Making extra mortgage payments can pay off, but should you?
DenverPost.com | August 21, 2016 | Alex Veiga
It’s a strategy that crosses the mind of many borrowers when they take on a home loan: Make an extra mortgage payment or two every year and save tens of thousands of dollars in interest. The move can shave off costs for a home loan and ensure it’s paid off faster. Even one additional payment a year can translate into big savings. On a $250,000, 30-year mortgage with a fixed rate of 4 percent, making an extra payment every year would save the homeowner roughly $27,724 over the life of the loan. It would also cut the amount of time needed to pay back the loan by four years and one month.
Even so, there are potential financial drawbacks to consider. Borrowers who can afford to make extra mortgage payments tie up cash that could be put toward retirement or used for emergencies.“It’s really important to look at your financial health in the broader sense,” said Suzanne Martindale, staff attorney at Consumer Union. “The most important thing is to maintain in good standing all of your debts.”
Here are some tips to consider before taking steps to make extra payments on your home loan:
1. WEIGH YOUR PRIORITIES
It may be tempting to double down on your mortgage payments, but doing so before you’ve taken care to shore up your finances overall isn’t a good idea. Financial advisers recommend ensuring that you are saving for retirement and have set aside three to six months’ salary to cover emergencies. If you have children, you’ll also want to put saving for their college tuition ahead of making extra mortgage payments. “At today’s low mortgage rates, if you are cutting into your retirement savings to pay off a mortgage, you are likely making a mistake,” said David Mullins, an independent financial adviser in Richlands, Virginia. “You don’t want to have your nest egg tied up in a property where you can’t easily convert it to cash.”
2. SLASH OTHER DEBT FIRST
Paying off high-interest debt such as credit cards is another priority that should be put before focusing on paying down your home loan faster. Consider paying off car loans, too. That’s because home loans are likely the least costly debt a borrower will have, especially if they took advantage of low mortgage interest rates. In addition, homeowners are allowed to take a deduction on their income taxes for the interest paid on their home loan.
3. DO IT YOURSELF
You’ve decided to accelerate payments on your mortgage, so what is the best approach? There are many ways to get there, including paying a little bit extra every month, or making a lump-sum payment at the end of the year. Another approach involves paying half of your monthly mortgage bill every two weeks. Over the course of a year, you end up making 26 transfers, which works out to an additional monthly payment. Contact your lender to make sure they allow extra payments and will apply the funds toward the principal on your loan, not the interest.
4. WATCH OUT FOR FEES
Regardless of the payment plan, steer clear of businesses that offer to handle your extra payments for a fee, said Martindale. “Consumers need to be very wary from sales pitches from third-party companies,” she said. “If they’re charging a fee for their service, it can undercut any potential benefits they might be offering. ”The Consumer Financial Protection Bureau has sued several companies that offer to handle borrowers’ twice-monthly mortgage payments. The agency claims the companies misled consumers about how much they could save in interest on their home loan. One company, Paymap Inc., agreed last year to pay a $5 million civil penalty and return $33.4 million in fees to consumers. Another firm in the biweekly mortgage payment collection business, LoanCare LLC, agreed to pay a $100,000 civil penalty.
Why Cities Lag Behind Suburbs in the Housing Recovery
Despite a boom in urban living and rapid run-ups in home prices in many cities, urban homeowners with mortgages are struggling more in the recovery than their suburban counterparts, according to new research. Nationally, 14% of homeowners in urban areas owed more on their mortgages than their homes were worth in the second quarter, slightly more than 11% in suburban areas, according to a report released on Thursday by real-estate researcher Zillow. Even though home prices are now just 2% away from their prior peak, much of that recovery has been concentrated in markets with rapid job growth, from San Francisco to Denver, while in other places a large share of homeowners remain years away from seeing their home values recover.
While overall urban areas have fared well in the recovery due to an influx of young, educated people attracted to urban living, the higher rate of so-called negative equity in urban areas is driven by a handful of poorer cities that have been deeply devastated by the housing bust and long-term economic decline. Overall, the housing market continued to recover in the second quarter, as the share of homeowners who are underwater dipped to its lowest share since the recession. Nationally, 12.1% of homeowners with mortgages are underwater, down from 14.4% a year ago. The negative equity rate peaked in 2012 at more than 30%.
In Detroit, 23% of urban homeowners with mortgages are underwater, compared with 12% of those in the suburbs, according to Zillow. In Cleveland, 27% of urban homeowners owe more than the value of their homes, compared with 14% in the suburbs. The persistence of high rates of negative equity in those places despite several years of rapid home-price growth nationally underscores that they are likely many years away from returning to normal. Researchers estimate that the normal share of underwater homeowners is around 5%. “Honestly, I think especially for a place like Detroit, it’s going to take a whole bunch of time,” said Svenja Gudell, Zillow’s chief economist. “There is no quick fix.”
Overall, the housing market continued to recover in the second quarter, as the share of homeowners who are underwater dipped to its lowest share since the recession. Nationally, 12.1% of homeowners with mortgages are underwater, down from 14.4% a year ago. The negative equity rate peaked in 2012 at more than 30%.
Million Dollar Sales Soften: Blip or Trend?
Sales of homes priced $1 million or above dropped 4 percent in July compared to a year ago, according to the National Association of REALTORS®. The entry-level and middle parts of the housing market, on the other hand, are much more active due to low mortgage rates and high buyer demand, NAR reports. “Existing sales above $1 million were down a bit in July. This was in large part due to the stock market volatility seen earlier this summer leading up to and immediately after Brexit,” says Lawrence Yun, NAR’s chief economist. “The financial markets have stabilized since then.”
But some housing experts still question whether the luxury sector will remain sluggish. The luxury market “was the first to recover after the financial crisis, but it’s run its course,” Jonathan Miller of Miller Samuel, a real estate appraisal and consulting firm, told CNBC. “Part of it is aggressive pricing and part of it is excess supply.”
Nationwide luxury home values (homes in the top 5 percent sold in cities) dropped in the first quarter and then rose just 1 percent annually in the second quarter, according to Redfin, a real estate brokerage. Notably, luxury home prices dropped 11 percent in San Francisco and by 4 percent in Bellevue, Wash. In the Hamptons, luxury prices dropped 2.3 percent in the second quarter from a year earlier, but sales were up by more than 20 percent, according to Miller Samuel. As the luxury sector softens, more builders are turning their attention to the entry level, where supply remains tight. “We’re seeing very robust activity in the entry space and the middle of the market, but we’re not seeing it at the top,” Miller says.