Early Repayment Of The Mortgage: How To Pay Off The Bank Faster & More Profitably

 

Repayment Of The Mortgage

The average term for which residents of the USA take out a mortgage loan in 2020 is approximately 18.4 years. But Americans pay off their debts much faster - in 7-10 years. Is it profitable to pay early with the bank and how best to do it? Let's figure it out.

To pay off a mortgage ahead of schedule, you must first take out a mortgage. And now seems to be the right time

By the summer, the average mortgage rate in the USA reached 7.4% and continues to decline, largely due to preferential mortgages with a 6.5% rate.

There have never been such low mortgage rates in the USA. This is a great opportunity to buy an apartment on the most favorable terms for those who have long been planning to do so.

Monthly loan payment. How much do you pay for the loan itself, and how much for the interest on it 

Each loan payment consists of two parts: one part goes to pay off the principal debt, the other goes to pay off bank interest on it (the same loan rate). Most banks in the USA now work with annuity payments: in this case, the bank first seeks to receive all payments on the interest that you owe, and only then on the main body of the debt. After a few years of repayment of the loan, the main body of the debt may decrease quite a bit, since the main part of the contributions goes to repay interest.  

The payment schedule usually indicates how much money is used to reduce the principal and how much is used to pay interest on the mortgage. 

Early repayment options: reduce the payment or term of the mortgage

2 main options: reduce the monthly payment or reduce the loan term. 

To choose the method that suits you best, you need to consider several conditions:

1. View the agreement - what options it allows and whether there are any commissions for early repayment. 

2. Evaluate what is more important to you - to pay less money to the bank or reduce the amount of the monthly payment. A combined option is also possible.

Reducing the loan term 

You pay some additional amount - once or every month. It goes to pay off your principal debt. By depositing this additional amount, you indicate that you would like to shorten the loan term. Let's say from 15 to 14.5. 

Usually, this method is advised by bank employees and estate agents.

Pros: Overpayment is greatly reduced, you save on interest.

Cons: It will not reduce your monthly load and may even increase it if you pay an additional amount every month and quickly shorten the loan term.

Take, for example, a loan of 3 million, issued in April 2019 for 15 years at 9% per annum, and calculate the benefit in a loan calculator. We have chosen the "Portal of Financial Calculators" for this, but you can use any other site.

We reduce the monthly payment

Additional funds are used to pay off the principal debt, while by reducing this amount, the interest charged by the bank on it becomes lower. Your payments are recalculated according to the new schedule; the monthly payment amount is reduced. 

If the monthly payment is too large for you, then it is more convenient for you to reduce the load right now and be sure that there will be no problems with the next payment. In this case, the savings on interest will be slightly less, but the standard of living will increase.

Pros: the monthly payment is reduced, this allows you to live more comfortably and save more money.

Cons: you still have to pay for a long time, but the overpayment remains large.

Combined method: we reduce the maturity, keep the same monthly payment amount 

If your budget allows it, you can combine the two described methods: use a large one-time payment for early repayment and reduce the amount of the mandatory payment, but continue to pay the full amount. These small overpayments will also be an early repayment, and due to them, you can already shorten the payment period.

You can do this as long as your income allows it. If you suddenly come across difficult times, you will be able to pay the minimum mandatory payment, this will not affect your standard of living, and there will be no violations in the payment of the loan either.

Pros: this scheme can be adapted to the circumstances - to reduce the loan term and overpayment in those months when it is comfortable for your budget, and in difficult times, pay the bank less.

Cons: overpayment of interest will be greater than in the case of a shortened loan term.

We will spend 10000 USD from our example to reduce the payment, but for the next months we will continue to deposit funds in the same amount - 30,42 USD, that is, 1041 USD more than needed. 

The overpayment will decrease by 25,974 USD, and the loan term will be reduced by 10 months.

Compared to the first option - shortening the loan term, this is a less profitable method for the long term, but it helps to adjust to the current situation. 

What is more profitable to pay off a mortgage ahead of schedule: one-time or systematically

It doesn't matter. Calculations can be checked in your bank's calculator. Almost everyone has an early repayment calculator, in which you can check how the term will be shortened or the monthly payment will decrease with a certain amount of early repayment. 

The most rational option is mixed. If you can afford the current payment, but there is a significant amount for early repayment, then it is most profitable to use it to reduce the minimum payment and continue to pay contributions in the same amount.

How to arrange early repayment

First of all, read your contract. The procedure for early repayment should be described there. If the conditions are not provided for by the contract itself, then they can be in the applications or general credit conditions that are publicly available on the banks' websites. 

Pay attention to the period for which you must apply for early repayment: it can be tied to the date of the next payment. Here, for example, is how this condition looks at Rosbank:

Many banks allow you to send such applications directly from the borrower's Internet account. 

You can also pay off your mortgage ahead of schedule even in the app. 

Almost all banks in one way or another give a play with the options for repayment of the loan and show how the loan term or the size of the payment will change if you choose one of the repayment methods. 

If you choose to reduce the loan term with an early payment of 10 thousand USD, then this will reduce the repayment period by almost 1 year. If we use these 10 thousand to reduce the regular payment - here it is made every 2 weeks - then the payment will be reduced by about 40 USD, that is, saving about 1000 USD per year.

After you transfer the money for the early repayment of the loan, the bank changes the payment schedule and sends you a new one. You can now follow it. 

Is it worth paying off the mortgage ahead of schedule?

To assess the feasibility of early repayment of the loan (and how quickly you want to repay it), it is worth considering the following factors:

1. Loan term and solvency during this period 

If you took out a loan at the age of 30 for 5-10 years, then, most likely, you will not have problems with work and demand, and the salary by the end of the loan term will be no less than the current one, besides, inflation will “eat up” part of the loan ...

The situation is different with longer loans, for 20-30 years, taken by people older. If you are not sure that in your 50-60 years old you will be able to earn the same as now and repay the loan without any problems, then it is better to repay the loan ahead of schedule and not worry about your future.

2.     Credit load

If you are about to buy an expensive car or another apartment, then a large mortgage debt can lead to the refusal of another loan. The less you owe the banks, the better.

3.    Are you going to sell an apartment in the coming years

For example, you are planning to replenish your family or want to improve living conditions.

Selling a mortgaged apartment or even renting it out is possible only with the consent of the bank, these are additional difficulties. It is easier to pay off the bank ahead of schedule, pay off the collateral, and dispose of an apartment that is free of any obligations. 

4.    Inflation rate and income growth

Assess the size of your payment, the rate of inflation, and how your income is growing. Perhaps, in a few years, the loan payment will become an insignificant share in your income and you will be able to pay off the debt ahead of schedule in a couple of years.

Short:

1. There are 2 main ways of early repayment: to reduce the loan term or the amount of payment.

2. It is more profitable to reduce the loan term; this will greatly reduce the overpayment of interest to the bank.

3. Another profitable option is to reduce the amount of the contribution due to early repayment, but continue to pay according to the old calculations, sending a small amount "ahead of schedule" every month in addition to the new payment. 

4. Carefully read the terms of early repayment; are there any commissions and in what time frame you need to apply to the bank.

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