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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