How to Save Hundreds of Thousand of Dollars with Your Mortgage
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I had the pleasure of reading David Bach's new book, Debt Free for Life. I've read a few of his books and I enjoyed his easy to follow advice on building your finances.
Bach's new book has some updated information on finishing rich by focusing on paying down debt. Rather than review the whole book (too much to cover!) I wanted to review one of the chapters – Mortgage Debt: How to Protect Your Home and Pay Off Your Mortgage Early.
15 Year Vs 30 Fixed Mortgage – Which Works for You?
One concern of people who hear about 15 year mortgages is how much more expensive the payments can be. However, they may mistakenly believe that the payments would be double -that's not the case.
Here's an example straight from David's book that demonstrates how affordable a 15 year mortgage can be.
Mortgage Amount: $300,000 at 6% interest rate
- 15 Year Monthly Payments – $2,532
- 30 Year Monthly Payments – $1,799
As you can see the mortgage payments are higher with 15 years compared to the 30 years ($733), but there is a big reward for signing up for it. The pay off with the 15 year loan, you save $192,000! That is significant savings that you can use for other financial goals.
Why Bach's Mortgage Payment Plan Works
Amortization is a method that lenders use to allocate payments of the life of the mortage that takes into account the principle and the interest. For a fixed rate mortgage the payment amount remains constant over the life of the loan.
For mortgages, in the beginning of your loan most of the money go towards paying interest. As the mortgages draw to a close, the payments increasingly towards the principle owed.
That’s why if you’re able to accelerate your mortgage payments with extra money going towards principle, you can cut years off your mortgage and save thousands of dollars by avoiding extra interest.
Paying Your Mortgage Off Early
What if you have a 30 year mortgage? Are you doomed to pay a ton of interest over the life of the loan? No! Whether you have a 30 year or 15 year mortgage, you can pay it off sooner and save a huge amount of money.
Setting Up a Payment Plan
David sets up a very good case for implementing a payment plan that is doable and relatively painless. If you have 5-15 minutes, you can call your lender and set it up.
David's suggestion of splitting your mortgage payments in half and sending in biweekly payments. It sounds too easy, but by following this plan you'll shave years off your mortgage and save tens of thousands (or even hundreds of thousands) of dollars.
Why We're Paying Our Mortgage Early
As many of you know, my husband and I are working towards paying off our own mortgage early. I mentioned before that keeping a mortgage just for the interest deduction on your taxes is crazy. You’re just sending over more money to your lender to reduce your interest rate by a fraction.
The numbers don’t add up. Bypaying our mortgage earlier than the 30 years scheduled, we’re going to save tens of thousands of dollars in interest.
Our Payment Plan
When deciding on how we were going to execute this accelerated plan, our main focus was creating something sustainable and had some impact with the mortgage. Right now we’re currently sending in an extra $175/month. We've automated the extra payments to go out on the 15th of the month.
How Others Are Achieving Their Dreams
Other people have come forward and have shared their own tips on how they're accomplishing their mortgage goals.
First Gen American has worked hard with her mortgage and figuring out a payment plan that works for her:
- Always pay a little extra every month, even if it’s just rounding up to $100.
- Put all windfalls towards mortgage (tax returns, health spending reimbursements, bonus’s, side income, proceeds from selling stuff, etc)
- Buy a house based on one income.
Generally I felt if my checking account balance was growing too big, then I needed to throw some extra at the mortgage before I figured out a more interesting use for the money.
Some others are very aggressive like the bloggers behind Death to the Mortgage:
My wife and I hope to pay off our mortgage in the very near future. We originally took out a 15-year loan, then after a year and a half we decided to aggressively attack it. We reorganized our financial lives to funnel as much extra money toward the balance as possible. After a year of our project, we refinanced to a 10-year loan.
Two years later, we are on the verge of paying it off. If we can get rid of the mortgage this year, we will have had it for 5 years. We’re very much looking forward to eliminating that recurring expense and using the free cash flow to build up some income-generating assets.
Different takes and speeds, but the idea is the same – reducing their mortgage on an accelerated schedule.
