pay closing costs on refinancing. You’ll need to weigh the cost of refinancing against the amount you’ll save on interest over the term of your mortgage to see if it truly makes sense to go through the refinancing process.
Paying more on your current loan
Even if you aren’t sure that refinancing is the best option, there are other ways you can make payments on your mortgage to pay it off years sooner than your term length.
One of the common methods is to simply make thirteen payments each year instead of twelve. To do this, homeowners often use their tax returns or savings to make the thirteenth payment. Over a thirty year mortgage, this could save you over full two years of added interest.
A second option is to make two bi-weekly payments rather than one monthly payment. By making biweekly payments you have the ability to make 26 payments in a year. If you were to just make two payments per month then you would make 24 total payments. Over time, those two extra payments per year add up.
Deciphering credit scoresMost major lenders assign your credit score based on the information provided by three national credit bureaus: Equifax, Experian, and TransUnion. These companies report your credit history to FICO, who give you a score from 300 to 850 (850 being the best your score can get). When applying for a mortgage (or attempting to be pre-approved for a home loan), the lender you choose will weight several aspects to determine if they will lend money to you and under what terms they will lend you the money. Among these are your employment status, current salary, your savings and assets, and your credit score. Lenders use this data to attempt to determine how likely you are to pay off your debt. To be considered a "safe" person to lend money to it will require a combination of things, including good credit. What is good credit? Credit scores are based on five components:
- 35%: your payment history
- 30%: your debt amount
- 15%: length of your credit history
- 10%: types of credit you have used
- 10%: recent credit inquiries (such as taking out new loans or opening new credit cards)
What does this mean for taking out mortgages?A higher credit score will get you a lower interest rate. By the time you pay off your mortgage, just a hundred points on your credit score could save you thousands on your mortgage, and that's not including the money you might save by getting lower interest rates on other loans as well. If you would like to buy a home within the next few years, take this time to focus on building your credit score:
- If you have high balances, do your best to lower them
- If you have a tendency to miss payments, set recurring reminders in your phone to make sure you pay on time
- If you don't have diverse credit, it could be a good time to take out a loan or open your first credit card
Although challenging life situations like a job layoff, rising mortgage rates and divorce can damage your ability to continue to make your monthly mortgage payments, you don't have to be hit with an unexpected shift to strain to meet your mortgage obligations. As an example, simply taking on another financial responsibility like a car payment, college tuition or small business loan could put you at risk of defaulting on your home loan.
Lower mortgage choices that hurt
To keep from defaulting on your mortgage, you could work a second job, put in longer hours at your first job or cut back on other expenses. Instead of getting a degree, you could try to make your current educational background help you land work opportunities that you really want.
But, those choices hold you back. They keep you from doing what you really want to do. Taking on a second job and working longer hours at your first job put you under too much stress. Fortunately, there's another option that you could take to reduce your mortgage.
This option is often overlooked when homeowners get into financial hot spots. A reason for that may have to do with the fact that some people buy houses to avoid connecting with others more deeply. That's right. Some people use their house as a hiding place.
If your relationships are good, you may be a prime candidate for this mortgage reducer
There's fallout from this decision. The fallout limits your ability to create rewarding relationships. And you definitely need rewarding relationships to take advantage of the overlooked mortgage reducer. A great place to start trying out this shortcut to a smaller mortgage is with your parents.
Similar to how you may have moved back in with your parents after college when you were trying to pay off your student loans and before you landed your first full-time job, open to the idea of living with your parents again. The difference is that this time you'll ask your parents to move in with you.
Even if your parents are living on a fixed income, they could help pay a portion of the mortgage. Not only may you and your parents grow closer with this arrangement, you'll both have someone to communicate with. Siblings, adult children and friends are other people who could move in with you and split the mortgage.
Tenants reduce mortgages, letting you stay in a good house
Shortcut to a smaller mortgage can also open up for you if you rent out a portion of your house. If your house has three levels, you could rent out the first and second levels to tenants. You'd have to make sure that the rented space meets local housing codes.
But, unlike living with family, you'll have to develop legal leasing contracts with the tenants. Of course, you could enter into legal written agreements with family members too, detailing when rent is due and the types of maintenance that you are responsible for at the property.