9 Questions To Answer Before You Prepay Your Home Mortgage
By Frank Oakerson
We are all different. At different times in our lives we have different goals and needs. You can ask different experts in financial planning, Texas mortgage brokers, and your banker "should I prepay on my home mortgage?" and you will get answers from "that is the greatest idea" to "that will be the worst financial mistake you will ever make". So what is a person to do? Let us look at 9 things you need to consider and have answered before you "prepay your home mortgage".
1. Do you have enough cash liquidity?
Never leave yourself cash poor. To pay down your mortgage early is very noble, but not currently beneficial if you have not prepared yourself first. The consensus among financial planners is one needs 3 preferably 6 + months of cash liquidity (funds one can turn to cash within approximately 48 hours). This is availability of cash in the event of unknown events occurring.
The roof needs repairing and insurance will not cover it (not storm damage). One loses their job and it takes 6 months to a year to find comparable employment again. A major medical emergency occurs and your medical policy does not cover all the expenses - this is becoming much more widespread than it used to be. These are just examples of life and there are many more to list. The point is you need the cash to carry you through. I want you to avoid the other side of adequate cash liquidity and that is using your high interest credit cards to bail you out of an emergency.
2. Have you seriously thought about the emotional and other non - financial benefits?
I realize that you thought that paying off your Texas mortgage early was just a financial decision, but it can have non - financial benefits. Will you receive any emotional relief from having "less debt" or "paying off your debt sooner"?
Will this provide more time and money with loved ones because your house is paid for? Where would you prefer that money to go?
3. Does your home mortgage have a prepayment penalty?
If you have been following my advice you would not have taken a Texas mortgage with a prepayment penalty. However, if your mortgage loan has prepayment penalties it could erase most or all of your anticipated interest savings from paying off your mortgage early. Now some ARM's have prepayment penalties for the first couple of years. Are you past that time frame with your mortgage? When in doubt contact your lender for the facts on your loan.
4. Have you adequately funded your retirement programs?
Before you take your extra cash each month and begin paying down your Texas mortgage have you maxed out your contributions to your retirement accounts? If you are employed you have access to your 401(k) and 403(b) accounts. If you are self employed you have access to your Keogh or similar plans. Either way (employed or self employed) your contributions are tax deductible, usually at both the state and federal level.
If you make additional payments on your mortgage these are not tax deductible - because you are prepaying principle not interest. So an extra $100 - 500 per month to your retirement accounts will do you much more benefit until the accounts are maxed out in your contribution than one could ever gain in prepaying their mortgage. The presupposition here is that you do not have your retirement accounts invested in CD's or money market funds whose rate of returns is less than the interest rate of your Texas mortgage you are seeking to pay off.
5. Are you an aggressive or a conservative investor today?
A conservative investor is comfortable with returns of less than 8% because stability and safety are of utmost importance. So to pay off a Texas mortgage with 8% interest would be a very safe use of extra funds.
An aggressive investor is seeking a return above 10% or often above 15% who is willing to take a few risks to achieve a higher rate of return on their investments. Now to pay off a mortgage of 8% interest may not be a wise use of funds. Read the next two sections to get a better answer.
6. Yes you can save a lot of money by prepaying on your home mortgage.
Let me illustrate with some numbers, yes I have done the math for you. First I will have a $250,000 loan at 8% interest. In 30 years I will pay the lender $660,388 total for the $250,000 loan or an additional $410,388 in interest. Ouch!
Now I will make an additional payment each month of $300 to be applied to the principle of the loan. I will make a total payment $487,626 for the $250,000 loan and have paid the lender $237,633 in interest. This will pay off my home in 19 years instead of 30 and will save me $172,755 in interest. (It would take 48 years at $300 a month for me to accumulate the same $172,755.)
What if I did a little better, say $500 a month to be applied to the principle of the loan? I would make a total payment of $439,720 for the $250,000 loan and have paid the lender $189,726 in interest. This will pay off my home in 16 years instead of 30 and will save me $220,662 in interest. (It would take almost 37 years at $500 a month for me to accumulate the same $220,662.)
7. What would you be able to make if you invested those same dollars?
Over the past 200 years the stock market has produced an annual rate of return of close to 10%. So for an apple-to-apple comparison with compound interest applied once per year and starting with a zero balance let us look at what we could do.
Let us take the same $300/month invested at 10% compounded annually for 19 years that would generate a sum of $202,590.
Now let us take the same $500/month invested at 10% compounded annually for 16 years would generate a sum of $237,268.
The decision is your. Please contact your Certified Financial Planner for their professional input.
8. What is the tax impact of my home mortgage interest (the law has changed)?
If you have been following me someone is going to say "but Frank you have not presented all the facts!" Correct. We get to deduct the interest we pay on our mortgage loans. For many taxpayers approximately 1/3 of the total interest cost of a mortgage loan is erased by the tax reduction in writing off the mortgage loan interest on their federal and state income tax returns.
For 2005 returns the standard deductions are:
$5,000 for single filers or married couples filing separately (up from $4,850 in 2004);
$7,300 for head of household filers (up from $7,150 in 2004); and
$10,000 for married couples filing jointly (up from $9,700 in 2004).
If your mortgage interest does not exceed these amounts you will receive no benefit in claiming your mortgage interest paid for that year. Please see your CPA for professional advice.
9. Should I refinance instead of prepaying on my home mortgage?
Contact your Texas mortgage broker to see if refinancing at today's rates with your current credit rating might give you a better mortgage at lower payments. This would save you money monthly giving you more to invest in your future.
You can find the articles I write on http://groups.yahoo.com/group/Free-Reprint-Articles as they become available.
Frank Oakerson is a licensed loan officer #56753 in the state of Texas. I am available to assist you in purchasing your first home, bad credit mortgage, FHA Loan, VA Loan, you name it. At YourMortgage123.com you will find a number of informative articles, mortgage calculators, info on VA loans, mortgage refinancing, stop my foreclosure, and getting pre-approved. Stop by and let me get started on a Texas mortgage for your property today. I have all of the information and tools you need to make your home buying dreams a reality. http://www.yourmortgage123.com