Saturday, January 4, 2014

Save thousands & cut your mortgage down by years

I'm not a world-wide syndicated radio host, but I've been lucky to have some good influences in my life.  Combined with the fact that I am fan-crazy for Dave Ramsey, I decided to jot down some of what I consider to be the most essential financial tips I've heard in the last several years and share them with you.  

Paying off your mortgage early and saving tons of money sounds like a scam, but it's not.  

Ready?  I'm going to start with the easiest tip first: Instead of making one fat monthly payment on your mortgage, divide it in half and make payments bi-weekly instead of monthly.  For example, if your mortgage payment is $1,000 per month, send $500 every two weeks.  Done.
How is this different that making one monthly payment?  Well, if you pay every two weeks you will make 26 half-payments per year.  That is equal to 13 monthly payments.  There is only 12 months in a year, so you are basically making one extra payment a year.  You may not even notice the extra payment, because you have conditioned yourself to make a half payment every two weeks.  This actually makes a HUGE difference to you in the long run.  You can cut off years of your mortgage and thousands in interest by using this one small trick.  If you think you can't afford this, think again -- even someone drowning in other monthly debt obligations can still make this small change.  
According to Jeremy Vohwinkle, "To better understand the true savings, on a $100,000 30-year mortgage at 6.5%, you'll pay $127,544 in interest, plus the $100,000 principal, for a total of $227,544. Paying one-half of your regular monthly mortgage payment every two weeks will result in interest of $97,215, a savings of $30,329. Obviously, the larger your mortgage and higher your interest rate, the greater the savings."
If you have room in your budget (you have one of those, right?!) to not just do bi-weekly payments, but actually add to the principle every month, great!  If you don't have the money right now, make a plan to pay off whatever is holding you back from kicking your mortgage to the curb (credit cards, cars, etc.).

Now, for the details to make your switch as easy as possible.

  • The first payment you make needs to be about 2-3 weeks before your due date, and the second payment just before your due date.  That way, your full monthly obligation is met before the due date.
  • Make sure that extra payments are applied directly to principle and that the payments are applied as soon as they are received (not held until the second payment is received).  Most lenders automatically apply payments and apply extra payments to principle, but not all.  Check first (that's important).
  • Beware of scams that charge you money to set this up.  Their facts are usually right on (such as how much exactly your will save and how many years exactly you will cut off), but charging a one-time set-up fee of $200 or more is a rip-off.  You can do this yourself or your online bank may offer this program for free or for a very small fee (like $1 per transaction). 

Making additional principle payments

Everyone knows that by making additional principle payments on your home loan you can shave off time and interest.  But how much, and is it really worth letting go of those extra dollars now for the return later?  For example, if your mortgage has $150,000 and a 30 year term with 6.5% interest, and you add a mere $25 to the house payment every month, you will end up saving $16,790.81 in interest over the course of the loan.  The bonus will be that you pay the whole thing off 2 years and 2 months sooner.  How about adding $100 extra per month?   That would save $51,725.04 in interest and 6 years 11 months of payments.  Adding a whopping $400 per month to this mortgage would result in saving $110,963.93 in interest and paying the whole thing off 15 years and 9 months early!  
If you want to know exactly how much you will save -- and are ready to have your mind completely blown -- use this Early Mortgage Payoff Calculator to plug in your exact numbers.

Now, let's double it.

By doubling your mortgage payment you may think that you are cutting your loan in half, right?  Make twice the payment, pay it off in half the time.  Sounds good, but the reality is that it is actually far better than that!  You will actually pay off your mortgage in a third of the time.  It makes "cents" when you think about how interest is calculated.  You can literally save thousands and thousands of dollars in interest.  
What would you do if someone gave you thousands of dollars?  Now, you can give it to yourself by paying your mortgage off early.  What would you do with all that extra money?  
Let's say that you DID make double payments on your mortgage and as a result you pay your 30-year mortgage off in 7-10 years.  Now you own your home outright and have extra money because you aren't making a mortgage payment anymore.  Let's say your mortgage payment was $900 per month.  What would you do with that $900 now?  

And then, as Emeril says, "Kick it up a notch!"

Since you paid your home off in 10 years, let's say you spend the next 20 years investing that same amount of money every month.  In other words, instead of sending it to the mortgage you are now sending it to a mutual fund.  Now you are really killing it!  At the end of your 20 years (this is when you would have finally paid off that mortgage had you stuck with the minimum payments) now you have $316,110.29 in the bank!  I purposely used a small interest rate, because I want to communicate that you don't have to be an investor guru to make plan work.  If you can get more of a return than that (I think around 10% is the average of a mutual fund left alone for several years), then your success goes up exponentially.
I am including the Dave Ramsey Investing Calculator here for you to see how much you could earn if your mortgage payment became your investment contribution every month.  
Recap.  You made double payments on your 30-year mortgage paying it off in 10 years, max.  You spent the next 20 years using your would-have-been mortgage payment investing monthly in a conservative mutual fund and have over $300 K in the bank.  

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