Financial Advice on Paying Off Mortgage Loans
Hi Kristin, I bought a house for $204,000 back in 2016 with a 30-year mortgage. The loan was divided into two parts, $182,000 at 3.5% and $22,000 at 5.50%. Both interest rates are fixed. The monthly payments for the main loan and the second loan are $992 and $126 respectively, with escrow being taken out from the main loan. I plan to retire in three years and I'm wondering if it would be better to pay off the smaller loan in that time frame, or if it's more financially beneficial to put that money towards the principal on the main loan. What are the short-term and long-term advantages of each option?
Dear Johan, You've raised some important questions, one of which is whether it's more beneficial to accelerate payments on your larger main loan or on your smaller loan with lower payments. Generally speaking, you'll save more money by paying off the debt with the higher interest rate, which in this case would be the smaller loan with the significantly higher interest rate. The advantage of this approach is saving money in the long run. Paying off a loan faster means reducing the total amount paid in interest over the loan term.
Given the substantial difference in the loan amounts, you will still end up paying a considerable amount of interest on the main loan. Hence, it might be worth considering paying off the smaller loan within three years, even if it means increasing your monthly mortgage payments to $626 from the current $126. While this may limit the extra funds available for speeding up payments on the main loan, the long-term savings could be significant.
By paying off the smaller loan in three years, you could save approximately $14,350 in interest payments over the next 24 years. With this smaller loan out of the way, you can then redirect the additional funds towards paying off the main loan. By paying an extra $500 per month, you could pay off the larger loan nearly 10 years early, saving around $29,779 in interest. Additionally, any surplus funds in your escrow account after paying off the loans would be refunded to you.
It's important to be aware of potential penalties for early payment that some states impose, so ensure that you won't incur any penalties by accelerating the loan payments. Make sure to review the terms of your loan agreement for any clauses related to early payment penalties. Depending on the penalty amount, the savings from early loan repayment might outweigh the fines, so performing a cost-benefit analysis is essential.
-Kristin
If you have financial questions, Kristin is here to provide assistance. Submit your queries anonymously, and she might address them in an upcoming article.
