published Wednesday, March 19th, 2014

Personal Finance: Big returns from paying down mortgage early

Chris Hopkins

For most families, a home mortgage represents the largest single obligation on the balance sheet. According to Federal Reserve data analyzed by Nerdwallet.com, the average loan balance is close to $150,000 for households that carry one. Today, thanks in part to the 2008 financial crisis and the retirement savings deficit, many people are redoubling their efforts to reduce debt including home loan debt before the end of their working years.

Since the numbers are so large, the benefits of even a modest effort can be substantial over time. So, how to get started?

The most obvious and impactful move is to refinance into a shorter term. Moving from a 30-year to a 15-year loan term could be more feasible than you might think. Considering that interest rates are still near historic lows, there may never be a better opportunity to improve your long-term financial trajectory.

Consider a hypothetical 30-year, $160,000 loan at a fixed rate of 4.5 percent. Monthly principal and interest payments will run $811, and you will shell out a total of $132,000 in interest costs over the life of the loan. Now look at a 15-year loan at 3.5 percent (maybe better with excellent credit). Monthly principal and interest expenses only rise by $332, but you will save more than $85,000 in finance charges. Think an extra 85k might help in retirement?

Of course, some homeowners are unable to refinance because their balance is too high relative to the property value, or they cannot qualify otherwise. Nevertheless, there are still a few tricks you can apply that will have a material impact. Most traditional mortgages allow early prepayment (you should verify this with your lender). Adding just one hundred bucks a month to the regular payment will knock $30,000 off your interest cost for the home in our example.

Another strategy is to make bi-weekly instead of monthly payments. This approach requires discipline, but is easily automated through your bank's online bill pay facility. Splitting the monthly amount into half payments every two weeks results in the equivalent of one additional monthly payment per year, and reduces the average carrying balance on which interest accrues. For our hypothetical 30-year mortgage, this plan knocks four years off the payoff and cuts about $22,000 from your finance cost. That's a new car.

If you are currently in an adjustable-rate loans and plan on staying put, make haste to refinance into a fixed-rate note before the train leaves the station. The shorter the better, but don't get stuck on the wrong side of the interest rate cycle.

These suggestions assume that you have already pursued higher priority debt reduction options. For example, it would make no sense to speed up the retirement of a 5 percent mortgage if you are carrying balances on high-interest credit cards, student loans or other costly debt. First things first.

Curious to see how various strategies might impact you? Free mortgage calculators abound on the internet. Start with Bankrate.com, which offers a number of tools to help you estimate your savings under various scenarios. Then get started. Almost everyone can apply at least one of these techniques to reduce their lifetime housing costs and plump up their retirement assets.

Christopher A. Hopkins, CFA, is vice president of Barnett & Co. Investment Advisors.

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