Question: Rates have risen since I got a mortgage so I don’t want to refinance. What’s the quickest and easiest way to knock down my mortgage balance and owe less to the lender?
Answer: For most mortgages today there are five reduction strategies to consider without refinancing.
First, there is the occasional prepayment. In this situation, every so often you add money to your mortgage payment by using the “extra principal” line on your payment coupon.
If you go this route, be sure to check your mortgage balance in the coming month to make sure the additional payment was properly credited.
Second, usually the term “extra principal” means that the borrower chips in some money here and there to reduce the principal balance. However, it sometimes happens that the borrower wants to make a single substantial payment, say $10,000 or $20,000.
If this is the case, do not simply make a larger payment without first calling the loan servicer and asking if the payment will be considered a “curtailment.”
If it is counted as a curtailment, the interest rate remains unchanged, the loan balance is significantly reduced, and in turn the lender will lower the minimum monthly payment because less is needed for the loan to be self amortizing over its remaining life.
The terms of a curtailment must be worked out with the lender in advance so that everybody understands what will happen once your payment is received.
Third, you can plan to make regular prepayments, say $100 every month. For example, if you have $175,000 mortgage at 4.25%, the monthly payment for principal and interest will be $861.
Add an extra $100 per month to the mortgage and it will be repaid in 293 months instead of 360 months, meaning the loan-term will be reduced by 67 payments.
Since most 30-year loans do not actually last three decades, what will most likely happen is that you’ll sell or refinance and simply owe less to the lender at closing.
Fourth, you can effectively decide your loan length. If you increase the monthly payment on our $175,000 loan to $1,317, the loan will be repaid in 15 years – or by paying $1,084 per month you can have 20-year financing.
Fifth, you can create what is effectively a bimonthly payment. Instead of paying $861 for principal and interest each month, we can instead pay $430.50 every two weeks if we go the bimonthly route.
While such as schedule will surely pay off the loan more quickly, it is not a plan which most lenders will accept – mostly because they do not want to handle 26 payments a year.
The solution is to keep lenders happy and get the same essential result as you would with a bi weekly payment. This can be easily done by dividing your current monthly payment by 12 and adding the result to the extra principal line of your payment coupon.
In this case, we would take $861, divide by 12, and that gives us $71.75. If we add $861 plus $71.75 the total monthly payments will be $932.75. If you multiply $932.75 times 12 you get $11,193.
Alternatively, if you multiply $430.50 times 26 you get the same result.
You will sometimes hear about third parties who offer to operate bi weekly payment programs on your behalf. Naturally, if you enroll in such a program you will have to pay various fees and charges, money better spent on paying down the mortgage.
Since your mortgage agreement is with the lender, you must make sure that all payments required for the mortgage are paid in full and in a timely way. If a third-party happens to be late with a payment or does not make it at all, then it’s your credit which will suffer.
For these strategies to work your loan must allow prepayments without penalty. In today’s mortgage marketplace most financing bans penalties, but there are some loans out there where you can still get dinged for prepayments.
Typically, if your mortgage coupon has a line which allows you to add “extra principal” or something similar then you should be okay.
If you have any question about penalties call your loan servicer and ask what penalties – if any — apply to your mortgage.