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How To Pay Your Mortgage Quickly

Corey —  September 24, 2012 — Leave a comment

Everyone dreams of the day that their mortgage for their house will be paid off right? I know I do! We bought our house around 3 years ago, and would like to have it paid off in around 4 to 5 years. We have a long 30-year loan though.

There are many reasons why people want to pay off their homes early. Maybe you just hate debt and want all of your debt to be gone. Maybe you want to retire and lower your spending so that you are more prepared.

However, I do know that not everyone is in a rush to pay off their mortgages early. Your mortgage rate might be extremely low and you might be earning a much higher return in the stock market or in your other investments, which would persuade you to invest and throw your money at your investments instead of your house.

How is it possible that we can pay off our house so much earlier than the planned 30-year loan that we have? There are many reasons for this, mainly because of the fact that we plan on paying extra large payments to our mortgage debt soon. Our goal is to make a couple thousand dollars extra towards our payments every month, and we also hope to switch our payments to biweekly if our bank allows for it.

1. Increase your payment amounts.

This one is a no brainer. If you throw more money towards your debts, then of course you can pay your mortgage off more quickly!

Another way is to make more payments towards your debt. Did you receive a bonus for the holidays, signing on with a company, or for some other reason? Put that extra money towards your debt and make a new payment!

Even if you can’t put a large amount of extra money towards your mortgage payment, even a little bit helps if it is put towards your principal. That way you are not being charged all of that extra interest anymore.

2. Increase the amount of payments that you make.

As stated above, try and apply any extra money towards your mortgage. Everything counts and one extra payment is worth it.

This also goes hand in hand with making bi-weekly payments. With biweekly payments, you make a payment every 2 weeks. There are 52 weeks in a year, so instead of making 12 payments in one year, you are making 13 payments.

You are also shaving a little off interest as well. Not all banks will allow you to do this though, so first ask your bank. You might have to sign up for some sort of biweekly plan with them.

With paying your mortgage biweekly, you will most likely be able to shave AT LEAST a couple of years off your mortgage, and it’s really just that simple!

3. Refinance your mortgage.

Mortgage rates are extremely low right now, and everyone knows that. My friends don’t have the greatest credit in the world (they don’t have a car payment or credit cards, so they haven’t been able to build their credit the normal way), but still received a 30-year loan at what I believe was a 3.2%. That is great! Our mortgage is at 5%. We should refinance.

Refinancing your mortgage might cost a couple thousand up front, but in the end, if you can slash more than 1.5% to 2% off your rate, then it is probably worth it to refinance your mortgage.

Do you plan on paying off your mortgage early? Why or why not?

       The personal finance world is filled with stupid rules of thumb that just don’t work when you want the right answer. Sure, they’re easy and simple. But the problem is that they ignore crucial bits of information that are absolutely essential to determining the right choice for you. One of these stupid rules is the idea that you can afford a mortgage that is 2.5 or 3 times your annual income. Here’s why this is just plain dumb.

A. H. Allyn Mansion by cliff1066TM on Flickr

It Ignores Interest Rates

       This one ought be be obvious. This 2.5 or 3 times your income rule of thumb completely ignores the fact that interest rates have a large effect on your payments.

       To keep our example simple, let’s imagine that Bob makes $50,000/year. This rule of thumb says that Bob can afford a $125,000-$150,000 mortgage. We’ll go with $150,000. Today, the rate on a 30 year mortgage is about 4.5%. At this interest rate, Bob would pay $760/month or $9,120/year – about 18% of his gross annual income.

       Rewind to just a couple years ago when rates were 6% and Bob would be paying $899/month or $10,778/year – about 21% of his gross income. Go back to the 2000s when rates were around 8% and Bob would be looking at $1,100/month or $13,200/year – about 26% of his gross income.

       Now, these all sound affordable for Bob but keep in mind that I’m only talking about principal and interest here. I didn’t include taxes and insurance, which could easily put him over the limit in that last example. So one major problem with the 2.5 or 3 times your income rule is that it cannot and does not account for changes in interest rates.

It Ignores the Time Period

       I assumed in the first example that Bob was getting a 30 year mortgage, but this rule of thumb doesn’t really say how long the term should be for your mortgage. I assumed 30 years because it’s the most common and it’s probably what people who spread this stupid rule are thinking. But look at what a difference it makes to go to a shorter time period.

       Using $150,000 as our mortgage amount and 4.5% as the interest rate, we saw that Bob would pay $760/month for a 30 year mortgage. Keep everything the same but change that to a 15 year mortgage with 4% interest (since rates are lower for 15 year mortgages) and Bob will be paying about $1,110/month. So he’s gone from paying about 18% of his gross income to almost 27% simply by choosing a different term for the mortgage.

       This rule of thumb doesn’t help us determine if we can afford a 30 year mortgage or a 15 year mortgage. There’s no distinction at all. That’s strike two!

It Ignores the Rest of Your Situation

       Finally, this stupid rule of thumb completely ignores the rest of your situation on a number of levels. Let’s look at them:

  • Taxes & Insurance – As I showed you before, Bob was getting close to pushing the limits on his income just with his principal and interest payments. What if real estate taxes are high in his area? What if insurance is expensive because he lives in a hurricane zone (or for some other reason)? This rule fails again.
  • Down Payment – What if Bob puts less than 20% down on his mortgage? Well, he’ll have to pay for private mortgage insurance (PMI). Bump up that payment a little bit more now. Oh wait, that doesn’t seem to matter in this rule of thumb.
  • Debt – What if Bob is up to his eyeballs in debt and on the verge of bankruptcy? This 3 times your income rule is absolutely ludicrous in that case, but it doesn’t seem to come with that caveat.

       These are just a few other areas where this rule proves to be absolutely stupid. I’m sure you can think of many more. The point is that simply multiplying your income by 3 to figure out how big of a mortgage you can afford is short-sighted, unwise, and just plain dumb.

The Solution

       There are other rules for figuring out how much of a mortgage you can afford. There’s the 28/36 rule, the 29/41 rule, the 4 times your income rule, the 5 times your income rule, and so on. Now I have to admit that the 28/36 rule is a little better than these “x” times your income rules. But it still ignores a lot about your personal situation.

       By now, the solution ought to be obvious to you. The best way to figure out how much of a mortgage you can afford is to look at your situation and your budget and work backward from there. If you blindly follow the conventional rules, you completely ignore the important factors that can help you make the best choice for you. You also fall into the trap of allowing society, culture, media, or businesses (banks and real estate agents, in this case) determine what your life should look like and how you should spend your money.

       Think for yourself. Work out the math on your own. (It’s not much more than addition, subtraction, and a little multiplication.) Figure out what you need and want. Then determine what fits in to your situation.

What Do You Think?

       What do you think about financial rules of thumb? Why do we like them? What are some rules of thumb you’ve heard that you’d like me to write about? Share your thoughts in the comments below!