It’s Smart To Prepay Your Mortgage – Right?
Maybe not. Of course, it completely depends on your situation. When you prepay your mortgage you pay less interest over the life of your loan, you increase your equity and you move toward living debt free.
All of that sounds great and it sounds like a decision to prepay your mortgage is a smart one. It could be, but before you decide to put all your extra cash into paying off your house, take a look at the excerpt below.
You might do better investing elsewhere.
By paying off your mortgage early, you are investing in your home with funds you could be able to invest elsewhere more profitably. Typically, investments in stocks or mutual funds do better over time than residential real estate, though all real estate market are local and today some are appreciating at rates faster than the stock markets today.
Avoid shorting retirement savings.
If you shortchange your retirement savings, you will lose the tax advantages of making your maximum annual contributions to your 401K or IRA account. You pay no tax on these contributions until you withdraw them as distributions after you retire. Above all, do not take out funds from your retirement accounts to pay off your mortgage if you are younger than 60. Withdrawals from your qualified plan are taxed as ordinary income and may be subject to a 10% Federal tax penalty if taken before age 59 1/2.
Keep a cash balance for emergencies.
Don’t diminish your emergency cash reserves to pay down your mortgage. As a rule of thumb, you should keep a balance in cash or easily accessible investments like money market accounts equal to six months income that you can access in the event of a financial emergency, like losing your job.
Losing mortgage interest deduction.
One of the advantages of mortgages is the deduction you earn on the interest you pay on your mortgage each year. As noted above, mortgages are structured so that you pay more interest than principal at the outset and as time passes, you may more principal. If you are in the final years of your mortgage, you will not lose much by losing your mortgage interest deduction. However, if you are in your early years, you might increase your income tax liability significantly by reducing your principal or paying it off altogether.
You gain less with a low mortgage interest rate.
Though you always end up paying less interest by paying down your principal early or paying if off altogether than making your payments as scheduled. However, your savings will be less if you have a lower interest rate than a higher one.
– via Everything Real Estate. Everything Homes.com.
How Do The Numbers Really Work?
Where you put your extra money to work to your best advantage is an important one. So when considering whether or not to prepay your mortgage you will want to take a hard look at the numbers.
Here is a good example of how making prepayments works out in dollars and cents.
Prepaying is not to be confused with making a mortgage payment early simply because you’re going to be out of town or indisposed next month, says mortgage banker Todd Huettner, president of Huettner Capital in Denver.
“When you prepay, you send your lender additional money and they apply it to your loan balance. This can save a ton of money, especially on a 30-year loan where most of your regular monthly payments go toward paying down your interest during the first several years,” Huettner says.
The savings could be huge.
A 30-year fixed-rate mortgage at 4% and $200,000 borrowed would require about $140,000 in interest over the life of the loan.
But if you were to prepay just an additional $100 a month toward principal, you would save about $30,000 in interest, and pay off that loan five years quicker.
Here’s another prepayment perk: unlike the capital gains and dividends earned on other types of investments like stocks and bonds, the savings earned from prepayments are not taxable.
The prepayment process is relatively simple. “Take the time to write a separate check or send a separate electronic payment to your lender and explicitly state in the memo or on a separate note that this extra payment is to be applied toward the principal on your loan. Otherwise, the bank could possibly apply your extra payment to the next month’s interest,” says Jason van den Brand, CEO of San Francisco-based Lenda.
In a quick call or online query, homeowners can find out how their mortgage servicer handles additional funds combined with a regular payment.
– via Mortgage Rates, Mortgage News and Strategy : The Mortgage Reports
Have you considered prepaying your mortgage?