How to Pay off Your Mortgage Faster (The Truth)

hey what's up everyone and welcome to the school of personal finance so a few months ago I received a viewer question asking my thoughts about using a home equity line of credit to pay off her mortgage faster and even though I had my response in my head I thought you know it let me watch some youtube videos on to see what I could find on the internet what other people are saying about it and boy did that bring me down the rabbit hole so I found these videos that had like millions and millions of views on them and thousands of comments talking about how you could pay off your mortgage in five to seven years throwing terms around like velocity banking and how the bank's rip you off and they front-load the interest so if they're watching these videos and reading through the comments I quickly realized that people really don't understand how mortgages work and how the interest works and how home equity lines of credit work so in this video I'm gonna do my best to make it simple for you explain how all these things work so then you could decide for yourself what the best way is if you want to pay off your mortgage quickly or not I'm also going to give you my five best tips for actually paying off your mortgage faster without using any of these you know terms that people are thrown around and spoiler alert my five tips they're not revolutionary it's pretty simple stuff where anybody could do it out there so let's go ahead and get to the video so now if this is your first time here I talked all about personal finance and investing saving money and just overall trying to help you become great with money if that's something that you are interested in hit that subscribe button for me and check out my other videos alright so let's start with mortgages let's make the assumption that you're taking out a three hundred thousand dollar fixed-rate mortgage four percent interest rate over a 30-year period so now with a mortgage payment you have two components of it you have the principal and you have the interest and the bank uses an amortization schedule so they calculate exactly how much you must pay every month over a 30-year period so at the end of it you owe zero now that monthly payment that it spits out of this amortization schedule it does not change so even if you're going to pay more each month or you throw extra money at reducing the principal your payment is going to stay the same what's going to change month to month are those two components the amount that goes towards principle and the amount that goes towards interest and now the amount of interest that you pay every month it is a direct mathematical calculation compared to how much money you actually owe at that time so if we look at the first month that's when you owe the most you have $300,000 if we do the simple calculation for percent of $300,000 that is $12,000 divided by 12 how many months there are in the year that comes out to $1,000 so in that first payment you owe $1,000 worth of interest and that is the most that you are ever going to owe because your payment in this scenario is one thousand four hundred and thirty two dollars so four hundred thirty two dollars is going to go towards the principal to the reduce the amount that you owe and $1,000 is going to go towards the interest and then they do the same calculation all the way through so for month two you just paid down four hundred and thirty-two dollars so they're gonna take this new outstanding balance to you oh they're gonna multiply it by four percent divided by twelve and that is the interest payment for payment number two and now the among the amount above that is what's going to reduce the principal and it's just going to continue your monthly payment is staying the same but the amount that you pay towards principal is going to go up a little bit each month and the amount that you pay towards interest is going to go down a little bit each month because you owe them less money so if you decide you know I don't want to pay all this interest over 30 years I would rather pay the bank less interest then all you need to do is oh them less money it's simple math and another point that some people don't understand is that with this monthly mortgage payment because it accrues monthly you don't gain anything by paying on the first of every month as opposed to paying on the 10th of the month or the fifteenth of the month it actually doesn't make a difference so you could pay your mortgage on the 15th of every month and you're still going to owe the same you're not accruing additional interest by doing that where it's the exact opposite with credit cards and with home equity lines of credit where the interest accrues daily on those for those you have a benefit by paying on the first of every month as opposed to paying on the 8th of the month so let's look at an actual amortization calculator that I found somewhere online and we'll just play around with the numbers based on this $300,000 mortgage 4% interest over a 30-year period and we'll throw some extra principle payments here and there and see what kind of difference it makes as far as paying the loan down faster so if we see right here we have our mortgage amount 300,000 30-year term 4% interest rate that gives us the monthly payment one thousand four hundred thirty two dollars if we look down at the bottom here we see the total payments