Prepaying
your mortgage
On our page about mortgage
interest, we saw that a 15-year loan saves you a
bundle of interest vs. a 30-year loan. But maybe you're
stuck with a 30-year loan because that's all the bank will
give you, or because you already bought a house with a
30-year loan. In that case, you can still save on interest
by making prepayments on your mortgage. That means
paying a little extra each month so that you pay off the
whole loan faster. Actually, you don't have to pay extra
each month -- you can pay extra only in the months you feel
you can afford it. But if you're able to pay extra each
month, you'll pay your loan off even faster and save even
more interest.
Why prepay?
The whole point of prepaying your mortgage is
to pay off your loan sooner, and to save on interest.
The sooner your loan is paid off, the sooner you can
stop making monthly payments. And the interest you save
is as good as interest you could have made in separate
investments. If you invest in the stock market you never
know what kind of return you'll get. But if you have a 7%
mortgage, then every dollar you prepay gives you a 7%
return. In fact, prepayments worth a little more than
separate investments, because income you make from
separate investments is taxable, while interest you save
by prepaying your mortgage is not.
The only downside of prepaying your mortgage is that
it ties up your cash. If you take the money you would
have used to prepay your mortgage and invest it in
something else, then you'll be able to easily access that
cash in case of an emergency. If you prepay your
mortgage, your equity is locked up in your house and it's
not so easy to access it. You can't easily spend your
house.
But as long as you have sufficient savings, I believe
it's a good idea to prepay your mortgage (and most
financial advisors agree).
How to make
prepayments
Making prepayments is easy.Whether you're
paying by check or online, there's usually a blank to
write in how much extra principal you want to pay. (If
not then contact the bank and ask them how to prepay.)
It's really unlikely that your mortgage argreement
requires any kind of prepayment penalty, but it couldn't
hurt to check it to make sure.
How much should you prepay? That depends on how
much you can afford, and how quickly you want to pay off
your loan. This calculator shows how much prepayments can
shorten your loan and save you on interest.
Should you pay off your
mortgage early?
Most financial advisors agree that it's a good idea to
prepay your mortgage to save on interest and accelerate your
payoff date, regardless of whether you have a 15- or 30-year
note. But they don't always agree on how much you should
prepay. The Get
Rich Slowly blog runs down the advice from the
experts:
- Your Money or Your Life book: Pay off
early
- Suze Orman: Pay off early
- Charles Givens: Pay off early (prepay next
month's principal to pay off the loan in half the
time)
- Dave Ramsey: Pay off early, but put 15% of
income towards retirement savings first
- All Your Worth book: Pay off early, but
put only 5% of your income towards prepayments
- Ordinary Wealth, Extraordinary People
book: Don't pay off early
On a separate page I explain the concept of taking
the cash you would have spent on prepayments and investing
it in something else (and conclude that it's not all
it's cracked up to be -- prepayments are usually
better).
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