As we enter into the peak of the home buying season, it is now a good idea to think about ways to reduce the term of your mortgage.
According to most lending professionals, the best way to do this is by switching from traditional monthly mortgage payments to either weekly or bi-weekly payments.
Why you ask? Because its the least painful and simplest way to shave approximately 4 to 4.5 years off the life of a traditional 30 year fixed rate mortgage.
Here is how you do it:
First contact your mortgage lender to set up automatic withdrawals from your bank account for your mortgage payments. While you could theoretically achieve the same thing by mailing in your payments, the vast majority of people won't have the discipline to stick to this alternate payment schedule if it's not set up as an automatic withdrawal.
Next, ask your lender to establish a payment every two weeks. Take your monthly mortgage payment and divide it by two to come up with your payment amount. For example, if your mortgage payment is $1,000 a month, your payment should be $500 every two weeks. You could also establish weekly payments instead, which would be $250 a week instead of a $1,000 monthly payment.
This simple change in your payment schedule will shave approximately 4 to 4.5 years off of a traditional thirty-year fixed rate mortgage. Check with your mortgage lender for an exact calculation of the reduction in years based on your individual circumstances.
Sounds painless and too good to be true, doesn't it, but here is how it works into savings. If you make payments every two weeks, you're making 26 payments a year. Since each payment is 1/2 of your normal monthly payment, take the 26 payments and divide by 2 to arrive at the monthly payments you are making each year. 26 divided by 2 results in 13 monthly payments that you've made each year instead of the 12 monthly payments that you would make under a traditional payment schedule. The same mathematical result occurs if you establish a weekly payment schedule at ¼ the amount of your normal monthly mortgage payment.
So, you end up paying an extra monthly payment on your mortgage each year, which has a profound impact on the compounding effect of the interest on your mortgage. Most homeowners would be hard pressed to come up with an additional mortgage payment at the end of the year, so this is a great way to accomplish some "forced savings" in a manner that most people don't even feel. In fact, for a $200,000 mortgage, homeowners will most likely save somewhere between $20,000 and $30,000 over the life of the loan, based on today's interest rates.
Check with your lender for an exact calculation of savings based on the specifics of your loan.
And this is not just for new homebuyers. If you're trying to refinance, make sure to consider this when you decide to take out your new mortgage.
You can also start this bi-weekly or weekly payment schedule at any point in time - not just at the beginning of your mortgage. You'll just save fewer years off of your mortgage the longer you wait to do so. So if you are thinking about doing it, it's best to start right away.
Also, check with your lender to make sure that they are not going to charge you an additional fee for these more frequent, automatic payments. Most lenders will not charge you a fee since automatic deductions from your bank account increase their likelihood of getting paid on time. But some lenders may try to slip in a junk fee for doing so. If they do that, I would recommend that you push back and ask them to waive the fee since many lenders will do this for free.
Finally, consider this scenario - if you are young and just starting a family, you might have a child in college during those last four years of your mortgage. The absence of your mortgage payments might be the solution for paying the tuition bills during those four years of college!