4 ways to pay off mortgage early

Congratulations, you finally bought your first home.

You got a great rate on a thirty year fixed rate mortgage, so your monthly payments are affordable. But a look at your amortization schedule gives you a shock - over thirty years, you’ll pay two hundred thousand bucks in interest as you pay for your house. There must be a better way!

Well, there is, and I am asked about this topic frequently. Here are the questions I hear most often:

Q: I just bought my house for $300,000 and put down 20 percent from my savings. But two hundred thousand bucks in interest alone seems like a lot of money — what’s the scoop?

A: It’s all mathematics. The more you borrow and the longer you take to pay it back, the more its gonna cost. There’s no magic here.

Q: But why does it seem so expensive?

A: Because you’re paying interest over a very long period of time. If you really want to save money, just wait until you have the cash in the bank, and then write a check for the home purchase.

Q: If we had to do that, we couldn’t afford to buy a house for many years, if ever.

A: I agree! So you are better off getting a loan and buying your house now, when you need it.

Q: But are there ways to pay off the loan early?

A: Here are four scenarios in which you can save some dollars on interest. All of them involve paying back the principal faster in one way or another:

Assuming we start with a typical home loan of $240,000 at 4.5 percent interest for 30 years with a monthly payment of $1,216. Over the 30-year term of this loan, you will pay almost $198,000 in interest alone.

No. 1: But if you add $100 per month in additional principal, you begin to see some savings right away. All of a sudden, your interest expense drops by over $33,000, and your loan pays off in just over 25 years.

No. 2: Next, you can consider raising your monthly payments by about 50 percent, from $1,216 to $1,835, and your loan pays off in exactly 15 years. Perhaps the best part of this plan is that you avoid over $100,000 in interest payments altogether, and own your home free and clear much faster.

In this example, I have left the interest rate at 4.5 percent so we can compare apples to apples, but you can find better rates for a 15-year loan.

No. 3: If you are truly ambitious and have the financial ability to do so, you can consider what I call the McKinney Plan. Under this scenario, you make double payments, with the second $1,216 being applied entirely to interest.

Not everyone can afford to make double payments, but if you can and you choose to do so, the interest savings are significant.

Your total interest expense drops to just over $60,000. But best of all, your term drops to 123 months, meaning you will be mortgage-free in just over 10 years.

No. 4: Finally, there is an option I hesitate to mention, because I consider it a gimmick. It’s called the bi-weekly mortgage, and some lenders allow third party vendors to offer this scheme to their borrowers for a fee. I believe it to be money wasted.

Under this plan, the lender cuts your payments in half, then you pay that half amount every two weeks, perhaps in step with your payday cycle. The trick here is that you end up making 26 half payments, which is the equivalent of exactly 13 monthly payments.

But upon closer examination, this scenario is almost identical to No. 1 in which we added $100 per month to our monthly payment (with no administrative fees, I might add). Why pay several hundred dollars in fees for something you can do for free?

Q: So, your lender will accept any of these options if you decide to use them?

A: Yes. You may need to mark the additional payments as principal, but, in almost all cases, the lender must accept partial payments at any time.

The bottom line: If you want to pay off your loan early, you are always welcome to do so.

My personal belief is that interest rates are so low that it makes no sense to pay off loans early, but you may feel differently. It’s up to you to decide if that course of action is right for you.