Make Extra Mortgage Payments
A little goes a long way when you take the long-term view. Applying extra money toward your principal every month can save you thousands in interest and can cut years off the repayment period. Be sure to indicate to your lender that these extra funds should be applied toward the principal, not interest. Many people prepay at the beginning of the loan when interest is the highest. Typically, the bulk of your monthly payment for the first few years goes toward interest, not principal. Keep in mind, interest is compounded, so the interest for each month is determined by the total amount owed (principal plus interest).
To illustrate, consider a 30-year fixed-rate mortgage at 4%. $200,000 is borrowed and would require about $140,000 in interest over the life of the loan.
But if you made an additional payment of $100 a month toward principal, you would save about $30,000 in interest, and the loan would be paid off 5 years faster!
Another option is to send one extra payment per year. This is a great option for those who receive an annual bonus or those who receive a significant tax refund. For example, A $200,000 30-year home loan with an interest rate of 5% would cost $186,512 in interest based on 12 payments a year. If you made 13 monthly payments every year, the loan would be done within 26 years and you would only have paid $153,813 in interest—a savings of $32,699.
Refinance to a Shorter-Term Loan
The typical fixed-rate mortgage used is based on 30 years, but you can get loans that last 20, 15 or 10 years. Shorter period loans generally come with lower interest rates. However, keep in mind that although these loans may mean paying out less in interest, shorter period loans also mean higher monthly payments. You need to make sure you can handle the additional monthly cost. Many people opt to just make extra payments without refinancing to avoid paying closing costs, and not be held to the higher monthly payments.
To illustrate, consider a $200,000 mortgage again, but based on 15 years instead of 30. At about one percentage point cheaper than a 30-year loan (let’s say 4%), you’d pay about $66,288 in interest over the life of the loan. You’d be saving $120,000 in interest compared to a 30-year loan at say 5% and you’d be mortgage-free more than a decade earlier.
Should I downsize? This is a big decision and should be weighed carefully. There are various factors to consider and pros and cons to review. It can be a viable option for many who aim to be mortgage-free in retirement. Maybe you don’t need all that space anymore. Do you have several rooms you never step foot in? Selling your existing home may yield significant profits that you can use toward paying your new, smaller home off in full. Smaller spaces typically mean lower carrying costs as well, which will also put additional money in your pocket.
Do you live in an expensive city or state? If so, you may be better suited to pack your bags and find a new place to call home. Forbes and Wallet Hub shared the best and worst places to retire. Kiplinger shared a similar article focusing on the 50 best places to retire in the U.S. Don’t forget to factor in taxes! Some states aren’t as tax-friendly as others.
Much like the decision to downsize, there are many factors to consider. The price of a new home, taxes, and costs connected with the transaction, changes in the cost of ownership, the cost of living (COL) in the new area, and more will help determine how much of a financial impact a decision like this could make.
Should you decide to take the leap, look for a house that costs at least 25% less than your current home, to overcome the high costs of moving. The decrease in price should translate to the savings from the move ultimately being worth more than the added expenses.
Rent Out a Room
Perhaps you have an extra room. Renting this space out to someone could help you pay the loan off much faster! An extra $250 a month on a $150,000, 30-year loan at 5% will shorten the loan repayment period by 12 years. Having a roommate can also help with paying utilities. Beyond the financial perks, sharing space with others has other benefits; companionship, new friendships, and shared activities can decrease stress and produce happiness. Be sure to review the tax consequences of doing so. The IRS will want their cut from the rental income!
Rent Instead of Own
Between the one-time home ownership costs such as closing costs, realtor fees, loan origination fees, etc. and the annual ongoing homeownership costs such as mortgage payments, property taxes, insurance, utilities, maintenance and repairs and HOA dues, it becomes clear that the cost of homeownership is typically more than the cost of renting. For many retirees, renting frees them from dealing with the headaches of maintenance and repairs, property taxes and more. They are not tied to a house. They can travel for extended periods of time or if they decide they want to relocate to another place, there is nothing preventing them from doing so.
Renting will not just lower your expenses, but it can save you a lot of capital too. The extra capital from the house sale can be applied toward investments, where even more growth can occur. House appreciation has run an average of 5.4% a year since 1968, according to the National Association of Realtors. The annualized return for Standard & Poor’s 500-stock index was 10% during that same period, which makes a good case for the pro renters.
Before making a decision, you need to consider how long you expect to stay in your new place. Renting may be the better choice if you’re not sure where you want to settle long term or if you don’t plan on staying put longer than five years.
Living a debt-free retirement is a dream many retirees share. It isn’t as far from your reach as you might think. Taking incremental steps toward achieving this is a sound strategy that has brought success to many.
Source: CNBC/ Kiplinger/ Forbes/ The Balance/ Fidelity/ Interest.com
© Geier Asset Management, Inc. December 2019. Thomas M. Geier, CPA, CFP ®, PFA is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of December 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.