5 ways to pay off your mortgage early: Pros and cons

Craig Berry
The Mortgage Reports contributor

Want to pay off your mortgage faster than 30 years?

Many homeowners with 30-year mortgages feel like they’ll never be without the burden of debt.

Fortunately, there are several good ways to pay off your mortgage faster and save big on interest payments.

Even better, not all methods require spending a lot of extra money.

But consider your options carefully. If you have extra cash to spend on your mortgage, it may generate more value elsewhere.

Here’s what you should know.

See if you qualify for a shorter loan term (Apr 21st, 2021)

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Why pay off your mortgage early?

Few people keep a 30-year loan for its full term. In fact, homeowners stay put just 13 years on average — and their loans might have an even shorter lifespan if they refinance at some point.

Homeowners who plan to sell their home or refinance soon usually aren’t concerned about paying off their mortgage early.

But what about homeowners who stay put for the long haul? Those 30 years of interest payments can start to feel like a burden, especially compared to the payments on today’s lower-interest-rate loans.

You may find yourself wondering how to pay your mortgage off faster so you can live debt-free and have full ownership of your home.

Here are five strategies you can use to meet those goals.

Five ways to pay off your mortgage early

There are a number of ways to shorten your loan term and save a ton of money in interest on your mortgage.

1. Refinance to a shorter term

The 30-year home loan is most popular, but lenders offer shorter loan terms, too. A 15-year loan is a common alternative, and many lenders also offer 10-, 20-, and 25-year loans.

Shorter repayment periods mean higher monthly payments, but less interest over the life of the loan.

Let’s compare a 20-year term to a 30-year term.

Most 20-year mortgages carry lower rates than 30-year mortgages. Typically, 20-year rates can be anywhere from one eighth (0.125%) to a quarter percent (0.25%) lower.

  • Let’s say you’re financing a $250,000 loan on a 30-year term at 3.75%. Your principal and interest payments would be about $1,150 per month
  • Using the same loan amount, but with a 20-year term at 3.625%, your monthly payment would be $1,450
  • You’d pay a few hundred more per month, but you would be mortgage-free a decade sooner

The best part? The savings in interest on that 20-year mortgage would be over $65,000 if you kept the loan until it was paid off.

Another benefit of refinancing to a shorter term is that you don’t have to start over with 30 more years.

For many homeowners who are well into their original mortgage term, starting over with another 30 years’ worth of interest might not make sense.

But with a 15-year refinance, you could lock in a low interest rate and a shorter loan term to pay off your mortgage faster. Just note: the shorter your mortgage term, the higher your monthly mortgage payments will be.

Verify your refinance eligibility (Apr 21st, 2021)

2. Make extra principal payments

Another way to pay off your home loan faster is to simply pay extra when you’re able.

Most mortgage loans issued after Jan. 10, 2014, do not charge prepayment penalties.

This means you can pay extra money toward your mortgage balance each month — or make a larger, lump sum payment on your principal each year — without facing a penalty for paying off your loan early.

Many homeowners make extra payments on their loan’s principal when they get an income tax refund. Extra principal payments can have a big impact.

Here’s an example.

  • Let’s say you took out a home loan for $300,000 on a 30-year term and rate of 4%
  • That’s a principal and interest payment of $1,370
  • 360 payments of $1,370 per month means you’ll have paid $492,500 over the life of the loan — that’s $192,500 in interest payments over 30 years

Using the same numbers for the loan amount and interest rate:

  • If you make extra principal payments of $250 per month, you’d shave seven years and four months off your term
  • And, you’d save more than $59,000 total in interest payments

There are benefits aside from interest savings, too.

Paying off your mortgage early lets you use the money you would have paid each month for other purposes, like investing.

Let’s continue with the example above. Instead of paying $1,370 per month on the mortgage, you could put the same amount of money in an investment account.

With a 5% rate of return over seven years and four months, your redirected mortgage payments would equal $135,000. Not only did you save $59,000 in interest, but you have an additional stash of cash after your original 30-year loan term.

3. Make one extra mortgage payment per year (consider bi-weekly payments)

Many homeowners choose to make one extra payment per year to pay off their mortgage faster.

One of the easiest ways to make an extra payment each year is to pay half your mortgage payment every other week instead of paying the full amount once a month. This is known as “bi-weekly payments.”

When you make bi-weekly instead of monthly payments, you end up adding one extra payment each year.

However, you can’t simply start making a payment every two weeks. Your loan servicer could be confused about getting irregular, partial payments. Talk to your loan servicer first to arrange this plan.

You could also simply make a 13th payment at the end of the year. But this method requires coming up with a lump sum of cash. Some homeowners like to time their extra payment with their tax return or with a yearly bonus at work.

However you arrange it, making an extra payment each year is a great way to pay off a mortgage early.

As an example, if you took out a mortgage for $200,000 on a 30-year term at 4.5%, your principal and interest payment would be about $1,000 per month.

Paying one extra payment of $1,000 per year would shave 4½ years off your 30-year term. That saves you over $28,500 in interest if you see the loan through to the end.

Paying down your mortgage balance quickly has other advantages, too.

For example, lowering your balance means you can stop paying private mortgage insurance (PMI) premiums sooner. Conventional loans let you cancel PMI when you’ve paid off 20% of the loan’s original balance.

