Every month, Linda and Jim Dunham of Lynnwood, Wash., make two extra $250 mortgage payments to reduce the debt on their home. They plan to pay off their mortgage in eight or nine years instead of the initially required 15 years.
C.A. Shah, a small-business manager in nearby Woodinville, pays an extra $2,000 to $3,000 each month toward his home loan because he doesn’t believe in carrying debt.
Mark Berman and his wife, Wendy Katz, “abhor” the idea of paying $150,000 in interest to a lender; so they have refinanced their home loan and are retiring a 15-year mortgage in 10 years.
These folks and others are paying off home mortgages early to save thousands of dollars in interest. The practice appears to be growing, though some question whether it is the most effective use of disposable income.Paying down mortgages is especially appealing to Baby Boomers as they begin looking ahead to retirement when they want to be debt-free. It’s so widespread that about 25 percent of the borrowers at Continental Mortgage in Seattle are adding to their mortgage payments, said Larry Plumb, the company’s vice president for loan services.
The early payoffs are being made in a variety of ways. Extra payments of any amount are beneficial, even to those with just a few dollars to spare.
Borrowers can schedule extra payments monthly or annually with their lender. They can apply for a 15-year mortgage instead of the traditional 30-year loan when buying a home. Or, they can simply pay $25, $50 or more in extra principal whenever it’s available in the family budget.
Gary Fee, director of mortgage loans for the Boeing Employees Credit Union, says he recommends adding one extra payment a year as a way to save money on a mortgage. He does it himself.
Savings can be substantial, though the amount depends on the loan, its interest rate and a family’s other financial and tax situations. For example:
The monthly payment for a 30-year, $100,000 mortgage at 8 percent interest is $733.76. That totals $264,155 over 30 years, more than 2.5 times the amount borrowed.
Robert Becker, corporate lending officer at Washington Mutual, said one extra payment a year (about $61 a month) could shave $61,635 from that total and pay off the loan in 23 years, seven years ahead of schedule. Larger payments would increase the savings and shorten the payoff period even more.
“The quicker you pay the balance down, the less interest you pay,” Becker said.
With this in mind, Shah and his wife, Daksha, bought a home at Lake Leota near Woodinville in 1994. Their extra payments–up to $3,000 a month–have reduced the loan debt to $39,000 in only three years. Their monthly payment on a $150,000 loan with a 15-year mortgage at 6 percent interest is about $1,265.
The Dunhams, who live near Lake Stickney in nearby Snohomish County, are enthusiastic advocates of the payoff practice they began years ago to reduce a car loan.
“The extra payments make a huge difference,” Linda Dunham said. She’s a sales representative at The Bon Marche and her husband is a building contractor.
“I’m surprised so few people make the extra effort. I advise others to do it and help them figure how much they can save.”
The Dunhams’ 15-year home loan of $129,000, at 6.5 percent interest, requires a payment of about $1,300 a month, including taxes and insurance. They expect to pay it off at least six years in advance with added payments.
Paying extra on a mortgage can be easy, but borrowers with other outstanding loans, such as car and credit-card debt at higher rates than mortgages, should pay off those loans first, experts say.
“How much, or even if you should pay extra on a mortgage, depends on your financial circumstances,” said Fran Church, a partner in Ernst & Young’s Seattle accounting office.
While the federal tax code allows deductions for interest paid on home loans, money saved by paying a mortgage off early generally offsets the benefits of those deductions, planners say.
Not all lenders advocate extra payments to reduce the debt, but few oppose the practice outright. Some question whether it is the best use of money.
Homebuyers may be able to continue taking the mortgage-interest tax shelter, using any extra money they might have for a more profitable investment than paying off the mortgage, said Toby Washington, president of the Seattle Mortgage Bankers Association and a portfolio manager at Washington Federal Savings and Loan.
“Borrowers should make the best of their cash flow and invest in the future. Why pay off a loan in today’s dollars when they can let the cash accumulate and make more?”
He said there are many investments that bring in more than what would be saved by paying off 7 or 8 percent mortgages. However, these are not in safe passbook or certificate accounts. Putting extra cash into securities, bonds or other investments depends on how aggressive a borrower wants to be and the ability to take risks.
Berman, a desktop publisher, said he and his wife, a technical editor, both in their 30s, prefer to pay off their home loan rather than invest the money in more tentative ways.
“We worked out what we could afford and where we wanted to be in 10 years and this seemed to be the best way,” he said.
The process can be formalized or done whenever a borrower sees fit.
At Washington Mutual, one of the area’s largest home mortgage lenders, borrowers can pay extra sporadically, or enroll in a program that helps them to pay down principal.
The bank will calculate the amount needed to pay off a loan in a specific period, arrange a 15-year loan or other alternatives. Some allow borrowers to fall back to the loan amount calculated for a 30-year loan if temporary circumstances prevent them from making a higher payment.
Nancy Chermak, vice president for loan administration at First Mutual in Bellevue, Wash., said her institution gets a lot of extra money when holders exercise Microsoft stock options. First Mutual’s loan-servicing manager, Pam Drexler, estimated 5 to 10 percent of its borrowers make extra payments on a regular basis, but said a lot also come in with one-time payments.
The main thing to remember about paying extra amounts toward a mortgage is to specify each time that the money go to reduce the loan principal.
Sometimes lenders don’t know what to do with irregular amounts paid and may add them to reserve accounts for taxes and insurance, or use them to pay interest, instead of reducing the principal, said Boeing credit union’s Fee. Interest is charged against the principal amount; so that is the part you want to focus on reducing.
To get started, ask the lender how to submit an extra payment. If the monthly payment is automatically deducted from a personal account, you can send an additional check.
Be sure to keep records and check lender reports to see that payments are credited properly.
Some other things to consider:
– Check with the lender to see if there is a prepayment penalty.
– If you think you may move and sell a home in two or three years, larger payments may not be beneficial.
– Evaluate the trade-off between making extra payments and other investments. Consider the impact of falling tax deductions as higher payments reduce deductible interest, or if a mortgage is paid off. You may want to consult a financial planner.- Payoffs for adjustable-rate mortgages work differently than traditional fixed-rate loans because of potential interest rate changes. Ask the lender how to handle these.- If payoff on a certain date is desired, ask the lender to figure the amount of extra payments.