Thoughts on David Bach's Mortgage Plans
I really enjoyed reading not only David's advice on mortgages, but I found his book to be a useful resource for people needing to get out of debt. If you're curious to learn more about Bach, there's a wonderful interview at Financial Samurai.
Now, I'd love to hear your thoughts about paying your mortgage quicker. How about you? If you’re a home owner, what kind of mortgage did you get and why?
I purchased my house before The Wife and I were married so even though she was part of the math equation the bank didn’t look at it that way so I was forced to get a 40 year loan believe it or not to get my Debt to Income Ratio lower. That being said, since I plan on selling prior to 5 years (I have owned in almost 4) I wish I took an ARM or something similar.
I prefer your plan to Bach’s. Get the lower monthly rate JUST IN CASE and then prepay like it was a 15 year note.
Yeah; we’re looking at all of our options. We’d pay faster than 15 years if we can increase our contributions to retirement. We’re trying to balance risk and returns, so I’m sure we’ll keep tweaking it as we go along.
In Romania the banks are not that “nice” when it comes to pay your debt upfront. In many cases (let’s say credits for personal expenses … usually used for cars or home improvement projects) if you reimburse the money sooner you’re gonna pay some “fees” just for the fact you paid before the final deadline. This is why many people just won’t bother speeding things up, since they’ll eventually lose money just to pay off the debt faster.
It’s true that our market is still in its infancy, so, in a better established estate world this is indeed an excellent idea. Instead of paying smaller amounts, but a bigger total sum, you can focus on speeding things up and actually have more years with no more debt.
I do find the chapter to be extremely useful and true in the end. I’ve done something similar with my car. I am paying it in 4 years, instead of 5 or 8 as other people I know. It’s a bit tougher than in their case, but my total price will surely be smaller than theirs. Not to mention that next year I’ll be debt free, which is something I really look forward to.
I’ve read that some mortgages here in the US also have prepayment penalties. It does pay to check for these things when you’re buying a house. Thanks for reminding me about that obstacle!
What wonderful advice, who wouldn’t want to be rid of a mortgage payment years earlier while saving thousands in the process! Only one piece of advice of my own – before you begin sending these extra payments toward your principal, just double check with your mortgage company to ensure that the will not charge you any pre-payment penalties.
Thanks Mary for the tip!
We bought our current house in 1989 with a 30 year 10% rate and put 20% + down. We have only bought two houses, but we made sure we had a loan which allowed pre-pay without penalty on both loans.
We had saved for years to send our sons to college. We both were working, but living off of spouse’s salary.
For 3 years we paid extra on the monthly payment, then got smarter. Since we were (as is still typical) getting much less in interest on our savings than we were laying out in mortgage payments, we used the college funds to pay down the house, then used the money we would have been paying on the mortgage each month to pay for the tuition and other college expenses.
It worked for us then, but if one of us had lost our job, we would have needed to find a fast way to finance those college years for our kids!
I wonder if folks think they should pay off mortgages early if they don’t plan to stay in the house they are buying? I’m thinking they wouldn’t want to, since you then have more equity tied up in the house.
Elle, Like the book and most of the concepts. (Revied ch. 5 earlier in the week)
For me, with the low interest rates, I can save overall by using the difference between the payment amount of a 15 and 30 year mortgage to invest. Over time, I usually make a larger return than the amount of interest we are paying on the loan. Obviously, this strategy isn’t for everyone.
Congratulations on your decision! I too enjoy David’s books– and he is a frequent guest on the TODAY SHOW as well.
Personally, I am trying to pay off my mortgage before I turn 30, less than 5 years after buying my home.
I’ve started blogging, and the strategies listed above really work.
First, I have bi-weekly payments. I also pay Wells Fargo an extra $860/month, which is automatically deducted as well.
Then, it’s like First Gen American’s strategy. The bonus? That goes to the mortgage.
And finally, it’s everything extra at the end of the month. I thought it would be impossible and I would need a second job.
As it turns out, I have found ways to drastically cut expenses, without sacrificing.
Once you get started with savings, it becomes an addiction. A positive one. It’s empowering to send that extra check to Wells Fargo.
I know one day soon I won’t have to send those checks anymore!