4. Recast your mortgage instead of refinancing

Mortgage recasting is different from refinancing because you get to keep your existing loan.

You just pay a lump sum toward the principal, and the bank will adjust your payoff schedule to reflect the new balance. This will result in a shorter loan term.

One major benefit to recasting is that the fees are significantly lower than refinancing.

Typically, mortgage recasting fees are just a few hundred dollars. Refinance closing costs, by comparison, are usually a few thousand.

Plus, if you already have a low interest rate, you get to keep it when you recast your mortgage. If you have a higher interest rate, refinancing might be a better option.

Check with your lender or servicer if you like this option. Not all companies will allow a mortgage recast.

5. Reduce your balance with a lump-sum payment

An alternative to recasting is to make lump-sum payments to your principal when you can.

Have you inherited money, earned large bonuses or commission checks, or sold another property? You could apply these proceeds to your mortgage’s principal balance and be debt-free a lot sooner.

Since VA and FHA loans cannot be recast, lump-sum payments might be the next best thing. Also, you’ll save yourself the bank fee for recasting.

With some mortgage servicers, you must specify when extra money is to be put toward principal. Otherwise the extra money could be split between the interest and the principal as it is divided within a regular monthly mortgage payment.

Check with your servicer if you don’t know how additional payments will be applied.

Check your mortgage options (Apr 21st, 2021)

Downsides to paying off your mortgage early

Most financial experts encourage homeowners to put their extra money into retirement accounts instead of paying off mortgages early.

The reason? For almost a century, the stock market has earned a 10% average annual rate of return. That means homeowners could potentially earn more by investing in the stock market than they’d save by paying down their mortgage balance.

Plus, some homeowners write off their mortgage interest payments as a tax deduction which means they could get some of that money back at tax time.

There are other potential drawbacks to consider before paying off your mortgage early:

  • Using all your extra funds to pay down a mortgage may tie up too much of your net worth in your home, making it harder to access later. You’d need a cash-out refinance or a second mortgage (like a home equity loan) to generate cash flow from your home investment
  • You may miss out on higher returns from investments whose rates of return could exceed the amount of interest you’re paying on the mortgage. But keep in mind that stocks don’t always go up. You could avoid big losses by applying extra funds toward your mortgage. A deposit toward your mortgage is a guaranteed return equal to your current interest rate
  • If the real estate market dips when you’re thinking of selling, you may not receive as much as you had hoped
  • Money you deposit into an IRA instead of paying down your mortgage can grow tax-free. Focusing on building a healthy retirement fund when you’re younger gives your savings more time to grow, plus you can deduct contributions to your traditional IRA up to the IRS’s annual limits

Finally, before paying extra on the mortgage, many personal finance experts recommend building an emergency fund in case you lose a job, get injured, or face other financial troubles. Without emergency funds in a savings account, you may have to use higher-interest credit cards to pay unexpected expenses.

Questions to ask before paying off your mortgage early

Is paying off your mortgage early the best financial decision for you and your family? It depends on your unique situation and financial goals.

Here are a few questions to help guide your decision:

  • How long do you plan to stay in your home? If there’s a good chance you’ll sell the home within a couple years, the benefits of refinancing or paying down your mortgage will be less likely to pay off. Your dollars may be better invested elsewhere
  • How much extra money do you have to work with? Do you have enough flexibility to pay down the mortgage and work toward other financial goals simultaneously? If so, you’ll have an easier decision
  • What mortgage interest rate would you qualify for? Today’s average mortgage rates are historically low — especially for 15-year loans. But your rate depends on your credit score, debt-to-income ratio, and other personal finances. If you can’t qualify for a significantly lower rate, refinancing will make less sense
  • Do you have an emergency fund? If your savings account couldn’t absorb at least three months’ worth of living expenses, consider saving up an emergency fund before paying more on your mortgage

If your main objective is to be debt-free as soon as possible, then look into one of the five strategies above to pay off your mortgage faster. You may have already paid off other personal debt like student loans or credit cards; it could make sense to target your mortgage, too.

This can be especially appealing if you’re close to your mortgage finish-line and starting over with a refinance wouldn’t make sense.

Should you pay off your mortgage early or refinance?

Do you want to pay off your mortgage faster because you’re worried about how much you’re spending on interest?

If you’re simply concerned about your mortgage interest rate, consider refinancing to a lower rate — and maybe a shorter term — instead of making extra payments on your existing mortgage.

But if you already have a competitive interest rate and an ideal loan term, you probably don’t need to refinance. You may be tempted to pay less interest by paying off your mortgage faster.

As you make your decision, consider whether you could earn more investing in securities than you’d save by paying down your mortgage balance more quickly. Investing that money in a tax-preferred IRA could offer more financial peace of mind than owning your home outright sooner.

Any kind of investing can be risky. Check with a personal financial advisor before making any big moves if you’re not sure about the risks you’re taking.

Verify your refinance eligibility (Apr 21st, 2021)

Recap of ways to pay off your mortgage faster

If you decide you want to pay off your mortgage early, ask your mortgage lender about:

  1. Refinancing to a shorter mortgage term
  2. Making extra principal payments
  3. Making one extra mortgage payment per year
  4. Recasting your mortgage
  5. Making a lump-sum payment

Whatever you choose, make sure you’ve weighed all your options to find the best use for your hard-earned cash.

Verify your new rate (Apr 21st, 2021)