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How to refinance to pay off a mortgage faster

Peter Warden
Peter WardenThe Mortgage Reports Contributor

In this article: 

There are many reasons that a refinance can help you improve your financial picture. And real financial security comes from having a home with no mortgage. Here’s how to pay off a mortgage faster.

  1. You can refinance to a shorter term, which usually also offers a lower interest rate
  2. You can refinance to a lower rate but keep making the higher payments, reducing your principal balance faster
  3. You can take a cash-out refinance to clear all your higher-interest debt, then use that monthly saving to accelerate the repayment of the mortgage

Usually, you have to make a higher payment to pay off a mortgage faster. But sometimes you can reduce your rate, continue to make the higher payment, and knock years off your mortgage term.

Verify your new rate (Oct 15th, 2018)

Living the dream

Do you ever lie there, imagining it? Do you dream of that morning when you make the very last payment on your mortgage? How you’re going to feel when you’re mortgage-free? What you’re going to do with all that extra money you’re going to have at the end of every month?

Related: How much to extra mortgage payments really save you?

Well stop dreaming and set about making it a reality — years ahead of schedule.

Early payment penalties

First, check your mortgage documents or call your loan servicer. Some mortgage agreements impose prepayment penalties if you pay off your home loan early. Many don’t have any such requirement, and some impose only small “fines.”

But some demand significant sums that can undermine the economic viability of early payments. Check your agreement to see which category you’re in.

It’s the economics!

Your decision to pay off a mortgage faster should be based on whether it makes economic sense for you.

And that means at least considering whether you’d be better off investing elsewhere the extra money you’ll expend in bigger mortgage payments. Just remember two things:

  1. High rewards involve high risk. If you’re banking on high returns on your investments, those won’t be certain
  2. You’re definitely going to receive (as savings) the money you don’t have to pay out by having fewer mortgage payments

You can easily work out the total costs of borrowing for your two models: leaving things as they are now and paying down your mortgage quicker. A mortgage refinance calculator can help you see if how much you’ll save by refinancing to a shorter term. The hard part is in making the right assumptions about alternative investments.

Refinance to a shorter term

The most obvious way to pay off a mortgage faster is to refinance to a loan with a shorter term. So, if you have 20 or 25 years left to run on your 30-year mortgage, you could refinance to a 15-year one. Some lenders are very flexible about loan terms and you may be able to find one that covers the range from eight years to 30.

Related: When to refinance (I need to lower my mortgage rate or payment)

One of these refinances may make sense even though mortgage rates have been rising recently. That’s because, all other things being equal, shorter-term loans come with lower interest rates than longer ones. And borrowing the same sum for a shorter period is going to cost you less because you sheer years off your repayment schedule.

However, these loans come with higher monthly payments. So you need to be absolutely sure you can — and will continue to be able to — afford those.

Just pay more

Many lenders will allow you to increase the size of your regular mortgage payment or simply make extra payments when you can. However, you must talk to your lender first.

Agree that your extra payments will be applied only to the “principal” (the amount of your original debt you still owe). Otherwise, there’s a risk your lender will assume they’re simply advance installments. And that would mean some of the money will go on interest on a part of the debt you no longer owe.

Even if things are tight, you may be able to round up your monthly payment so it ends in two zeros. Or perhaps you could use your tax rebate to make a 13th payment each year. Both those could shorten your loan appreciably and possibly save you thousands of dollars.

Pay every two weeks

This can be a relatively painless way of making the equivalent of 13 monthly payments a year. But, again, you must speak to your lender first.

You halve your monthly payment and make that every two weeks. Because there are 52 weeks in a year, that will mean you’ll make 26 half-payments, which is the same as 13 full ones. If you carry on paying monthly, you’ll make only 12.

In 2018, U.S. News quoted Jonathan Scott, professor of finance at Temple University’s Fox School of Business: “This strategy can shave four to six years off of a typical 30-year loan,” he said. “On a 15-year mortgage, biweekly payments may cut one to three years from the repayment time, depending on the loan amount and interest rate.”

Cash out to cash in

If you’re burdened with piles of high-interest debt, you’re likely skint at the end of each month. But that doesn’t necessarily mean you can’t pay off a mortgage faster.

One way forward is to consolidate all those expensive loans through a cash-out refinance. You’ll be free of all those payments on credit cards, personal loans and perhaps even auto loans. You can then use all that extra money to pay down your mortgage faster.

Related: Cash-out refinance to buy a car (or pay one off)

There are obvious risks with this strategy. If you fail to address the bad habits that saw you build up all those debts, you’re likely to soon end up with similar ones again. But you’ll also have a higher mortgage balance and probably a longer loan. In other words, you’ll be worse off.

So don’t go down this road unless you first put in place a realistic household budget. You must also promise yourself you’ll stick to it. Inside your head, there’s a still, small voice telling you whether you’ll keep that promise.

How should YOU pay off a mortgage faster?

The two refinance options above are the big-bang ways to shorten the time before you’re mortgage-free. They can be highly effective but they come with their own risks.

Those higher payments on a shorter-term loan may be fine now. But how will you cope if your life hits a bump, perhaps as a result of sickness or unemployment? And a cash-out refinance can certainly leave you worse off unless you address your bad borrowing habits. But those options can work really well for the right borrowers.

Paying more on your existing mortgage probably won’t deliver the same savings or shorten your loan term as much. But they’re relatively safe. Only you can decide which works best for you.

Verify your new rate (Oct 15th, 2018)