|By David Pilley on December 23, 2011
Interest rates on mortgages are below 4 percent for the first time ever. Many people in the financial world are also telling homeowners to stop paying down on their mortgages, so they can have some extra money in the not-so-great economy. Paying down simply means to make more than the minimum monthly payment. When you pay down on your mortgage, you’re making an extra payment to the principal. By paying more than the minimum, the amount of time you have to spend paying on the loan gets shorter, and the amount of interest you will have to pay also shrinks. A 30-year mortgage can be shortened by a couple of years if you pay down multiple times. With record-low mortgage rates, you don’t have to be as aggressive with paying over the minimum, but don’t stop altogether.
Your lender might be telling you to stop paying over the minimum on your monthly mortgage payment. It’s not just because you will be saving a little bit more in the short run; by paying just the minimum, you are assuring your lenders get the most amount of interest possible. Interest is how they make their money, and they get less if you pay more.
Your mortgage loan is amortized, meaning the minimum monthly payment is the same for each month. The interest is already factored in with the principal. The earlier you are in the loan, the more interest you are paying; therefore, it would be most beneficial for you to pay more than the minimum as soon as possible! Not all lenders are heartless, but I’m sure they would love to see interest rates go up in the near future.
There are many different strategies in paying down your mortgage, some more structured than others. The first one is to simply send extra money with each monthly payment. Whether it’s $10 or $100, whatever you can afford, tack it on to the payment and specify to your lender that the extra money is going to the principal, not next month’s payment. The next one is cycling, a strategy I’m actually using with my student loans. Continue with paying the monthly minimum, but every six months, send in a large lump sum. This lump sum should be at least double the monthly minimum, and you can knock off multiple years on the loan if you can keep up this strategy. Cycling is an aggressive plan (it’s easier to do if you’re managing a small loan), so use this one only if you can contribute an extra few thousand dollars twice a year.
A more structured plan is the four-week plan. Make your mortgage payment every four weeks instead of every month. Since there are 52 weeks in a year, this means you’ll be paying 13 times instead of 12, one extra payment per year. You will further shrink the time of repayment if you give more than the minimum at any time. One final plan to consider is the bi-weekly plan. It works the same as the four-week plan, except you make half of a monthly payment every two weeks. The bi-weekly and four-week plans don’t necessarily involve higher monthly payments. You are simply making an extra payment each year, and this can shave a couple of years off the loan’s term.
Whatever you can do, do it. The more minimum monthly payments you make, the more money your lenders make. However, you may end up in more dire straits if you ever pay less than the minimum. Even with mortgage rates at all-time lows, I encourage you to use one of the pay down strategies. You never know when rates are going to increase.