How to Pay Off Mortgage Debt Early

A little bit of knowledge and some proper planning is all you need to pay off mortgage debt early. Whether your mortgage term is 15, 20 or 30 years, it is possible to shorten the length of your loan by almost 50 percent without taking too big of a bite out of your finances.

Mortgage repayment differs from other loans, like credit cards or car loans, in a few key ways:

• You always pay your mortgage in arrears. A payment made in February, for instance, satisfies the principal and interest accrued during January.
  
• Lenders calculate accrued interest only once per month based on the principal owed at the end of the previous month. This makes when you pay your mortgage during the month less important than how much you pay -- assuming you pay by the due date to avoid any late-payment penalties and dings on your credit score.

Mortgage lenders use a method called amortization to determine the total amount of your monthly payments and how much of it to allocate between principal and interest. Although your monthly payment does not change (except in the case of an interest rate change on an adjustable rate mortgage), the amount applied towards the original loan balance and interest changes with each payment.

The concept is simple -- every penny that you pay towards your principal balance reduces the total amount that the lender uses to calculate accrued interest. If you have a $100 loan at 10 percent interest, your first payment would include $10 in interest charges. If you pay $25 towards the original loan amount, your next payment would include only $7.50 in interest charges, or ($100 - $25) * 10% = $7.50.

In the early years of a mortgage, accrued interest takes the lion's share of each payment. With each payment that you make, the amount applied towards the original loan balance increases and the accrued interest decreases accordingly. In the last few years of a mortgage, the bulk of your payments apply toward the original loan balance.

To calculate your current interest payment multiply your principal balance by the interest rate divided by the number of payments you make per year.

For a mortgage with a monthly payment, use the calculation:

• Principal Balance * (Interest Rate / 12)

For a mortgage with biweekly payments, use the calculation:

• Principal Balance * (Interest Rate / 26)

For a complete mortgage amortization schedule, use an online mortgage calculator or the mortgage amortization template for Microsoft Excel. 

Using a strategy to pay off your mortgage early has the additional benefit of saving you money in accrued interest payments. You need to take several factors into consideration, however, before you implement any of these early pay-off strategies, including the loss of income tax deductions on interest payments, the length of time you plan to spend in the home, the current interest rate of your mortgage and any other debt you may have that carries a higher interest rate.

Double Your Principal Payments

Many think that doubling the principal payment each month is an old wive's tale, but the fact is that it works. Not only will it cut the length of your mortgage roughly in half, but it drastically reduces the amount of interest you accrue over the life of the loan. This is a good plan for young couples who plan to stay in their home long-term, as the amount of principal payments starts out relatively small, and increases over time, hopefully in line with increases in income.

A $200,000 fixed-rate mortgage over 30 years at six percent interest would require only an additional $200 in extra principal at the beginning of the loan. If you continued to double the principal payments each month, you would reduce the length of your loan to 15 years and would save over $115,000 in interest payments.

You don't have to double the principal to see some reduction in mortgage length and interest payments. If you paid an additional $100 per month on that same $200,000 mortgage, you would shave 5-1/2 years off the length of the loan and save yourself almost $50,000 in interest.

Make At Least One Extra Payment Per Year

Committing to even one extra payment per year towards the mortgage principal can have a tremendous effect on the length of your mortgage. This type of early pay-off strategy is particularly beneficial to those who rely heavily on annual bonuses or commission payments.

If you made one additional payment of $1,199.10 per year on a $200,000 30-year fixed-rate mortgage at six percent interest, you would cut a little over five years off of the length of your loan and save over $47,000 in interest. Up that additional annual amount to $5,000, and you would save over $115,000 and pay off your loan in a little over 16 years.

Switch To a Bi-Weekly Payment Schedule

Switching to a bi-weekly payment schedule is only beneficial if you make formal arrangements with the bank for this type of repayment plan. Since lenders only apply payments and recalculate your loan once per month, sending in payments every two weeks would have no benefit to you without the lender's engagement and approval.

With a bi-weekly mortgage, the lender sets up a repayment schedule with payments due every two weeks that are roughly half of what a traditional monthly payment would be. Since there are 52 weeks in a year, you make 26 payments per year which effectively nets out to the equivalent of 13 monthly payments.

Following the strategy of making one additional mortgage payment per year would have almost the same benefit of a formalized bi-weekly mortgage, except that you would not be committed to that extra payment amount if your finances took a turn for the worse.