Owning a home is one of the most important parts of the American Dream. Except most people don’t really own their home, they only own part of it. The mortgage company owns the rest. But when that last payment is made to the mortgage company, most people can’t help but feel that sense of freedom.
I won’t lie to you. Most financial advisors will tell you that paying off your house is not the best investment of your money. Investing in a high return mutual fund or a 401k plan will get you a better return, at least that is what they will say. But no matter what they tell you, a mutual fund or a 401k plan can be a gamble. If you don’t believe me, just ask the employees of Enron or the employees of several state governments, who’s 401k funds were invested in Enron.
Your house is a sure bet. Your house will go up in value. You are getting a return on your money when you pay. Basically, whatever you pay towards the principle is like putting that same amount into a savings account with an interest rate that is the same as your mortgage rate. How many savings accounts have you seen lately that have an interest rate of 5% - 8%? How many mutual funds can guarantee a return to 5% - 8% every year without fail?
Now I am not saying don’t invest in your 401k. Do put money there. 401ks are good ideas. Just think of your mortgage as your safe money. Something you can fall back on if your 401k fails.
There are four ways to pay off your mortgage faster. One is to pay extra on your monthly mortgage payment. The second is to switch your payments to bi-weekly payments. The third is to make one extra payment a year. The fourth is to refinance for a shorter term.
The first way, adding a little extra to your payment each month is by far the most common. If you are smart, you will be a landlord to yourself and raise the “rent” every year. Even five or ten dollars extra a month can make a big difference and take years off your mortgage. It’s not so hard to do this. Think of it as a cost of living increase.
The second, switching your payments to bi-weekly, can help to shorten your mortgage because of timing. Basically, with bi-weekly mortgage payments, you are paying half of your payment 2 weeks early. You don’t have to pay the interest for two additional weeks on that half of the payment. So you say, big deal, what’s two weeks interest. Try seven years off your mortgage (if done from the beginning on a 30 year) and tens, yes, tens of thousands of dollars saved in interest.
The third is to make an extra payment each year. It has almost the exact same effect on your mortgage as the bi-weekly payments. Seven years off the mortgage and lots of money saved . Don’t think you can swing an extra payment? It may not be as much as you think. The amount most people pay to the mortgage company each month is inflated. You have your escrow (for taxes and insurance) and the PMI. Look at your bill and find the breakdown of where the money goes. Your mortgage payment is what goes towards your interest and principle. It can be half to two-thirds of what you pay each month to the mortgage company. A much easier number to obtain.
The fourth is to refinance at a shorter term. Most people finance their house on a thirty-year term, meaning they are expected to pay it off in thirty years. After a few years in the house, they find that their circumstances are more prosperous. Don’t waste your money on a new car (you just lose money anyway), refinance to a fifteen-year loan. Even if your rate doesn’t change, you are in for big savings. For a mere $350 a month extra (based on a $150,000 loan at 7%) you can have your loan paid off in15 years instead of 30 AND, you will have saved a whopping $170,000 dollars in interest over the course of the loan. You will have saved more than the original price of your home just by refinancing. So what will it be, an extra $350 a month in your pocket now or an extra $1000 dollars a month in 15 years? Think about it, fifteen years isn’t so long. Your kids won’t even be out of the house (and wouldn’t it be nice to have that extra money for college). But a note, refinancing at a shorter term should only be done if you plan on staying in the house.
So, what is even better about these different ways to pay off your mortgage? You can combine them! Refinance and add a little to the payment when you can or make an extra payment each year. Pay bi-monthly but add a little each payment too. Do all of them. Definitely do one of them. No matter which you choose, you will find that your house can be your own personal piggy bank.