As a realtor, I get this question all of the time. Should I move, or spend the money to make the necessary improvements to my home, and stay put? It sounds like a simple question, but the answer isn’t always that easy. Every situation is different but there are some key factors to consider when trying to make this decision…(READ MORE) (more…)
Shopping for a house online can be overwhelming. Are you sure the information is accurate? Are you getting all the information you need to make an educated decision? With all of the information available, it’s important to….READ MORE
Having a mortgage is a beautiful thing because it means you’re putting equity into a valuable asset. At the same time, nobody likes to have debt looming over them—and mortgages come with a lot of debt. So many people wonder how to pay off their mortgage in the most timely manner.
You may be surprised to learn that there are plenty of ways you can do this. Most of them involve finding ways to make extra payments, but there are also some other tips you can use too. For example: Switching your payment frequency and refinancing for a better deal.
Here’s my guide to paying your mortgage off faster, no matter what your means.
Make an extra payment every year (because every extra cent adds up)
One of the simplest ways to pay off your mortgage faster is to add a single payment each year. If you’re on a monthly schedule, simply make a thirteenth payment at the end of the year that’s equal to your other monthly payments.
To achieve this, you don’t need to come up with a lump sum. Just put aside one-twelfth of a payment each month, so you’ll have the money ready come the year-end.
If a full extra payment isn’t feasible for you, remember that every penny counts. Even if you set aside a few extra dollars each month to apply as an extra payment at the end of the year, it will still help save you money in the long run.
Here’s an example to illustrate the importance of extra annual payments:
You start with a $200,000 mortgage and a 4.5 percent interest rate.
For the first five years, you make the minimum payment because you just bought a house and things are tight.
After five years, your budget is more relaxed, and you start making the additional payment each year.
By the end of your mortgage, you’ll have saved nearly $20,000 in interest payments, and shaved about three years off your amortization.
Double up on regular payments whenever it’s feasible
Instead of making an additional annual payment, you can choose to increase the amount of your monthly payments. If possible, double each payment, so you’re paying twice the minimum. If you’re able to do that every month, you’ll pay your mortgage off in half the time.
Even if you can only do this a few times throughout the year, each payment will help. Furthermore, you don’t have to go full double to reap the benefits of this method.
Laura Adams, better known as Money Girl, says even minimal extra sums will help: “Let’s say you have a $100,000, 30-year, fixed-rate mortgage at 4.5 percent. If you add an extra $100 to your payment each month, you’d pay it off almost nine years earlier and save over $26,000 in interest.”
Make lump sum payments whenever you have a few spare dollars
Most mortgages will allow you to prepay up to 20 percent of the principal every year, free from any fees, and you can take advantage of this to pay your mortgage off faster and save money should you come into some extra cash.
Everybody loves a windfall, but if you’ve got a mortgage on your hands that you want to pay down, you’re better off putting this money toward your loan than spending it on a fancy dinner or taking a trip. Stay focused on your goal, and you will own your home outright that much sooner.
In fact, put all your extra money toward your mortgage
The same principle holds true for any extra money you have while you’re still paying off your mortgage. Whether you’ve got extra money from a raise, bonus, gift, tax return, inheritance, or even a lucrative night at bingo, put it toward the mortgage and get it paid off faster.
Michael Saves is a finance blogger who started writing about savings after paying off his $86,000 mortgage in just two years. A big part of his strategy was working more so he’d have more money to put toward the mortgage.
“First, I made a commitment to work 10 extra hours per week, so 50 hours total. In addition to volunteering for overtime at my full-time job, I waited tables on the weekends and took care of pets around the holidays,” he says.
He also used apps like Mint to track his spending and make sure that he wasn’t wasting too much money in other areas.
On top of scrimping and saving as much as he could, another big part of his approach was making sure every penny went to the mortgage: “Any extra money that came my way went to the mortgage, including work bonuses, birthday cash and credit card rewards,” he says.
Try switching to accelerated biweekly payments instead of monthly ones
Non-monthly payments are great because you end up paying off the mortgage faster without even really noticing. The idea is simple: You end up making more payments each year, which translates to more money paid toward the debt, meaning you pay off the mortgage faster.
Let me call on Laura Adams again to explain this: “Biweekly payments aren’t magic-–they simply take advantage of the fact that there are 13 weeks in each quarter, not 12, and there are 52 weeks in a year, not 48.”
