People on social media love developing with so-called “hacks” to excite their followers.
Within the mortgage realm, this sometimes means highlighting math that appears unbelievable at first.
And it normally revolves round paying down a mortgage forward of schedule, a lot to the chagrin of the banks.
For the document, the banks in all probability don’t care that a lot if in any respect, since lately they’d in all probability pay you extra in the event you put cash in a financial savings account as an alternative of towards the mortgage.
However I digress – let’s take a look at the most recent scorching pattern, the two% mortgage hack.
What Is the two% Mortgage Hack?
| $400k mortgage @ 6% | Authentic | 2% Hack |
| Yr 1 cost | $2,398.20 | $2,398.20 |
| Yr 2 | $2,398.20 | $2,446.16 |
| Yr 3 | $2,398.20 | $2,495.09 |
| Yr 5 | $2,398.20 | $2,595.90 |
| Yr 10 | $2,398.20 | $2,866.10 |
| Yr 15 | $2,398.20 | $3,164.41 |
| Yr 20 | $2,398.20 | $3,493.77 |
| Yr 21-30 | $2,398.20 | $0 – paid off! |
In a nutshell, the two% mortgage hack requires you to extend your mortgage cost 2% every year.
This doesn’t imply simply paying an additional 2% primarily based on the unique month-to-month cost.
As an alternative, you pay 2% additional in yr two, then 2% extra on prime of the two% additional in three yr, and so forth.
Each 12 months, your mortgage cost grows bigger, primarily based on the quantity the yr earlier than.
For instance, let’s take a look at a $400,000 mortgage quantity with a 6% mortgage price and a 30-year mortgage time period. Fairly widespread state of affairs these days.
Should you had been to only make the traditional, minimal required cost, it’d be $2,398.20.
Now think about beginning in yr two, you add 2% to that cost. It’s $2,446.16. That’s not a giant leap up. It’s about $48 extra per 30 days.
For many, this might be manageable, and certain wouldn’t require any way of life modifications or slicing again.
That alone wouldn’t do a lot although. It might merely shorten your mortgage time period to twenty-eight years and 6 months.
Nevertheless, it could prevent practically $29,000 in curiosity. Not too shabby.
However the place the two% mortgage hack will get attention-grabbing is you compound the additional funds every year.
So starting in yr three, we add one other 2% on prime of the elevated cost from yr two.
That places funds in yr three at $2,495.09. In yr 4, it climbs to $2,544.99. In yr 5, it’s $2,595.89.
Every year, you’re including 2% from the yr prior. You are able to do this by multiplying the mortgage cost by 1.02 in a calculator.
By yr 20, the mortgage cost is almost $3,500 per 30 days, however it’s gradual and knocks down the excellent mortgage steadiness rather a lot sooner.
What Does the two% Mortgage Hack Accomplish?
In brief, the two% mortgage hack reduces your complete curiosity expense and shortens your mortgage mortgage time period.
Most of the posts I’ve seen about it declare it reduces your mortgage time period by 12 to 14 years, however it is determined by the mathematics, aka the mortgage steadiness and rate of interest.
The quantity of curiosity saved can even differ primarily based on these inputs, however the basic thought is you possibly can considerably cut back your mortgage time period and save on curiosity.
So as an alternative of ready 30 years to personal your private home free and clear, you possibly can personal it rather a lot sooner, assuming that’s a purpose.
And you may pay rather a lot much less curiosity within the course of.
In my instance, you’d cut back the mortgage time period by a few decade, so 20 years as an alternative of 30.
The curiosity financial savings from making additional mortgage funds would additionally cut back your curiosity expense by about $135,000.
Merely put, you’d have a paid off mortgage in about 20 years and save greater than six figures. Good!
You’re Basically Emulating Inflation by Growing Your Mortgage Fee Yearly
By making a cost that’s 2% larger every year, you’re mainly emulating the speed of inflation.
The greenback’s worth erodes every year by round this quantity, so by paying the additional 2%, you’re primarily adjusting it to maintain tempo.
This could imply it’s not an additional burden, as your wages/revenue may also be anticipated to extend by this quantity.
And every thing else you pay may enhance by this quantity too, whether or not it’s your grocery invoice or householders insurance coverage.
It’s additionally fairly widespread for renters to see their month-to-month hire get elevated by their landlord yearly.
So in the event that they had been paying $2,000 per 30 days, the next yr they could be advised the brand new hire is $2,100.
That’d really be a 5% enhance, and this illustrates why homeownership may be nice. It’s an inflation hedge.
You aren’t required to pay extra every year with a mortgage, however as this technique exhibits, it can save you rather a lot in the event you select to.
And since 2% is such a small quantity, it’s a delicate method to paying additional towards the mortgage with out overextending your self.
However is it the most effective technique on the market?
You’ll Save Even Extra by Paying Further Earlier On
Whereas the two% mortgage hack is a cool approach to cut back your curiosity expense and shorten your mortgage time period, with out a huge bump in cost, it’s considered one of many choices.
First off, it ought to be famous that some householders could not need to repay the mortgage early in any respect.
That is very true for these with low mortgage charges, whether or not it’s a 2% or 3% price. For these people, their cash could be higher off deployed elsewhere.
For individuals who do need to repay the mortgage early, you save extra whenever you pay extra earlier on.
What if as an alternative of two% starting in yr two, you simply began paying 5% additional per 30 days instantly?
Nicely, you’d cut back the mortgage time period by about 15 and a half years and save $211,000 in curiosity.
So you might save extra in the event you don’t wait 12 months to start making bigger funds, and much more in the event you look past a 2% bump.
The two% enhance is simply $48 additional. Likelihood is householders can go a little bit greater, granted over time that quantity does get exponentially greater.
However you might nonetheless implement say a 3% or 4% enhance proper off the bat and turbocharge the financial savings of this technique.
Learn on: Ought to I prepay the mortgage or make investments as an alternative?
Earlier than creating this web site, I labored as an account govt for a wholesale mortgage lender in Los Angeles. My hands-on expertise within the early 2000s impressed me to start writing about mortgages 19 years in the past to assist potential (and present) dwelling patrons higher navigate the house mortgage course of. Observe me on X for warm takes.