that are made over the 30 years five hundred fifteen thousand and change and of that you have paid two hundred fifteen thousand six hundred seven dollars in interest so you might say to yourself holy cow that's a ton of interest I could buy another home for that amount but that's just the way the numbers work if you want to borrow three hundred grand over a thirty-year period that's how much interest you're gonna pay so if you say screw that I'm not paying that much interest I'd rather pay much less interest so if we cut it down to a 15-year mortgage now you've cut the interest down over that 15 years to be a hundred thousand dollars but if we look your monthly payment has now jumped from 1425 a month now you have to pay two thousand two hundred and nineteen dollars a month so now let's go back to a 30-year mortgage and let's say you know what I get a tax return once a year of around three thousand bucks so I'm gonna take that and I'm going to prepay my mortgage every year around April or whatever when I get my tax return and I'm just gonna throw to my mortgage so if you do that if you pay $3,000 yearly throughout the term of this mortgage you would save sixty one thousand four hundred and ten dollars on there and if we scroll down and look you would be done with this mortgage in 22 years and five months so you saved basically a little over seven and a half years by just throwing $3,000 a year once a year extra towards your mortgage now if we say you know what I could pay I can't pay on that 15-year schedule but I can pay an extra four hundred dollars a month towards this thing so I don't have to pay so much interest over the 30 years so if you throw an additional $400 you will save eighty one thousand dollars throughout the term of this mortgage and you'll be done with it in just about 20 years 19 years and 10 months you'll be done with this mortgage total savings eighty one thousand dollars in interest so now let's take a look at how home equity lines of credit work so home equity line of credit is just a revolving line of credit very similar to a credit card the big difference is that your home is the collateral so you have to apply for it you have to have the equity in your home to get approved for it good credit score all that stuff to get approved for it but with a home equity line of credit the money that you borrow on it the interest is calculated daily that's different than with a mortgage where it's actually calculated monthly so if you borrow $10,000 on your home equity line of credit the interest is accruing at a daily rate so they take their interest rate it's say it's 5% and divide it by 365 days a year so they're looking at how much you owe on that home equity line of credit every single day and calculating the interest on the daily basis and then they add it up at the end of the month to come to your interest payment for the month so now because the interest is calculated daily you do save money by paying it by the due date or a little bit before the due date where you it cost you more if you wait and you don't pay till 10 days after the due date because the interest is being calculated each and every day and the home equity line its revolving so let's say that you borrow $5,000 on it and then you pay it off now you have it available again just like a credit card it's pretty simple to understand so now the concept of velocity banking that these videos are based upon how you could pay off your mortgage in five to seven years it's that you get a home equity line of credit so you have your mortgage you take out a home equity line of credit and you use a chunk of the home equity line of credit let's say it's ten thousand dollars and you prepay your mortgage with it you throw it at your mortgage so that you're reducing the principal balance of that mortgage and now by doing that you are now reducing the interest that you owe on that mortgage because you owe $10,000 less on it even though you're suddenly making the same monthly payment on your you now owe 10 grand less so more of your mortgage payment is going to go towards the principal so this is going to accelerate the pay down of your mortgage but now you owe 10 grand on this home equity line of credit here so what velocity banking is is you use this home equity line of credit as your cash accounts basically it's like your checking account so when you get paid you put your paycheck in there you take your paycheck you pay down the line of credit you then pay your bills out of the home equity line of credit and you keep on doing this using it paying it down using it paying it down and you just have a focus you have a goal of paying it back down to zero and then doing it over again so instead of having money sitting in the bank where you earn zero interest on it you have it sit in the home equity line of credit because this is a crewing daily so if you park your paycheck in your home equity line of credit you're not paying interest on those days because you have paid down the balance on it and then when you actually need the money to pay a bill you write a cheque out of the home equity line of credit to pay a bill now in theory this could work if you're very diligent if you watch it very closely if you don't you know continue to use the home equity line of credit and spends more than what you typically spend because now you have all this money that's available to you but if you're very