Rebecca and Trevor MacKenzie paid their mortgage off in five years. When they got married, Trevor moved into the house Rebecca already owned. They started paying off the mortgage together, but the biggest part of their strategy was switching from monthly to biweekly payments.
Rebecca told the Financial Post that “that while she was originally making payments of a little over $700, they bumped that number up to a little over $3,000.” Thanks to this strategy, they paid off the remaining $104,800 on the mortgage within two years.
Refinance to get a better rate or shorter term
There are a few ways that refinancing can help you pay off your mortgage faster, including by securing a lower interest rate or by switching to a shorter-term. Ideally, you’ll even be able to pull off both.
When you get a lower interest rate and keep your monthly payments the same, it means that more of each payment goes toward the principal, and this means you’ll pay off the balance sooner and save money in the long run.
Similarly, a shorter term means your monthly payments will go up, but also that you’ll pay the loan off faster and be debt-free sooner. Before opting for this, make sure you can afford the increased payments.
The ideal situation is refinancing to get a lower rate and a shorter term. According to Dana Dratch at Bankrate, you could save yourself thousands of dollars and years of mortgage payments if you do this right.
“Let’s say you got a 30-year, fixed-rate mortgage for $200,000 at 4.5 percent. Then, five years later, you can refinance into a 15-year loan at four percent. Doing so pays off the mortgage 10 years earlier and saves more than $60,000,” she says.
However, it’s important to note that refinancing does come with fees, so you’ll have to factor those into your budget and calculations.
Before you do anything, check your mortgage terms for penalties or special instructions
Some mortgages come with prepayment penalties. What that basically means is that if you try to make an extra annual payment, increase your monthly payments, or make a lump sum payment, you may have to pay a fee for paying your mortgage off faster.
Similarly, other mortgages allow prepayments, but they only allow them at specific times, such as the anniversary of the mortgage. The best thing to do is call your lender to ask how you can go about paying more aggressively without paying penalties.
Lastly, when you talk to your lender, ask if there are any specific instructions that you have to give along with your additional payments. Some lenders require that you explicitly state or write a note explaining that you want the payment applied to the principal.
Otherwise, your payment could be applied improperly, making your effort for naught. For example, say you sent an additional end-of-year payment. Some lenders might, without the note, simply apply the additional payment to the following month instead of doubling up.
Paying off your mortgage is a big deal, and even if you’ve managed to pay down other debts in the past, nothing brings quite the same satisfaction as mortgage-free day. Most of the strategies you can employ to pay your mortgage off as quickly as possible include making prepayments, including extra annual payments, additional monthly ones, and even lump sums when you come into extra cash.
On top of that, make sure you budget wisely and put as much money toward the mortgage as possible.
Homeownership is practically a part of the American dream. Before you start dreaming of a picket fence, take the time to make sure that buying a home is the best decision for you right now. Once you’re sure that buying is better for you than renting, the next decision is how much house will be suitable for your family and your budget. (Try our rent vs. buy calculatorOpens in a new window if you’re not sure.)
“One big mistake that many first-time homebuyers often make is not factoring the household’s current debt situation into the decision-making process,” says Beau Zhao, a senior associate in Fidelity’s Strategic Advisers, Inc.
You may be able to avoid this mistake by using these simple rules of thumb for determining how much house you can afford.
First: Determine how much house
Using a factor of your household income, you can quickly gauge how much house you can afford. The total house value should be a maximum of 3 to 5 times your total household income, depending on how much debt you currently have.
- If you are completely debt free, congratulations—you can consider houses that are up to 5 times your total household income.
- If less than 20% of your income goes to pay down debt, a home that is around 4 times your income may be suitable.
- If more than 20% of your monthly income goes to pay down existing debts in the household, dial the purchase price to 3 times.
One of the major factors that determines how much house you can afford is your debt-to-income ratio—that is, your monthly debt obligations divided by your monthly income. Generally, lenders like to keep that ratio around 36%–42%. If you have no preexisting debt, a lender might approve a loan that would bring your debt-to-income ratio up to 42%.
We assume 36% as the baseline maximum debt-to-income ratio you can have in the analysis. Because both your existing debts and your future mortgage payments are components of your household debts, the sum of both should not exceed this 36%. Using this metric, we can solve for the suitable home price so that your household has a healthy, manageable debt-to-income ratio.
