How to Shave Years Off a 30-Year Mortgage
How to Shave Years Off a 30-Year Mortgage
Most strategies to pay off your mortgage faster involve making radical principal prepayments or moving to a shorter-term debt structure. But here’s a way to pay your loan off faster by refinancing your home … using your lender’s money.
Here’s a quick finance lesson: Lenders generate more revenue on higher interest rate loans. But with this approach, the additional revenue is not kept by the lender, but passed on to the consumer. This is how a true no-cost refinance loan works—having the lender pay the closing costs in full (as opposed to rolling the closing costs into the loan or paying them yourself).
If you were to take a market interest rate on a 30-year fixed rate loan at 3.875% vs. a no-cost loan at 4.375% (with the lender fully paying the closing fees using a lender credit generated by your taking the higher rate)—you would essentially be using other people’s money (OPM) to your financial benefit.
How the strategy works
It is important to know this strategy utilizes taking a higher-than-market rate, but arranging for the lender to pay for the closing costs in exchange. Note: the rate needs to be lower than the one you currently have—this is key, and the market needs to be in your favor to do this.
So each time you refinance, lowering the interest rate on your current mortgage—even as little as .25%—can pay off. The numbers pencil because you only take a rate that generates enough to cover the closing fees, thereby keeping your loan amount unchanged. You heard it accurately; you can accomplish this without your loan balance increasing. Keeping the loan balance the same is critical. Now, with the lower interest rate on the same loan balance, your monthly payment is lower.
Keep in mind that each time you refinance your loan, the clock does start over if you are keeping the same loan term. So if you go from a 30-year fixed rate mortgage to another 30-year fixed rate mortgage, you essentially begin again. This can make the decision to refinance unattractive, but you can change the strategy—continue making the same payment as you were before on the new lower-payment loan.
This refinance strategy, compounded with reducing your interest rate at every available opportunity, can save you thousands in interest while simultaneously accelerating your principal pay-down. Moreover, you may be able to effectively pay your loan off in half the time using a 30-year loan.
Here’s an example of this strategy at work, using a 30-year fixed rate mortgage:
Year 2008: $ 400,000 loan taken out at 6.375%—with a $ 2,479.55 monthly payment
Year 2010: $ 390,000 loan taken out to refinance at 5%, lender pays the closing costs. Your new payment = $ 2,072.94, BUT you continue to make the $ 2,479.55 payment.
Year 2013: $ 356,000 loan taken out to refinance at 4.625%, lender pays the closing costs. Your new payment = $ 1,808.20. (By continuing to make the $ 2,479.55 monthly payment, now $ 671.35 per month is going on top of the principal, resulting in a compounded interest savings over time.)
Year 2015: $ 327,000 loan taken out to refinance at 4.375%, lender pays the closing costs. Your new payment = $ 1,609.49
Your payment now reflects a whopping $ 870 per month going directly to principal. This scenario is equivalent to having the mortgage paid off in about 22 years. Not too shabby using a 30-year loan with some financial discipline.
Tips for using this strategy wisely
- Each time you refinance your home, do it for at least a 0.25% reduction in your interest rate.
- If you can select a lower interest rate with a lender credit and move into a shorter-term debt structure, such as a 25-year loan, 20-year loan or a more aggressive 15-year loan, the payoff benefits accelerate dramatically faster, but it’s not mandatory to realize the savings.
- Refinance your home as often as the numbers allow, as the lender is paying your closing costs, and your loan balance each time is equal to your current principal balance.
- Make the same payment you planned to make from the beginning. Put simply—prepay your loan on the principal by the difference of the savings generated.
- Get used to the paperwork. Electronically, save your tax returns, W-2s and pay stubs so you’re ready to go each time the market reacts in your favor. You’ll be doing yourself —and your lender—a big favor by having the financials ready to go at a moment’s notice.
With this strategy, it’s also helpful to come to the table with good credit, which can give you access to lower interest rates. Do what you can to keep your credit in good shape along the way—make all your debt payments on time, keep your revolving (credit cards, etc.) balances as low as possible, ideally 10% or less of your available credit, and apply for credit sparingly. Pull your credit reports regularly to look for errors or other problems that need your attention—you can get your credit reports for free once a year from each of the three major credit reporting agencies. And you can check your progress by getting your credit scores for free from many sources, including Credit.com, which updates your scores every month.
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