disciplined and you stay all over this then yeah you could save money by using the home equity line of credit through this velocity banking idea personally I think that it's way too involved and way too confusing and it's just not really necessary so if paying off your mortgage early is one of your goals and you're focused on doing it here are five tips that I have to help you get there all right so number one is pretty earth-shattering and it's just make random extra principal payments towards your mortgage so if you have extra money laying around go into the bank and throw some money at it make a principle payment make sure you're telling them that it's a principle payment because if you don't they'll apply it to your next monthly payment so go in and throw chunks at your mortgage if you have the money laying around that's the best way to pay off your mortgage early tip number two is to do the bi-weekly payments so by doing this instead of making 12 monthly payments you're making 26 bi-weekly payments which is the equivalent of 13 full payments so you get one extra payment a year by doing bi-weekly payments throughout the year and one payment the year goes directly towards principal and that'll knock years off the back end of your mortgage so that's a simple way that you could go about getting done with your mortgage faster so then my third tip is to just make payments as if it was a 15-year mortgage so I still think that it's a good idea to do a 30-year mortgage but if you want to pay it off quicker make payments as if you took out a 15-year mortgage this at least gives you the flexibility where if you don't have the money one month you could make the payment as if it was a third a year but if you do have the extra money and you want to make the additional payments pay it on that 15 year schedule and try to pay it off that much faster then tip number four is to check your current interest rate rates are crazy low right now and see if we find makes sense for you the kitty is can you save enough on the interest rate to make it worthwhile so you have to see how much the closing costs are and the interest savings that you're gonna have over the life of it and make sure that it makes sense to do that and one important factor in that is how long you're going to stay in the home so there's a break-even point if you're gonna be in the home for only like two or three more years it's not gonna make sense to refinance your home because of the closing costs but if you're gonna be there 10 15 20 25 years and you could save a point on the interest rate it's going to make sense to refinance your mortgage and then number five which is along the lines of velocity banking and that is using a home equity line of credit as your emergency fund and using the cash or a portion of the cash in your emergency funds and making principal mortgage payments with it so if you've been very good with your money and you have like six months saved up in the bank in an emergency fund that's only 2% right now a strategy that you could implement is maybe taking half of that maybe taking three quarters of it and paying down the principal on your mortgage this way your future payments war is gonna go towards principal less is gonna go towards interest because now you will less on that mortgage and now get a home equity line of credit to just sit there don't borrow against it just have it sit there and act as a backup to your emergency fund if something were to happen but there are some risks to that with the home equity line of credit you know if we go through a recession the banks could pull it from you or freeze it on you that did happen in 2008-2009 so it's just something you want to be careful of but in my opinion that's a better way to go than the velocity banking which is basically borrowing money to throw at the at the mortgage this way you're using you know dead money money that's sitting in your savings account that's not really earning anything you throw it at the mortgage you have the home equity line the credit act is your emergency fund I think that that's a better way to do it but unfortunately when it comes to paying off your mortgage faster there's no easy button there's no simple you know ninja trick that that people aren't telling you about it just doesn't exist the best way to do it is to pay more towards your mortgage the question is should you be doing that should you be paying more towards your mortgage or should you be investing that money in something else and that is a discussion for a different day all right so that's it for this one hopefully you found that helpful hit that subscribe button if you've not done so already please hit that like button if you enjoyed this video I will see you again in our next one thanks a lot

Channel: School of Personal Finance

Views: 341,660

Rating: 4.9084339 out of 5

Keywords: mortgage calculator, how to payoff your mortgage faster, how to payoff your 30 year mortgage, how to payoff your mortgage in 5 years, how to payoff your mortgage in 7 years, how to payoff your mortgage, school of personal finance, how to payoff your mortgage quickly, how to payoff your mortgage early, home mortgage calculator, cfp, rich mccormack, pay off your mortgage, pay off your mortgage fast, pay off your mortgage faster, pay off your mortgage in 5 years, velocity banking

Id: ocm-ShNaK28

Length: 14min 3sec (843 seconds)

Published: Tue Sep 17 2019