Your Money_ The Missing Manual - J. D. Roth [109]
Should you prepay your mortgage?
You can save tens of thousands of dollars by paying your mortgage off early. But is it a smart move? You won't find a definitive answer in this book or anywhere else. Ask a dozen different financial experts and you'll get a dozen different answers—literally: http://tinyurl.com/invest-prepay.
Why wouldn't you pay off your mortgage early? There are actually several sensible reasons you might choose to hang onto that debt:
If you prepay in good times, there's no easy way to get that money back during bad times. The only way to "undo" prepayments is to take out a second mortgage.
When you have a mortgage, inflation is your friend: In 30 years, your $2,000 monthly payment will seem like a $500 payment.
No matter how much you prepay, the bank doesn't give you a break—you still have to make payments each month until the mortgage is completely paid off, even if you get sick or lose your job.
There's an opportunity cost to prepaying your mortgage: When you send in an extra payment, you can't use that money elsewhere—such as investing in the stock market, which might give you a better return.
Despite these compelling arguments, millions of Americans prepay their mortgages. Their reasons make sense, too:
Prepaying gives you a guaranteed return on your investment equal to whatever your mortgage rate is. That's because any time you pay down debt, you earn a return equal to the interest rate you're being charged. So if your home loan has a 6% interest rate, then paying extra on that debt is like earning 6% in a savings account. You'd be hard-pressed to find other places to earn a guaranteed 6% return!
Prepaying gives you a safety net. While you'll still have a mortgage payment until you've paid off the loan, when you do pay it off, you'll have a huge cushion because your monthly expenses will drop by $1,000, $2,000, or even $3,000. Just think of what you could do with that cash flow!
People who've paid off their homes feel a huge sense of relief (see http://tinyurl.com/GRS-nomortgage). It's freeing to not have a mortgage holding you down.
Few people would argue that prepaying your mortgage is a bad move, but there are some who don't think it's the best move. Is prepayment right for you? If you plan to stay in your home for a long time, it may be. The choice depends on your financial goals and what will make you happy.
Note
When should you refinance your mortgage? When you can recover the costs in a reasonable amount of time, typically just a few years. The standard advice used to be to consider refinancing if interest rates dropped by 2%. But closing costs are lower now, and it often makes sense to refinance sooner. You'll need to run the numbers based on your own situation using a refinance calculator like the one here: http://tinyurl.com/refi-calc.
Strategies for prepaying your mortgage
If you've weighted the pros and cons of prepaying your mortgage and decide to go for it, there are several ways to approach it. You could:
Make extra payments to your mortgage each month. This will give you a guaranteed rate of return equal to your mortgage interest rate, and will reduce the amount of interest you pay over the life of the loan. But doing this makes it difficult to get at your money if you need it for something else.
Make lump-sum payments to your mortgage every year. Instead of paying a little bit every month, you could put the money in a savings account during the year and make a single, large payment every 12 months.
Note
Whenever you pay extra money toward your mortgage—or any other loan, for that matter—always note that you want the extra applied to principal only, not interest. (Check with your mortgage company to find out exactly how they'd like you to indicate this.) If you don't, some lenders will apply your extra payment to interest, which is lame but legal.
Send half the monthly amount every 2 weeks. This is perhaps the most common way to accelerate mortgage payments. If your monthly minimum payment is $2,000, for example,