International Mortgage

How To Pay Off Mortgage Early – Detailed Guide

Author: Jana Ilić

Publish date: 02 Oct 2024

Understanding how to pay off your mortgage early can be challenging. Not only do you want to find the best, suitable way to achieve your goal, but you are also worried about potential downsides and penalties that you might encounter. Making a good choice is essential, but not easy.

To tell you the truth - it is a universal feeling, and you are not alone. Understanding mortgage terminology is a complex feat in itself, and adding a personal, financial involvement to it creates even more space for confusion and stress.

At Kredium, we’ve guided countless clients through this exact challenge. With our expertise, we’ve created a detailed guide to help you navigate your potential mortgage payoff with credence. In this detailed guide, you will learn everything you want to know about ways you can pay off your mortgage loan early, as well as understand the benefits and potential drawbacks of such a venture.

Understand Your Mortgage Terms and Conditions

We must start by stating the obvious: before you begin thinking about paying your mortgage early, you need to familiarize yourself with your mortgage terms and conditions. Understanding them is an essential step since it will significantly impact your ability to pay off your mortgage early, and work in your favor during the process. If you want to take part in something as important as that, you will need to do a lot of preplanning in advance.

The most essential aspects to focus on when considering your mortgage terms and conditions are interest rate, loan balance, prepayment penalties, and amortization schedule. In the following paragraphs, we are going to break down each one of them, explaining what they entail, and highlighting their importance.

Interest Rate

It is important that you know your interest rate and should check your interest rate by calculating it. It can be either fixed, or adjustable. With a fixed interest rate, the rate doesn’t change throughout the loan term. However, if your rate is adjustable, or variable, it is prone to change and can increase or decrease depending on the broader interest rate trends.

Knowing this information about your mortgage loan is important, considering it will affect your remaining payments. For example, if you have a high fixed interest rate, refinancing to a lower rate could be a good solution because it might reduce your interest payments. If you have an adjustable rate, then paying off the loan early could be a great way to avoid potential rate spikes in the future.

According to Forbes, mortgage options include 30-year fixed, 15-year fixed, and 30-year jumbo loans. The average annual percentage rate (APR) varies across these loan types. Each option offers different terms and rates based on loan size and repayment period (the chart with Mortgage Rate Trends is shown below).

Loan Balance

The loan balance is the remaining sum you have to pay off on the mortgage principal. Knowing your loan balance is going to help you plan and organize your best course of action. Additionally, it will prepare you for what is to come if you decide to pay off your mortgage early.

Prepayment Penalties

Although you are considering paying off your mortgage loan all at once for its financial benefits, you will still need to tackle the prepayment penalties. The prepayment penalty is a percentage of your mortgage loan that you pay and is usually between 1% and 5%. The percentage tends to decrease over time, meaning the closer you are to repay the whole loan, the prepayment penalty is lower.

Pre-payment is anywhere between 5-10 years, and generally, lenders default to 5 years, If you wait until the pre-payment window is completed you won't need to pay a penalty and can refinance or get a new loan without facing prepayment penalties.

However, the specifics can vary depending on the loan and the lender. Some loans may not have prepayment penalties at all, while others do. In cases where there is a prepayment penalty, clients might have the option to choose the penalty structure or remove it altogether. However, removing or altering a prepayment penalty could result in a higher interest rate.

Amortization Schedule

The amortization schedule, or amortization table, tells you the amount you are expected to pay monthly. You must review your amortization schedule to see how much of your monthly payment goes to the loan’s principal balance, and how much towards the interest. This schedule will clearly show how much you’ll save in interest if you pay off the mortgage early. That will serve as an extra boost of motivation in the process.

5 Ways to Pay Off Your Mortgage Early

Now that you have established and concluded that you understand the terms and conditions of your mortgage loan, you are ready to learn more about the ways you can achieve to pay it off early. Owning a property outright, and being mortgage-free, sounds like a dream come true. It is the ultimate goal of every property owner. This doesn’t have to be just a dream though, because there are straightforward and practical steps you can take to make your homeowning fantasy into reality.

In the following paragraphs, you will learn everything you need to know about paying off your mortgage early. We are going to focus on five different options, and they are: making one extra payment per year, biweekly payments, paying off the balance in cash, having an offset account, and following the 10/15 mortgage rule. By reading these thoroughly, you will gain a deep insight into different processes, the information, and the knowledge necessary to take action.

One Extra Payment Per Year

Paying one extra payment per year is as simple as it sounds. Instead of issuing 12 mortgage payments per year, you issue 13. This option usually works best for those who get a large sum of money at some point in a year, whether that is from a raise, a large tax refund, a work bonus, investment returns, or another financial influx of that nature.

If you can’t relate to those particular situations, you can save a necessary amount each month of the year, and issue a final 13th payment at the end of the year. Although this seems like a minor step towards a mortgage-free life, it adds up in the end and shaves off a significant amount of your loan.

Biweekly Payments

Biweekly payments represent a significant step up compared to one extra payment per year. By making biweekly payments instead of monthly payments, you will pay off your mortgage loan twice as fast. If you are spending much less than you are making, the biweekly payment option might be a perfect solution for you.

Furthermore, a biweekly payment schedule usually matches the payday schedule. This makes it easier to follow and manage your finances.

However, before you choose this option, you must check if your lender charges additional fees for making biweekly instead of monthly payments.

Pay Off the Balance in Cash

Although there are other options for paying off your mortgage loan at once, the first one that comes to mind is usually this one: paying off the balance in cash. This option depends on whether you can save enough money to pay off your loan in its entirety, or not. Nonetheless, it is a great option that helps you save money you would otherwise spend on interest rates while making monthly payments until the end of the loan term.

