By Zillow Team February 27, 2015 1:28 PM
So how do you fix your budget with a loan you can afford, yet still pay it off early if you have extra money? Here’s a look at four common approaches.
Refinance, then reinvest savingsIt’s always prudent to evaluate refinancing when rates drop, but unless you refinance from a 30-year loan to a 15-year loan, refinancing doesn’t automatically shave years off your mortgage.
If you bought a home for $300,000 with 10 percent down five years ago, the rate on your 30-year fixed loan of $270,000 was about 4.875 percent, giving you a payment of $1,429 (plus mortgage insurance). With today’s refinance rates of about 3.625 percent on your remaining $247,494 balance, your new payment would be $1,129, saving you $300 per month.
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It’s a huge savings, but you’re resetting your payoff clock from 25 years back to 30 years. However, if you take the extra step of applying the $300 savings toward your new loan each month, you’ll shave 9.5 years off your new mortgage, giving you a shorter term for the same budget.
You can run your own refinance calculations to find the best balance between monthly budget and the fastest loan payoff.
Make biweekly paymentsA biweekly payment plan is the simplest way to shorten your mortgage without a material budget increase. This plan shaves about four years off your mortgage by paying half your payment every other week.
Doing so means you’re making 26 biweekly payments per year, which is the equivalent of 13 monthly mortgage payments per year instead of 12. Your budget can usually absorb this because you’re simply chopping your mortgage payment in half and paying each half every other week.On a $300,000 home purchase with 10 percent down, a 30-year fixed rate of 3.625 percent gives you a payment of $1,231 (plus $88 in mortgage insurance). By paying half ($616) every two weeks, you’re paying your loan down by an extra $103 per month, ultimately saving $26,511 in interest and paying off your loan in about 26 years.
Your lender can brief you on how to set up a biweekly payment plan.
Increase your monthly payment amountThe biweekly example above shortens your 30-year loan term four years by paying about $100 extra per month, but what if you could afford more?
If you paid $200 extra per month on your 30-year fixed loan at 3.625 percent on a home purchase of $300,000 with 10 percent down, you’d save $42,969 in interest and pay off your loan six years and eight months years early.
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If you paid $300 extra per month, you’d save $57,122 in interest and pay off your loan eight years and 11 months early.
And if you paid $400 extra per month, you’d save $68,426 in interest and pay off your loan 10 years and 10 months early.
Once you go higher than this, it’s worth looking at whether your budget can accommodate a 15-year loan, because rates on 15-year loans are about 0.5 percent lower than 30-year fixed loans, which means $113 less interest per month versus the 30-year loan.
That’s a clear interest cost savings, but your budget is higher: you pay $1,881 per month (plus $59 for mortgage insurance) for a 15-year loan versus $1,231 per month for a 30-year loan (plus $88 for mortgage insurance).
Make one-time loan payments when you get extra cashIf you can’t commit to the 15-year loan budget but know you may have cash infusions along the way — like bonuses from work, inheritances, or selling other properties or investments — you can shave years off your 30-year mortgage by doing a large loan pay-down.
Here are two scenarios using a $300,000 purchase price with 10 percent down:
- If you got a bonus at work and paid down your loan by $10,000 in year three, you’d save $15,747 in interest and pay off your loan one year and eight months early.
- If you got a signing bonus for a new job and paid down your loan by $25,000 in year five, you’d save $32,556 in interest and pay off your loan three years and 10 months early.
Normally, when you pay extra on your loan, it shaves years off your mortgage, but your payment stays the same. However, for large one-time pay-downs like this, some lenders may lower your payment, too. When you’re shopping for mortgage lenders, ask them in advance if they’re willing to do this.