Should You Pay Off Your Mortgage Early?

Because mortgages tend to be large loans that last for a couple of decades or longer, paying off the loan early can save you tens of thousands of dollars in interest. Not to mention, it feels good no longer having a monthly mortgage payment to worry about.

When you send in your monthly payment to your mortgage lender, the payment is split between principal and interest. Early on in the loan, a large portion of that payment is applied to interest. As time goes on, more of the payment goes toward paying down the principal. This is known as amortization, and it allows the lender to make back a larger portion of their money within the first several years of repayment.

The key to paying off your mortgage early is by applying extra payments to the principal.

Just because you can pay off your mortgage early doesn’t necessarily mean that you should. Of course, it would feel great to rid yourself of a huge financial burden like a mortgage. But if you really want to know if it’s a good decision, you have to look at the math.

There are pros and cons to paying off your mortgage early. Whether the pros outweigh the cons will depend on your overall financial situation.

• Save money on interest. By reducing the length of time you spend making mortgage payments, you’ll cut down the amount of interest you pay over the life of the loan. Depending on the loan amount, interest rate and original term, paying your mortgage off early could result in significant savings.
• Free up money for later in life. The typical mortgage lasts 15 to 30 years. That’s a long time to be saddled with loan payments. By paying off your mortgage early, you’ll free up cash to spend on more exciting things when you’re a bit older, such as travel.
• Increase home equity. Paying off your loan will increase the amount of equity in your home, which you could tap into with a home equity loan, home equity line of credit (HELOC) or cash-out refinance.

• Less money for higher-interest debt. If you have credit card or student loan debt, funneling your extra cash toward paying off your mortgage early can actually cost you in the long run. This is because these other types of debt likely have higher interest rates.
• Less money for savings. Putting all of your money toward your mortgage can also cut into what you can set aside in savings. If you’re going to focus on paying off your home loan early, it’s a good idea to make sure you have an adequate emergency fund first. It’s usually recommended to save up enough to cover three to six months’ worth of expenses so you can manage any unexpected costs without having to go into debt.
• Could miss out on higher returns from investing. If you have the opportunity to invest your money for returns that are significantly higher than your mortgage rate, you’d be better served doing that than missing out on compounding earnings to get rid of your mortgage faster. For example, if your mortgage rate is 3.5% and your portfolio earns an average of 6% per year, you’d lose money by using extra funds to pay off the loan early.

If you’re thinking about paying off your mortgage early, ask yourself these three questions first:

1. Am I sure I won’t need the money? Home equity isn’t liquid. If you later need to borrow money because you accelerated your mortgage payments, the new loan could be costly. You’ll also need good enough credit and sufficient income to qualify for a home equity loan. You’ll have to weigh these risks against the savings from paying less in mortgage interest.
2. How low is my mortgage rate? If your mortgage rate is lower than the inflation rate or lower than the returns you could reasonably expect to earn by investing your extra cash, paying your home off ahead of schedule may not save you money.
3. How much do I care about owning my home free and clear? For some people, the psychological benefits of not owing money are so substantial that they outweigh considerations like whether they could earn a higher financial return elsewhere. If that’s you, it might make sense to pay off your mortgage early.

Keep in mind that some lenders charge a prepayment penalty; if yours does, be sure to factor in that cost, too.

A prepayment penalty is an extra fee that you must pay under the following circumstances:

• You pay more than the additional amount allowed on your mortgage.
• You break your mortgage contract.
• You transfer your mortgage to another lender before the end of your term.
• You pay back your entire mortgage before the end of your term, including when you sell your home.

Prepayment penalties can cost you thousands of dollars and are usually calculated based on the higher of an amount equal to three months interest of what you still owe or the interest rate differential, (IRD) which is the difference between your posted mortgage interest rate and your actual contract mortgage interest rate. How a prepayment penalty is calculated also depends on your lender and factors such as the following:

• The amount you want to prepay (or pay off early).
• The number of months left until the end of your term.
• Interest rates
• The method your lender uses to calculate the fee, whether that be the higher of the IRD or three months interest of what you still owe.

There is usually an administration fee that goes along with paying a prepayment penalty and always review your mortgage contract to determine exactly how your mortgage lender calculates prepayment penalties, but you can avoid them all together with the following strategies:

• Take advantage of prepayment privileges. Some mortgage lenders allow you to put an additional payment of up to 20% on your mortgage each year without paying a penalty. These are called prepayment privileges.
• Wait until the end of your term to prepay. This will allow you to make a large lump sum prepayment without penalty.
• Port your mortgage. If your lender allows you to port your mortgage or apply your same mortgage conditions, terms and interest rates to your new home, you won’t have to break it and can avoid all prepayment penalties.
• Shop around. When its time to renew your mortgage look for a new mortgage arrangement that offers more flexibility, including prepayment privileges, and less penalties. If your mortgage is an open mortgage, you’ll be able to do what you want without penalty.

