Real Estate Financing and Investing/Should You Pay Off Your Mortgage Early

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Suppose you have decided to refinance your home with a lower fixed rate mortgage. You should consider the term of the loan. Although the standard 30 year mortgage is still very much alive and well, you might want to consider the loan with a shorter term such as a 15 year fixed rate loan.

The overall savings in interest paid to the lender over the life of the 15 year mortgage can be quite substantial, yet the monthly payment is not significantly higher. Recommendation: Even if you decide to stay with your current 30 year mortgage, you might be able to save a bundle by paying off more in each month, treating the 30 year loan as if it were a 15 year loan.

Example:
Suppose you currently have a $100,000 30 year fixed rate mortgage at 13 percent. Your monthly payment for principal and interest is $1,106.20. You have decided to refinance your home with a fixed rate loan at 10 percent. You have two options available: 30 year loan at 10 percent vs. 15 year loan at the same rate. Look at Table 3 for comparison regarding monthly payment and total interest over the life of the loan.

Note: In either case, the monthly payment is less than the 13 percent mortgage. Between 30 year and 15 year, however, the monthly payment increases about 22.45% while the savings in total interest payments over the life would be almost 57 percent. From this example, you learn some valuable lessons:

  1. It was a good decision to refinance your home, since, in either case, you save in your monthly payments ($1,106.20 vs. $877.57 and $1,074.61). In this example, a 3 percent drop in the fixed rate made this possible.
  2. You would be able to save $122,495 in total interest payments by election of a 15 year loan without increasing your monthly burden.
  3. Among other things, you will be a 100 percent equity holder in your home within 15 years instead of 30 years.

Table 3. Comparison of 30-Year vs. 15-Year Fixed Rate Mortgage

30-year 15-year $ Increase (Decrease) % Increase (Decrease)
Principal $100,000 $100,000 -- --
Rate 10% 10% -- --
Monthly Payment $877.57 $1074.61 $197.04 22.45%
Total Interest $215,925 $93,420 ($122,495) (56.73%)