What should I do with my mortgage? That’s the question I hear a lot these days. How do I benefit if I pay down the principal? Interest rates are low, should I refinance? My answer: it depends on your goals and your individual financial situation. No single answer fits all. (Note: this article does not cover those who for one reason or another cannot afford to continue to pay their monthly mortgage. These people have a different and more challenging problem.)
When I bought my first house decades ago, I had only one consideration – the monthly payment. I didn’t care about the amount borrowed or the interest rate or the length of the mortgage or the fees or the total amount of interest I would pay. I was only concerned about the monthly payment – the lower, the better. Now with maturity and years of work experience on my side, I can more clearly see other factors, the most important of which for me is can I make my mortgage go away when my regular work income stops. As your life and financial situation changes, your mortgage goal will change along with it.
One major factor is how long you plan to stay in that house. Keep in mind on average people move once every seven years. So, chances are you are not going to be in the house when your 30-year mortgage is finally paid off, you will have sold it and the payments will be somebody else’s problem. Another factor: is this going to be the right house for me in the future. As the size of your family goes up (kids) or down (empty nest; spouse passes), what you require in a house will be different.
With mortgage rates at an all time low, you might consider a refinance. Consider that fees will eat up some of the savings from your interest rate change. If you lower your monthly payment by $100 and the refinance fee is $3000, then it will take you 30 months to break even. Don’t refinance if you plan to move in two years. If you are 50 and have 10 years to go on your mortgage (and you plan to stay in the house), refinancing with a new 30-year mortgage might not be what you want. If, however, you are thinking long-term and your focus is on low monthly payments, perhaps a refinance is the best option.
Putting extra money against the principal will not change your monthly payment (wish I had known that years ago). Remember that interest is applied to the unpaid balance. When you reduce the unpaid balance by paying extra principal, the interest portion of your mortgage payment becomes lower and you will pay off the principal at a faster rate. With additional payments towards the principal, as an example, you may be able to reduce your mortgage from 360 months to 345 months. You will see no additional cash flow until month 345 (unless you sell the house in which case you will see an increase in equity). If you have 10 years to go on your mortgage and want to stop work in five years and lower your overall expenses, then you should consider paying enough extra each month to bring the mortgage to an end in five years. But do this yourself – do not pay $3500 for a software program to “assist” you (this was one of the mortgage schemes going around the last couple of years). If your mortgage is 7% and you have cash in the bank earning 0.1% now, a pay down may be good use of your money. (Your savings won’t be 6.9% because the mortgage deduction will be less. But the mortgage deduction is often overstated since couples receive a standard deduction of $11,400 anyway.)
When considering what to do with your mortgage, get some outside help, but not from someone trying to sell you something.