Here are the five best ways to pay off your mortgage faster, with the numbers to prove it.

1. Create Room in Your Budget

One of the most effective ways to pay off your mortgage faster is to pay more than the monthly amount due. That might seem obvious, but you might not realize just how far a little extra money can go.

For example, say you took out a 30-year fixed-rate mortgage of $250,000 at 5% annual percentage rate (APR) and have 25 years left on the loan. That would mean you owe $1,342.05 per month. Now imagine that you tack on just $20 extra to each payment. You’d shorten the repayment period by eight months and save $5,722 in interest. Use a mortgage calculator to help you do the math.

For an extra $20 per month, you’d simply need to cut out one fancy coffee a week or a couple of takeout lunches. Obviously, putting even more money toward extra payments will result in even more savings.

Just keep in mind that you don’t want to go overboard here and sacrifice other financial goals to pay down your mortgage faster. Mortgages are some of the cheapest loans out there, so be sure you’re paying off other higher-interest debt and investing before you start cutting back in other areas of your budget.

2. Schedule Extra Payments

Maybe you aren’t able to come up with the extra cash to make additional payments each month (or don’t want to). That’s OK—a couple of well-timed extra payments throughout the year can be even more effective as long as you don’t surpass the annual percentage cap on your prepayment privileges–usually 20%.

Perhaps you receive an annual bonus from work or tax return each April. If you were to take $1,200 per year and apply it to that same mortgage example above, you’d cut your loan down by over three years and save over $25,000 in interest.

If you do decide to make extra payments toward your mortgage, be sure to check with your lender that the extra funds will be credited toward the loan principal. If you don’t specify how you want these payments applied, the lender will likely use them to prepay interest owed on your mortgage instead.

3. Refinance to a Shorter Term Length

It’s common for mortgage borrowers to opt for a longer repayment term in order to keep monthly payments low—typically 25 years. However, as time goes on, your income may increase or your lifestyle may change to free up more cash flow.

If that’s the case, you may be able to refinance your loan to a shorter term. Since the repayment period gets crunched into a shorter time period, the monthly payments will likely increase. However, this is an effective way to pay off your mortgage much earlier and save a ton of money on interest, especially if you also qualify for a lower interest rate.

Take a look at this comparison of a $250,000 loan with a 30-year, fixed-rate term versus a 15-year, fixed-rate term:

As you can see, it’s possible to save $84,655 in interest and pay off your mortgage in half the time by refinancing from a 30-year to a 15-year term.

Something to consider before refinancing, however, are mortgage closing costs. You’ll want to make sure that closing costs don’t negate the interest savings; otherwise, it may not be worth it.

4. Recast Your Mortgage

You’re probably familiar with refinancing, but you may not have heard about mortgage recasting. When recasting, you make one large lump-sum payment toward your principal balance. Usually, at least $5,000 is required to recast. The lender then reamortizes the loan to reflect the new balance. This is different from refinancing, where a current mortgage is replaced by a new mortgage under the current interest rates.

Recasting a loan accomplishes a few things. For one, your monthly payment will decline. You’ll also save money on interest over the life of the loan. And if you apply those savings toward larger monthly payments, you’ll also pay off the mortgage early.

There is usually a fee required to recast a loan. Also keep in mind that not all loan types can be recast and not all mortgage lenders allow your mortgage to be recast.

5. Pay Biweekly

One way to pay off your mortgage early that doesn’t require coming up with any extra payments is to split your monthly payment into two smaller payments and paying biweekly.

Here’s how it works: Most mortgages require a monthly payment, or 12 payments per year. If you switch to bimonthly payments, you end up making 26 payments per year—in effect, one extra payment. This not only quickens the pace of your loan payoff, but also saves you money on interest over the life of the loan.

Wondering how effective this strategy really is? Consider this: On a $250,000 30-year fixed-rate mortgage at 3.5%, you’ll pay off your mortgage four years early and save more than $20,000 in interest.

Not all lenders allow biweekly payments, though many do. If you want to switch to this payment method, contact your lender and double-check that they don’t charge a fee to do so.

Let’s imagine that you did pay off your mortgage early (a hypothetical congratulations to you!). What are the final steps for officially ridding yourself of the loan?

Just because you’ve paid off your mortgage doesn’t mean that your lender automatically gives up the rights to your property. There is a process involving you, your lender and your provincial or territorial land title registry office. This is called discharging a mortgage. Keep in mind, if you have a HELOC, you’ll need to pay it off before you can discharge your mortgage.

Typically, in this process, you work with a lawyer, a notary or a commissioner of oaths (but it depends on your province or territory, as some will allow you to do it yourself, though you’ll still need to get documents notarized).

From there, you’ll need to make a request for your your lender to provide a confirmation that you paid your mortgage in full. Then, the land title registry office has to make changes to your property’s title. To do this, you or your representative has to provide the office with all the required documents and they can then remove the lender’s right to your property and update the title to reflect this.