How to painlessly prepay a mortgage and save thousands
There are several ways for borrowers to pay their loan off ahead of schedule and save tens of thousands in finance charges in the process.
Q. I have 21 years left to go on my 30-year mortgage, but I would like to pay the loan off by the time I retire, in about 15 years. A private company recently sent me a letter, saying that it will convert my mortgage to a bi-weekly payment plan instead of the once-a-month plan I have now, which in turn would trim several years off the length of my mortgage and save me several thousands of dollars in interest charges. The company would charge a $750 setup fee to arrange the bi-weekly payment program, and I would be required to send my payments directly to the new firm instead of to the bank. Are these types of companies legitimate, or are they run by rip-off artists?
A. Some companies that offer to convert a once-a-month repayment plan to a bi-weekly format are "legit," while others are operated by con-artists who will deposit a borrower's check into their private account and never forward a payment to the original lender. Homeowners who fall victim to such scams can quickly wind up in foreclosure because the original lender isn't being paid.
Since it's July Fourth weekend, I'm devoting this entire column to answering some common questions from readers who would like to pay their loan off early and thus gain "independence" from their lender.
Q. How can making one-half of my required monthly payments once every two weeks instead of once per month save me money?
A. It will save you money because there are 52 weeks in a calendar year. Most lenders send out mortgage bills only once per month: By instead paying half the amount every two weeks, you will make the equivalent of 13 monthly payments a year rather than 12.
Such savings quickly add up: On a $150,000 mortgage at today's going interest rate of about 5.6 percent, opting for a biweekly repayment plan would trim about five years off the life of a typical 30-year loan and save more than $30,000 in long-term finance charges because the loan's principal amount would be paid off much faster.
Q. What about choosing a 15-year amortization plan instead?
A. Fifteen-year loans are a great way to pay your loan off early and save tens of thousands in interest charges, provided that you can handle the slightly higher monthly payments that the quick-pay mortgages involve.
Many borrowers don't even consider 15-year loans when they're shopping for a mortgage because they mistakenly think that their monthly payments would be twice the size of the payments required under a 30-year schedule. But in reality, payments on a 15-year loan would be only about 40 percent higher because the principal amount of the loan would be paid off in half the usual time and rates on 15-year loans are usually between one-quarter and one-half of a percentage point lower than rates charged on 30-year mortgages.
Let's go back to the example of the borrower who needs a $150,000 mortgage. If he opted for a 30-year repayment plan, his monthly payments for principal and interest would total about $861, and he would pay $160,003 in interest charges over the life of the loan.
Conversely, if he chose a 15-year loan instead, his monthly payment of $1,210 would be only about 40 percent higher than it would under the 30-year plan. And by paying the mortgage off in half the usual time, he'd save about $92,245 in finance charges over the life of the loan.
Q. I like the idea of paying my loan off early, but I don't want to lock myself into the higher payments that a 15-year mortgage would entail. What if I simply added $100 or $200 directly to my outstanding loan balance whenever I have some extra cash?
A. That's a good way to pay your loan off ahead of schedule and save thousands in interest charges too, provided that you make such "principal only" payments as often as you can.
One trick would be simply to add an amount each month that is equivalent to 1/12 of your regular payment: Doing so would essentially allow you to make 13 payments over the course of the year, knock several years off the life of the loan and save you tens of thousands in interest. And as a bonus, you wouldn't have to pay a private company to set up a bi-weekly plan for you - nor risk the chance that the firm would merely deposit your monthly checks without forwarding the money to the lender.
• For a copy of the booklet "Straight Talk About Living Trusts," send $4 and a self-addressed, stamped envelope to David Myers/Trust, P.O. Box 2960, Culver City, CA 90231-2960
© 2009, Cowles Syndicate Inc.