How To Pay Off Your Mortgage 4-12 Years Sooner
How To Pay Off Your MORTGAGE 4-12 Years Sooner
HOW DOES INTEREST & MORTGAGES WORK?
Let’s say someone has a $250,000 mortgage at 6% over 30 years. In this example, $250,000 will go to the principal and $1247 goes to interest. The higher the interest rate, the less principal you’re paying in the initial portion of the loan. If you were to get a loan right now, approximately 30% of your payment would go toward the principal and 70% goes straight into the pockets of the bank.
When you look at it on paper, it seems quite unfair. Why would anyone buy a home if they end up paying triple the price in the end? Would a bank even lend you money in this case? Of course they would! Again, this is why I serve as the advocate, or go between, with the bank and the borrower to minimize the issues, get the best rates and ensure my clients understand how to pay off their mortgages faster.
Why Should We Pay Off Our Mortgage Faster?
Financial freedom comes when you make more money than you have to pay out each month. This ideal is achieved when your expenses are less, and you don’t have work just to breakeven. If you’re getting to the point where you want to retire maybe 15 to 20 years from now, you certainly don’t want to be paying a mortgage and taxes. Paying off your mortgage will allow you to live the lifestyle you want to live when you get older. Eliminating your mortgage payment greatly reduces the amount of cash you need to meet your monthly expenses.
WHAT IS MORTGAGE INSURANCE AND HOW DOES IT IMPACT MY LOAN?
By paying off your mortgage faster, you can get out of that mortgage insurance cost quicker as well. For conventional loans, at the point where your home equity is 22% or greater, meaning you owe less than 78% of the value of your home, you can drop your mortgage insurance altogether.
What’s The Burden Of Mortgage Insurance?
Mortgage insurance is based on your credit score, down payment and loan amount. For example, if someone has a 640 credit score and wants to make a 5% down payment on a $300,000 house, he is probably going to be paying $180 a month in mortgage insurance. However, if someone has a 765 score, and puts 15% down and finances $150,000, the mortgage insurance could be $200 each month. Again, it can vary greatly based on those several factors mentioned above.
How And Why Should You Eliminate Your Mortgage Insurance?
A good first milestone and step toward financial freedom is paying enough on your mortgage balance that will allow you to drop the additional cost of mortgage insurance.
For example, if you have 78% equity based on the original purchase price, you can just make a simple phone call to the bank to ensure they understand you have reached this milestone. The mortgage insurance may drop off on its own, but if not, a reminder to the bank should do the trick for a conventional loan.
You can also order an appraisal through the lenders channel. If the current sale price shows that you have 22% equity, then you can drop the mortgage insurance.
There is another way to be rid of mortgage insurance as well. Instead of just hoping the value of your home goes up enough to get rid of the mortgage insurance, or paying enough slowly over time, if you accelerate it, you’re much more likely to get to hit that milestone quicker. Once are rid of the mortgage insurance, you can then put that extra money toward your payment every month and further accelerate the pay down on the mortgage.
Furthermore, we know loans with smaller down payments generally come with higher interest rates. So, as you pay down your mortgage, you also unlock more favorable interest rates, thus making a refinance to a lower rate which will also accelerate your payoff.
What If I Have An FHA (Federal Housing Administration) Loan?
People who don’t qualify for a conventional loan are generally able to get an FHA loan, which are for any financially qualified borrower. With an FHA loan, the mortgage insurance stays for the life of the loan, unless you put 10% down, where in that case the MI premium falls off after 11 years.
FHA mortgage insurance premiums are more expensive based on the overall credit risk the consumer brings to the mortgage market. This is the main reason FHA loans are less favorable than conventional loans. In order to remove these higher MI premiums, you would have to refinance out of the FHA loan.
Let’s say you start with a low down payment and you get up to 10% equity – if the rates are favorable, will it be a lot better for you if you refinance, and if you get up to 20% is it even better?
We live in a capitalistic economy. Current market conditions determine what the market rates will be at any given moment. For example, let’s assume interest rates are as favorable as when you originally took out the loan and you reach the milestone of 10% equity. In this case, let’s say your credit score has slightly improved so you can refinance strictly to get a lower mortgage insurance premium.
On the other hand, say you keep the same rate your mortgage insurance premium may still drop from $250 a month to $80 a month.
Everything is based on your credit score, loan value and current market interest rates.
WHAT IS LENDER LEVEL PRICING ADJUSTMENT?