Be cautious. Buying the biggest home you can afford means you have to obtain a large mortgage. This means sizable monthly payments—which might make it hard to meet your other financial priorities. A good rule of thumb is to hold your housing costs to about 30% of your monthly income. The U.S. Department of Housing and Urban Development considers families who pay more to be “cost burdened”; such families may have difficulty covering other important expenses.
Try this simple calculator to find out how much house you can afford.
Second: Save at least your annual salary before taking any action
Keep saving until you have saved an amount equal to your annual income. This should cover your down payment and the other expenses associated with buying a house. If you purchase a home that is 4 times your annual income, 1 times your income is 25% of the value of the home, accounting for a 20% down payment and other home-buying expenses. Consider saving this amount first before taking any action.
Paying a 20% down payment is the ideal option in most cases, because you can avoid private mortgage insurance and save money in the long run. If you have trouble paying for a 20% down payment but still want the big house you’ve always dreamed of, you could benefit from selecting a nonconforming loan, like an FHA loan.
Note: You don’t have to borrow the full amount a mortgage lender will give you. “Just because a bank tells you that you can borrow $300,000 doesn’t mean that you should,” cautions Zhao. “And always compare all mortgage options available to you, because there might be a better option.”
Read Viewpoints on Fidelity.com: How to pick a mortgage: 5 considerations
The preapproval process
Once you’ve saved enough for a down payment and determined your home-buying budget, it’s time to check your credit before approaching a lender for a preapproval. This is an important step, because you don’t want to have any unwanted surprises from the lender after you find a house you want to buy. It’s always good to know whether your current credit qualifies for a good mortgage beforehand. The lender will evaluate your savings, income, and credit score to roughly determine how much you can borrow.
It’s important to verify that your credit reports from the 3 credit bureaus reflect accurate information and that everything is up to date. Making sure your credit score is as high as possible can help you get a better mortgage rate, and that can save thousands of dollars in the long run.
Other costs to think about
The cost of a home is more than just a down payment and monthly mortgage payments. During the home-buying process, you’ll need an appraisal to verify that the home is worth the price, and you’ll be responsible for closing costs, which may amount to several thousand dollars. Ongoing costs include homeowners insurance, property taxes, and any homeowners association or condo fees.
And then, of course, there are the costs of maintaining and improving your home. Utilities in a house may cost more than the utilities in an apartment because of increased square footage. Plus, that lawn won’t mow itself. Paying for monthly or weekly trims—or a lawnmower—may need to be in your budget.
New homeowners are often surprised by the unexpected costs that come up in the first few months. You want to make sure you have some savings set aside to take care of those expenses.
Don’t forget about all your other priorities, such as saving for retirement and, if you have kids, their college education. If buying a house would put such a crunch on your budget that it would put these goals in jeopardy, you might consider continuing to rent for a while.
Once you’ve reviewed your savings, considered your budget, and factored in your other priorities, you’ll have a much better sense of how much house you can comfortably afford. And finally it’s time for the fun part—shopping for your new home.
Owning a home has long been considered to be part of the American Dream, but as the huge tidal wave of foreclosures has taught us in recent years, it can also be a major disaster if you buy a house you cannot afford – or if you buy a home before you are ready for home ownership.
Purchasing a home is a major investment, and as with any investment, it is important to be educated before you dive in. Once you have a basic understanding of what home ownership entails, you must carefully consider whether you are truly ready to buy.
When determining whether you are ready to buy your first house, there are six key factors to consider.
Am I Ready to Buy a House?
1. The Current State of Your Finances
The current state of your finances is perhaps the single most important factor to consider when determining whether you are ready to delve into home ownership. When examining your current financial state, you must answer two questions:
- Do I Have Cash Set Aside for a Down Payment? Ideally, you need to be able to put down at least 20% of the cost of the home to avoid having to pay private mortgage insurance (PMI). PMI is a huge waste of money, since it essentially just protects the bank’s investment in case you default on the loan. Buying a house without a down payment is risky for the bank and for you, since you could end up owing more than the home is worth if property values fall. PMI protects the bank, but you won’t have a safety net if you haven’t put money down on the home.