Offset Account

An offset account works as a savings account that you will use to pay off your mortgage loan. It is a transaction account that is linked to your mortgage loan. The big difference between an offset account and a regular account is that the longer you keep money on the offset account the interest amount charged on your loan will reduce.

We will paint you an example: if you have a $450,000 mortgage and $25,000 in an offset account, you will be charged interest on $425,000. Reducing the amount of interest you pay, leads you to pay off your mortgage early. However, if your offset balance is low, usually under $10,000, this option might not be as beneficial to you.

The 10/15 Mortgage Rule

The 10/15 mortgage rule is a concept that suggests that property owners can pay off a 30-year mortgage in 15 years. Here is how it works: make one extra payment per week that is equal to 10% of your monthly mortgage payment, toward the principal. For example, if your monthly mortgage payment is $2,000, you ought to pay an extra $200 every week, and by doing that, reduce your loan term by 15 years.

Why is this so popular? Simply because the majority of payments you are making at the beginning of your mortgage are actually to pay off the interest charged by your lender. However, if you were to make the period of your loan shorter by introducing the 10% weekly payments, you are essentially reducing the amount of interest you will pay over time because you are decreasing the principal rate.

The Benefits of Paying Off Your Mortgage Early

As we have already stated, there are multiple ways of paying off your mortgage early. However, we still haven’t discussed the benefits of doing so. Yes, we have talked a little about interest savings, yet there is still so much more to cover.

You are about to learn all the pros of paying off your mortgage early, including interest savings, reduction of financial risk, financial peace of mind, and flexibility for other goals.

Interest Savings

Interest savings is one of the primary benefits when you pay off your mortgage early. Whether you are making one additional payment per year, biweekly payments, paying off in cash, using an offset account, or following a 10/15 mortgage rule, you are saving money long-term while paying your principal balance sooner. Essentially, by engaging in an early payoff, you can reduce the overall interest you would have paid during your loan. Interest savings can potentially save you up to hundreds of thousands of dollars.

Reduction of Financial Risk

When you ensure your mortgage is already paid off, you no longer have to worry about potential economic, or financial downturns. If you are a homeowner outright, you don’t have to rely on a regular income to cover your home expenses. Reducing the financial risk provides you with significant financial flexibility which we will expand on in one of the following paragraphs.

Financial Peace of Mind

Feeling secure in your financial future brings you an irresistible, financial peace of mind. Not only will the financial peace of mind offer security, but also elevate the financial burden that is often associated with a mortgage. Now that you have paid off your mortgage, and achieved that invaluable peace, you can choose to use your funds for something else, which leads us to our next and final benefit.

Flexibility for Other Goals

If you pay off your mortgage loan early, you have officially embarked on a journey to financial independence. Having control over your financial future, and being flexible with your finances can help you focus on other goals you want to achieve.

Additionally, if you pay off the mortgage early, you are leaving a valuable asset to your loved ones and family. Think of it as a long-term financial investment that will create a stable financial future for them.

Consider Potential Downsides

Although the idea of paying off your mortgage earlier than expected sounds appealing and fascinating, we should always be aware of potential downsides. We want to show you both sides of the coin. That’s why we are going to discuss some aspects that you might want to consider before opting for the early mortgage payoff.

Opportunity Cost

If you use your finances to pay off your mortgage, you might miss out on other investment opportunities that could provide higher returns than interest savings. It is advised that, if your interest rate is on the lower side, you might want to invest the extra funds elsewhere, rather than paying to end your loan term sooner.

Another important aspect to consider is if you have multiple high-interest loans, like credit card debt or personal loans, merging them into a singular, lower-interest loan might be a more strategic approach.

Lack of Liquidity

Lack of liquidity represents a deficit of liquid assets, such as cash or other highly marketable assets. When a company, a business, or an individual encounters said lack of assets, they are running into a liquidity problem.

Making a large payment towards your mortgage loan translates to less cash available for emergencies or potential investments. Before you decide to take this leap, you need to ensure that you have an emergency fund to maintain your financial stability and independence.

Tax Considerations

When you pay off your mortgage early, you can’t get some tax deductions from your mortgage interest. When you are actively paying your mortgage, you are able to take some tax deductions. Early mortgage payoff can, in turn, lead to a higher tax bill because you can’t deduct the interest that you paid on your mortgage from your taxable income.

If you are already set on your early payoff choice, you must ensure your strategy is stable and certain. It is highly advised you re-evaluate your plans and tax strategy carefully before embarking on the early payoff journey.

Penalties

Prepayment penalties are considered a downside of paying off the mortgage early. Essentially, by trying to pay off the mortgage as soon as possible, or making significant additional payments, some penalties must be paid. These penalties often offset the financial benefits of an early payoff. It is up to you to decide whether the goal is worth the price.

Unlock Mortgage Freedom with Kredium: Expert Support for Early Payoff

Understanding the ins and outs of paying off your mortgage early is of utmost importance for your financial stability and well-being. That being said, deciding which path to take, and what to consider on your journey can be extremely challenging. On the one hand, you are dreaming of living mortgage-free and attaining financial flexibility, but on the other hand, you are anxious about the intricacies and hidden penalties that might affect you.

This is why it is essential to consult with an expert - and Kredium can offer you just that! At Kredium, we offer personalized advice and introduce you to everything you need to know about all things mortgage. Whether it is wanting to pay off your mortgage early, or buying a property abroad, Kredium will provide the best guidance and offer personalized advice that is just one phone call away.

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