Check out the image below, which shows a variety of LLPA hits for various combinations of credit score and LTV. Note that for a 95% LTV loan, there is a 3.000% hit for borrowers with credit scores less than 620 but no hit for borrowers with credit scores better than 740. Assuming all other factors are the same, this means that the borrower with a qualifying credit score of less than 620 will have to pay a charge of 3% of the loan amount to get the same interest rate as the borrower with a 740 credit score. For example, on a $200,000 loan, the borrower with the low credit scores would have to pay a $6,000 buy down fee to get the same rate as the borrower with the good credit scores.
A lender level pricing adjustment is a charge or adjustment that the lender makes to offset their risk with their business partner, the homeowner. LLPA’s are based on risk factors including low credit scores, high loan-to-value (LTV), and property types and so on.
One example of this would be if the business partner has more equity in, the lender can adjust their lender level price adjustments to be lower, because the default rate is generally less for people who have more equity in their home.
Let’s say I have 15% equity in my home, which is a huge milestone but all the sudden, I fall on financial hard times. Under these circumstances, I might miss a car payment, or I may be late on my credit card payments. However, no matter what, I’m going to make my mortgage payment. I have $80,000 invested in my home that I am not willing to lose. Lenders know this. They know you have more skin in the game when it comes to your house.
As people, we have a psychological connection to our homes. We are living the American dream as we get closer and closer to eliminating our mortgages. The banks know that as we pay down our mortgages, we become more connected to our homes and to our communities. They know the chance of defaulting on our loan goes down We’ve earned that money. We’ve earned the right to home ownership. It’s our own blood, sweat and tears that have gone into this property. They know very well I’m not foreclosing on this property because I’ve worked hard for it. Home equity is like cash in the bank.
The bottom line is, the more equity you have in your house, the better interest rates you can expect. When you have a better interest rate, your cash flow will increase and you will be in more of a position with discretionary income to decide how you want to spend it.
To reiterate 10% equity is a good milestone, it will reduce your MI if you have it, again, depending on your credit score and the home’s value. Having 15% equity in your home is another big benchmark to hit. There’s a big difference between 90 and 85 and remember, at 80, your mortgage insurance premium goes away. If you choose to do a straight refinance at 15% equity, you will likely get a lower rate and save on your monthly payment or you can put more money towards paying it down faster and therefore, reduce the mortgage insurance premiums. Either way, you should have even more money freed up to pay off your mortgage faster.
The next milestone of 20% equity, the mortgage insurance goes away and the lender pricing also gets better all the way down to 40% equity in the home. Again, the more equity you have in your house, the better interest rates you can expect. Once again, as homeowners we’re not going to walk away from a home where we know we owe half of its value.
WHAT IS COMMON AMORTIZATION
FOR RESIDENTIAL LOANS?
Every homeowner knows their financial limitations and financial discipline patterns. If you agree to a new 30- year loan at a lower interest rate, you may only commit to paying the minimum monthly payment because that’s your level of discipline.
Know yourself. There is no shame in one’s financial aptitude and exercising the knowledge they know is going to help them. The decision should be individual, and it should be intimate. It should be based on information to help you achieve the most palpable return as quickly as possible.
That being said, at the 20% mark there is more ability to do things like refinance for a shorter payback period, or a shorter amortization. A homeowner might say, “You know what? Even if I have to pay more each month, I’m going to refinance a 15-year loan now or maybe a 25-year loan. Whatever I can do. Yes, my payment will go up but I’m going to pay this off even faster this way.”
Of course, in this case, you are going to see a higher mortgage payment each month. However, you are also going to pay far less interest over the remaining life of the loan. If your goal is to pay off your loan faster but you know your discipline level is to only make the minimum payment put in front of you, then do yourself the favor. Get a 26-year loan versus a 30-year loan. Your future self is going to thank you. It’s okay if you aren’t someone who’s natural instinct is to pay more than your monthly minimum payments. Most people aren’t. That’s why doing a custom tailor amortization based on what your finances will allow, creates a way for you to get the results you want in a more timely manner. If you set yourself up to make monthly mortgage payments that are slightly higher but you can afford it, you are actually saving money in the long run. It’s often easier for people to have the bank give them a minimum monthly payment based on that amortization schedule. They are going to make that payment versus leaving it to self-will to pay more each month.