- Can I Afford the Cost of a Mortgage? This question seems obvious, but it is important to think about future mortgage payments, as well as current payments. If you take a fixed-rate mortgage, your payments will not change over the life of the loan, and it will be easier to predict whether you will be able to afford future payments. However, if you take an adjustable rate mortgage, you may be able to afford the payments now, but not when they adjust upward in the future. This is a significant risk, and these types of adjustable rate mortgages have been a major contributing factor in the ongoing mortgage crisis in the U.S.
So, why have people taken adjustable rate mortgages? Usually it is because their initial interest rate was lower – making it seem like they could afford the mortgage when they really could not. Don’t fall into this trap. If you need some type of creative financing to afford your house, then you simply can’t afford it.
2. The Stability of Your Financial Future
This is another important factor when determining whether you should buy a house now or wait until the future. If you have recently changed jobs, if you are thinking about changing jobs, or if you are expecting any major changes to your income, it is not a good idea to buy a house until you are on more solid footing. Banks and mortgage lenders typically require you to have been with your employer for at least a year or two before they will consider you for a loan.
Furthermore, you need to have a plan to pay your mortgage in the event that something does go wrong in the future, such as a layoff or a medical problem. Typically, this means you should have an emergency fund – at least a few months’ worth of living expenses – set aside before you buy a home.
An emergency fund can also come in handy to help you to bear all of the unexpected costs that come along with being a homeowner. For instance, having cash set aside for repairs is essential, since you will not have a landlord to call when something goes wrong.
3. Your Credit Score
The state of your credit is just as important as the state of your finances when it comes to deciding whether you are ready to buy a home. Your credit score determines whether a mortgage lender will give you a loan at all, as well as the rate. A low credit score can result in a significantly higher interest rate, which means that you will pay thousands (or hundreds of thousands) more over the life of the loan.
Typically, you need a credit score above 720 in order to get the most advantageous rates. If your score is lower, consider waiting a while to buy a house as you try to improve it. You can do this by:
- Paying down debt
- Having inaccuracies removed from your credit report
- Making payments on time every month
- Avoiding opening new types of credit or applying for new loans
Over time, with responsible borrowing behavior, old negatives on your report will have less of an impact, your score will go up, and you will be ready to purchase a home at a better rate.
4. Your Commitment to Staying in One Place
Buying a house entails a large initial expense. First, you must pay the closing costs associated with your mortgage, which can total several thousand dollars. Once you are in the home, most of the initial mortgage payments go toward paying interest on the loan, rather than paying down the loan balance. Keep in mind too that selling your home in the future may also be expensive, as you typically must pay commission to a real estate agent.
With all of these costs, it is very difficult – if not impossible – to make money on a home unless you plan to stay in it for a while. Until recently, many experts recommended that you plan to stay put for at least two years if you are going to buy a home. However, because of an uncertain real estate market and uncertain property values, this estimate has been revised to suggest that you refrain from buying unless you plan to stay put for at least three to five years. If you aren’t committed to staying in one place for that duration, now is not the time to buy.
5. The Current Real Estate and Credit Market
While this factor may not be as crucial as the other considerations, you still need to consider it. Look at the current interest rates, and consider the experts’ opinions as to whether property values are on the rise, or are likely to fall.
- If interest rates are at record lows, it may be a good time to buy, as you will pay a reduced cost for the privilege of borrowing money.
- If property values are on the decline, it may be a good time to wait as you could end up getting a better deal on the same type of home in just a few months’ time.
It can be very hard to accurately predict what interest rates or property values will do, so these shouldn’t be deciding factors – but they are worth considering.
6. Your Commitment to Home Ownership
Being a homeowner is different than being a renter. You need to take care of all of your own home repairs and maintenance, rather than counting on someone else to do it. You may have more yard work, as well as additional responsibilities (such as shoveling snow and cleaning out gutters) that renters don’t have to worry about. While some people don’t mind such chores, others don’t want the hassle. Consider whether you are ready to take on these added responsibilities of home ownership before you make your decision.
All of these factors need to be weighed and considered when deciding if now is the right time to buy a home. Make sure everyone in your family is on board and that you think with your head, not your heart. If you don’t carefully consider every aspect of this important financial decision, you could find yourself struggling to make mortgage payments you can barely afford – or worse, you could find yourself in foreclosure.