The biggest factor in considering the purchase of a home is whether a potential buyer can afford it. The Housing category in a budget should be about 38 percent of one’s Net Spendable Income (the amount of money you have left after Tithe and Taxes), based on a family of four with an annual gross salary of $30,000 or less. This amount should include mortgage payment, insurance, property taxes, maintenance costs, telephone, and utilities. Some families can allocate up to 45 percent, if they have no other debts.
Although the best way to buy a house is to pay cash (if money is available), most families cannot pay cash for a home; therefore they must rely on financing. The most common type of loan is an institutional home mortgage, and the most common type of home mortgage is the 30-year fixed or adjustable rate loan.
Since Christian families should retire their home mortgages and any other personal indebtedness they may have, not on the basis of what is logical, but on the basis of God’s Word— “As the rich shall rule over the poor, so then shall the borrower become a servant to the lender” (Proverbs 22:7) —each family must make a decision according to God’s specific plan for them. One of the primary family goals should be to pay off houses as soon as possible and then put the money that was being used for a mortgage payment into savings and investments.
30-year Mortgage
Although 30-year mortgages are the most common type of home loans, they are not economically beneficial for the homeowner. On the other hand, economic benefits for the lender are nothing short of phenomenal on 30-year loans. For a typical 30-year mortgage, it will take nearly 24 years to reduce a mortgage to one-half the amount originally borrowed. Because less than 20 percent of mortgage payments are generally applied to loan principals during the first 15 years —91 percent is paid to interest during the first 7 years—home owners will pay nearly three and one-half times the amount originally borrowed before the 30-year loan is paid off. In other words, it will take nearly $500,000 in gross income to net $300,000 in mortgage payments to pay off a $100,000 mortgage loan.
Nevertheless, homeowners do have options that could save them thousands in interest dollars and cut the length of their loans by years: mortgage prepayment. There are various ways to prepay: by adding a little extra to regular monthly payments; by making one extra payment a year; or by paying biweekly rather than monthly (making half a monthly payment every two weeks), which comes out to one extra full payment each year. Yet, statistics tell us that of the over 50 million homeowners with mortgages in the United States over 97 percent never prepay on their mortgage.
Biweekly Payments
By changing payment frequency from once a month to half a payment every two weeks, homeowners will make 26 one-half payments over a year’s time. That’s equivalent to 13 monthly payments. This means that homeowners will automatically pay an amount equal to an extra monthly payment on the principal every year. On a 30-year $100,000 mortgage, this will save a homeowner over $60,000 over the life of the loan, which itself will be reduced by 7 to 9 years.
However, experts generally advise against using companies that offer to set up a prepayment plan in the form of a biweekly payment schedule, because there is usually a fee from $200 to $500, plus a monthly service charge. Homeowners can accomplish the same thing by making an additional one-time payment each year (ideally the additional payment should be made with a separate check rather than combining it with a regular monthly payment). Nevertheless, if homeowners lack the discipline to be consistent in making biweekly payments, these companies can assure that payments are made.
Prepaying on the principal
Another method to reduce interest, as well as cut years off of the length of a loan, is to prepay on the principal of the mortgage loan (make sure there is no prepayment penalty). Homeowners do not need to sign up for a special equity anticipation program to enjoy the benefits of prepaying a mortgage loan. All they have to do is make extra payments each month and designate to the lender in writing that the extra amount is to be applied to the loan principal (ideally the extra amount should be paid with a separate check rather than including it with the regular monthly payment).
By paying $25 extra each month on a fixed-rate, 30-year, $100,000 mortgage, at 7 percent, homeowners would save $18,214 in total interest and shorten the term of the loan by more than three years. If as much as $100 extra is paid each month on the mortgage principal, a 30-year mortgage can be reduced by at least 10 years, saving over $60,000 in interest.
Prepayment Errors
Lender miscalculations of mortgages are rampant. The federal government has estimated that in 50 to 70 percent of common home mortgages, lenders have made mistakes in calculating payment adjustments and in properly crediting prepayments. These miscalculations have cost homeowners $15 billion. Common errors include posting prepayments to escrow accounts, waiting to credit the prepayment to the principal for up to six months, or posting payments to reducing interest rather than the principal balance. So, homeowners who prepay need to monitor carefully any request made to the lender to apply additional payments to the loan principal.
Paying off mortgage with savings or retirement As homeowners begin to accumulate funds in their retirement accounts or cash reserve savings accounts, many times they may become tempted to use these funds to pay off their home mortgages. However, decisions to liquidate retirement funds or savings accounts in order to pay off a home mortgage should not be made unless several factors are considered first:
• The number of earning years homeowners have left before retirement and the quality and stability of current income.
• The retirement plans made to fund retirement and whether paying off the home mortgage would completely exhaust savings and/or retirement funds.
• Whether there are plans to live in the home five years or longer.
If a house can be paid off in five to seven years, a homeowner may want to consider using a portion of his or her savings or retirement in order to pay off the home mortgage. But, if the homeowner can’t pay off the home within the next five to seven years, he or she can either build the retirement account until the account can pay off the home in a lump sum or set up an escrow or diverse investment account to accumulate assets and then pay off the mortgage in one lump sum at retirement.
Nonetheless, homeowners should not sacrifice all of their savings or retirement to pay off their home mortgages. Because there may be other things that are priorities in their families, they should use no more than a percentage (not all) of surplus funds if they do decide to pay off their homes. Proverbs 16:9 says, “The mind of man plans his way, but the Lord directs his steps.” Be sure that the steps taken are God-directed steps.
Conclusion
One of the essential foundation blocks of a biblically oriented financial plan is a debt-free home. This should be the goal of all Christians. Anything can happen to this economy and, certainly, something will eventually. Debt-free homes belong to the owners, not to the lenders, and one of the best ways owners can be assured that they can eventually have a debt-free home is to pay off their home mortgages as soon as possible.
This article was formerly posted on the web site for Crown Financial Ministries, Crown.org. You can find many other helpful articles and recommended resources posted on their web site. We highly recommend you check to see how they can help you with your financial concerns.
(USA) Paying off early or not is a complex decision and takes some math skills or ability to use a spread sheet to see if it works for you.
But deciding how much house to buy is pretty simple. If you’ve not purchased before, you have to understand the costs of purchasing a home, and what the periodic costs are. It’s not just principle and interest. There is also property taxes, homeowners insurance, and perhaps PMI (mortgage insurance if you don’t have 20% to put down on the house) that you have to consider. Not to mention you own the home, so you are on the hook for any maintenance and repair, so budget for that.
One of the best decisions we’ve made was to base our purchasing on the income of only ONE spouse. Just because you qualify for a half-million dollars in mortgage financing doesn’t mean it’s a good idea to do so. I’ve typically purchased homes that were between 1/3rd and 1/2 of what I qualify to borrow. It just makes life a lot less stressful. I can invest more in savings and retirement at rates typically better than what I would save on mortgage interest.
With mortgage rates in the 4-5% range, most money does better when invested. Especially if you can deduct your mortgage interest. For me, a 5% mortgage is effectively less than 4% when deductions are figured in my taxes.
Overall, the S&P 500 does 8-12%/year. Some years better, (2009-2010), some years not so good (2008-early 2009). So I’m better off sinking more into index funds and precious metals than paying off my mortgage.
But you have to look at your situation, decide how much risk will not keep you up at night, and decide. But with houses staying flat, or dropping in value, I’d not be in any hurry to pay off a mortgage any time soon.