You've taken the leap and decided to buy a home. After signing a mountain of paperwork, you are now the proud owner of your own residence. Thirty days later, when the first mortgage payment comes due, you are hit by the reality of what you have done. You have taken on 30 years worth of massive payments, in an economy that makes no promises about long-term job stability. Don't panic.
In this article, we'll look at the benefits of paying off your mortgage as soon as you can and give you pointers on how to do it.
Pay It Off: Pros and Cons
The first and most obvious reason to pay off your mortgage as soon as possible is that it will save you tens of thousands of dollars. Read the papers you signed when you bought the place and take a close look at your amortization schedule. The mortgage companies disclose right up front that you will pay more than twice the purchase price of the home, before you actually own it.
(To learn more about the amortization schedule, see "Understanding the Mortgage Payment Structure.")
The second reason is the peace of mind you gain from owning your home. With the lower monthly cash outlay requirement, the prospect of unemployment or underemployment is no longer so daunting. You can now afford to take a job that pays a whole lot less than your previous position, without any concerns about losing your home.
However, many people argue that paying off your mortgage is a bad financial move. They claim that you will get a higher return, in the long run, if you invest your money, instead of making extra mortgage payments. While there is some chance that you will achieve such a feat, there's also a chance that you won't. Given the choice between a guaranteed savings of the 6% interest on their mortgage (compounded for 30 years), or the possibility of achieving some other rate of return, which may be higher or lower, conservative investors will take the safe bet.
Of course, the entire argument is moot when you truly look at the facts of the situation. Most people buy a home so they have a place in which to live. Even if it doubles or triples in value, they aren't going to sell it, and if they do, it will take every cent they earn to buy a comparable home in the same neighborhood. Besides, since you can't live in a mutual fund, most home shoppers don't make their purchase in an effort to beat the return of the S&P 500.
The next argument against paying off your mortgage is even more dubious, but you hear it all the time, even from sophisticated investors: mortgage interest will provide you with a tax break. While technically this is true and you spend $1 in interest to get a or 25- or 35-cent tax break, it only works if you a) itemized deductions, and b) are in the highest income tax brackets. For the average person, it's not a good return on your investment.
Paying off your mortgage provides a return on your investment that is much more reliable than anything the stock market can offer. It also saves you tens, and sometimes hundreds, of thousands of dollars. To top it all off, it provides the security of having an affordable place to live, in the event that your income declines. With all of these benefits in mind, it's time to look at the strategies that will help you pay off that mortgage.
Plan Before You Buy
Look before you leap and do the math in advance, to determine how much house you can afford to buy. Then buy less house than you can afford. This strategy will ensure that you have adequate cash flow to make extra mortgage payments and will provide some cushion, should you have to take a lower-paying job at some point in the future. Also, make sure that your mortgage does not impose a penalty for prepayment. This clause can put a damper on your efforts to get out of debt.
(To learn more, see "Mortgages: How Much Can You Afford?")
Next, you need to pay attention to the financing terms. While adjustable-rate mortgages (ARMs0 offer lower initial payments, they are used all too often to enable buyers to get into homes they cannot actually afford. When interest rates rise, some homeowners are caught unprepared. Similarly, home buyers often plan their finances based on the idea that their mortgage payments won't change; they discover this isn't always true, when their local government raises real estate taxes. If your plan is to get out of debt as quickly as possible, a fixed-rate mortgage provides the predictability of a steady interest rate, and it can always be refinanced if rates fall.
(To learn more, see "Mortgages: Fixed-Rate versus Adjustable-Rate.")
How to Pay Off a Mortgage
Once you have a mortgage, the key to paying it off is simple: Send money. Some mortgage plans offer a bimonthly payment schedule, which results in one extra payment per year. It's a great strategy, unless there is a fee associated with it. If there is, simply set aside some cash and make an extra payment on your own.
If your career advances over the years, put those raises and bonuses to work by sending them to the mortgage company. You were doing just fine without that money, and you won't miss it if you don't get used to having it in your budget.
Keep an eye on interest rates and, if they fall, consider refinancing. If you can reduce your interest rate, shorten the term of your loan or both, refinancing can be an excellent strategy. Just don't make the mistake of keeping your term the same and taking money out.
(To learn more, see "Mortgages: The ABCs of Refinancing.")
The Bottom Line
There's no time like the present to begin your quest to pay off that mortgage. Start by reading your amortization schedule; once you see exactly how much of your monthly payment goes to interest, and what a tiny portion goes toward paying off the principal, you will realize that every extra dollar you send reduces the portion of your payment that services your interest expense. That can be a powerful motivator for financially savvy individuals.
If you focus your efforts on the task at hand, you may be surprised at how quickly you can retire a mortgage. With your mission accomplished, you will find that the comforts of home are even more pleasurable when it is you, not the bank, who owns the home.