NEW YORK (MainStreet) – Think turning a 30-year mortgage into a “30 year” lien you pay off a few years early is as easy as sneaking in some extra payments?
In most cases, a home mortgage is the heaviest debt average consumers will carry over the course of their lifetime. Susan Tiffany, a financial counselor and board member at the Credit Union National Association’s Center for Personal Finance, notes that the size of that debt doesn't necessarily make it a person's highest priority. In mid-February, for example, the average rate for a 30-year fixed-rate mortgage was just under 3.7%. The average annual percentage rate on a fixed-rate credit card, meanwhile, was 13% — with the APR on variable-rate cards coming in at nearly 16%.
”If you're carrying credit card debt, I'll bet you a cookie it's at a heck of a lot higher interest rate than your mortgage is,” Tiffany says. “If you can't pay your credit card bill off every month, you shouldn't be putting extra money toward mortgage payments, you should be putting those extra mortgage payments toward your credit card bills.”
Even if you're clear of credit card debt, that doesn't mean you should start paying down your mortgage. Are you saving and investing? Tiffany says if you aren't aggressively investing in your 401(k) for retirement, that's a better priority than an extra mortgage payment. Do you have a substantial emergency fund stocked away? At least six to eight months' worth of living expenses in liquid, accessible savings? No? Bulk that up instead.
If you have all of those priorities in order, it's time to start thinking about paying down that mortgage. Curt VanderZanden, a loan officer with Mortgage Express in Portland, Ore., notes that the the most straightforward means of cutting your mortgage term is to simply refinance to a shorter term.
“A 20-year mortgage track [is] similar to 30-year interest rates, but are a little better, [while a] 15-year is better than 20 and 10-year is less than the 15,” he says. “Shorter-term loans are always better in rate, so, you don’t just save by the amortization, you also save interest.”
On paper, he's right. Freddie Mac's 3% 15-year rate beats its 3.7% 30-year rate, but Tiffany notes that there are benefits to hanging onto that 30-year term. If you have a fluctuating income — from working on commission or relying on overtime that isn't always there — it may be worth maintaining some flexibility. That way, if you have extra cash, you can put it to your mortgage if you choose. If you've made a commitment to higher payments on a 10-year mortgage, however, you could find yourself in a bind.
”I used to think, when I was younger, that I was better in a short-term loan,” Tiffany says. “The more I've dealt with mortgages since that time, I've come to the opinion that you're better off keeping your options open, and you can do that with a longer-term loan.”
Besides, there are a whole lot of options for shaving years off of that 30-year span. Tiffany advises adjusting mortgage payments from once a month to half-payments every two weeks. That's 26 payments total and 13 payments a year instead of 12, which takes up to two-and-a-half years off a 30-year mortgage.
Without refinancing, VanderZanden notes that even rounding a monthly payment to an even number and applying it toward the principal can cut years off a loan. For example, a $200,000 loan at 3.875% interest comes out to $940 per month. Rounding up to $1,000 can cut as much as three years off of a mortgage. If you want to get more aggressive, take your total monthly principal-and-interest payment and divide it by 12. Add that amount toward the principal each month, and that can shave another four years off of the loan.
VanderZanden and Tiffany note that unless a homeowner has been stuck in a 30-year mortgage with a high rate and sat out the last few rounds of post-recession financing while waiting for the economy to recover, it may not be worth refinancing. Tiffany also discourages putting too much weight behind the tax benefits of the mortgage interest deduction, as it will only decrease regardless of the number of years you take to pay off a mortgage.
“I don't try to be too prescriptive about this stuff because I think these things are very personal,,” she says. “People are going to make the decisions that resonate best with them and make them feel better.”
Finally, both made it very clear that options including extra payments and doubled payments headed into retirement are free through your current mortgage provider. It doesn't cost anything to discuss options with a loan officer or credit union adviser, though, and third-party programs that set up alternative monthly mortgage payments for a monthly transaction fee or service fee are typically also available for free.
“There are paid opportunities for people who will set this up for you, and they're completely unnecessary,” Tiffany said.
— By Jason Notte for MainStreet