Paying off your mortgage sooner can free up cash to add to savings or invest in your future. The most common approach is bi-weekly, paying half of the original monthly payment every two weeks, which has the effect of making an additional monthly payment each year. The standard loan repayment schedule requires the homeowner to make 12 monthly payments each year, whereas an accelerated payment schedule with bi-weekly withdrawals consists of 26 half payments, or 13 full payments, each year. Paying off a mortgage early provides various benefits, such as shortening the length of the loan, reducing the interest, building home equity quicker and facilitating financial management.
Shorter Loan Term Benefit
The time required to repay a loan is commonly known as its term. An accelerated mortgage schedule reduces the term of a loan, although the exact reduction depends on the interest rate and original term. Assume for this example that the original amount being borrowed, or principal, is $100,000. This mortgage carries a 5 percent interest rate, and has a term of 30 years. An accelerated mortgage schedule with bi-weekly payments reduces the term of this mortgage to just over 25 years. This term drops to slightly more than 24 years if the interest rate is increased to 6.5 percent.
Interest Savings Benefit
Interest is essentially the cost of renting money, which depends on the principal, interest rate and amortization period. Paying off a loan early therefore reduces the total interest that a homeowner will end up paying to the mortgage lender. Assume for this example that a $100,000 mortgage charges 5 percent interest and has a term of 30 years. The borrower of this loan will eventually pay a total of $93,256 in interest over the term of the loan. Paying off the mortgage quicker reduces the total interest payment to $77,343.34, which is a savings of $15,912.66.
Build Home Equity Benefit
Equity is generally the value of an owner’s interest in a property. Home equity is specifically the difference between the unpaid portion, or balance, of the mortgage and the market value of the home. The payments at the beginning of a loan are primarily applied towards the interest instead of the principal, and gradually shift towards the principal over the course of the loan. The regular monthly payments in the example above will be $536.82. However, the first payment will only apply $120.15 towards the principal while the final payment will apply $534.59 towards the principal. Rapid loan payoff allows a homeowner to build equity in the home quicker, especially since the additional payments apply directly toward the principal.
Rapid loan payoff of mortgages can also facilitate financial management, since most people are paid on a weekly or bi-weekly basis. This arrangement means that the mortgage payment is deducted from each paycheck in the case of a bi-weekly income, and every other paycheck in the case of a weekly income. Rapid Loan Payoff also allows the homeowner to easily invest the amount of the mortgage payment once the mortgage is paid off. Assume for this example that a homeowner is receiving a bi-weekly paycheck and is making bi-weekly mortgage payments of $268.41. This payment comes out of each paycheck until the mortgage is paid off. The homeowner can then invest $268.41 from each paycheck without missing it, since this deduction is already part of the household budget.
Are you Interested in Learning More about Paying off your Mortgage Sooner?
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