Look at it like running a marathon. When you’re halfway through a marathon you know the end is in sight. Making headway on your home mortgage is the same thing. In this way, paying off your house becomes more achievable. Psychologically, it puts a spring in your step when you can see that loan shrinking every month. It invigorates you to want to pay off your mortgage faster. The closer you get to the finish line, the greater the pride of home ownership becomes.
An admittedly gross analogy, albeit true, is that watching your mortgage go down is like watching that Dr. Pimple Popper show. Both are a release of burden. However, paying interest to banks is even grosser than a show about popping pimples.
How Much Should Or Could People Pay Off And What Does That Do?
There are different ways to go about paying off your mortgage early. One way would be to save up money by investing, hoping that in a few years you will have enough to make a large, lump-sum payment against your mortgage rather than paying it monthly. For some people it helps people having a safety net outside of their home equity in the event real estate values drop. If that happens, sure your mortgage may go down but you find yourself looking at a 40% loss at equity in your home as well. If you have invested outside of your home, this way you at least have money in your retirement account or savings account that you can use in an emergency situation. That’s one school of thought that needs to be addressed and discussed with a financial planner and your loved ones.
WHAT ARE THE BEST PRACTICES AND WHY?
Let’s look at a few examples:
1. Let’s say you are a salaried employee. It may make sense to make one extra payment a year or 1/12 of an extra payment every month on a $300,000 loan at a rate of 4% over 30 years. By paying the 1/12 of an extra payment every month on this loan, you would pay off your mortgage four years and one month sooner, saving you $33,315 dollars off your loan. If you made the one extra payment a year instead, you would pay off your mortgage four years earlier instead of four years and one month earlier. Taking it one step further, if you made two extra payments a year, you would pay off your loan seven years earlier. These are a few good examples and scenarios of how you could pay off your mortgage earlier by paying a little extra toward the balance. If you want to go yet another step if you paid two extra payments a year you would pay off your loan seven years early! As I said, there are many different variations of paying down your mortgage. However, the bottom line here is, without making any extra payments, you end up paying enormous amounts of interest.
2. Right now, the average purchase price homes my client’s is around $400,000. Let’s say they put 5% down and finance $380,000, with a goal of being able to end the mortgage insurance. With a loan at 4% interest, by doing nothing in this scenario, they would reach a $312,000 loan amount after 104 payments, or just under nine years, hitting the 22% mark which would end the mortgage insurance.
Using this example, let’s say you made one extra payment a year or an additional 1/12 of a payment month. In this case, you would get to the $312,000 mark, or in other words when you can drop the MI, after 84 months, saving yourself just about two years on those payments.
3. The last scenario we will look at is really aggressive but worth having a look at. If you paid one extra payment a quarter, it would save 11 years on your mortgage. Again, let’s say you start at 5% down and you’re paying an additional $665 dollars a month. It’s another additional payment a quarter and you can get rid of your mortgage insurance in four years. You effectively turn your 4% interest rate into a 2.41 % interest rate. That’s a 32% interest savings over 19 years! Think of it this way. For the price of a luxury vehicle lease, you would be mortgage free. “Mortgage free” is the new BMW status symbol.
What Do People Feel When They Pay Off Their Mortgage?
When you pay off your mortgage, it’s like being released from a debtors ‘prison. My clients feel amazing and why wouldn’t they. With no lifestyle change, they are looking at approximately $2,000 – $2,500 extra a month in their pocket. Paying off a mortgage is almost like retiring early. Instead of paying the bank each month, your money is just sitting in your checking account or wherever you choose to keep it.
Also, regardless of what anyone ever tells you about the tax consequence of paying off a mortgage, you are still getting taxed at probably a 50% rate. So really, it’s like a $4,000 a month pay increase. Think about that. Even though you may pay a little bit extra in taxes, due to the lack of mortgage interest paid, you’re still $4,000 a month richer at a $2,000 payment in a 50% bracket, for example.
From the first time you take out a mortgage until the time you pay it off, there will be various circumstances that come up where you will consider refinancing. Some of these events could be when it comes time to drop your mortgage insurance, when your equity increases, as your credit score increases, or even as external market conditions change. At times like these, it is important to have someone you can call who you trust to give you sound advice. You need someone who is well positioned to offer the lowest rates and fees and someone who puts your best interests above his own.
Visit my site at JakeTaylor.com or text me at 480-999-3339, or call 1-800-855-CallJake.
In the subject line of your email or in your text add “Mortgage free now”.