When and Why to Prepay Your Mortgage
Those considering a new house have numouers options in front of them. One of them? Prepaying a mortgage. Let’s talk about when cashing out in this manner is the proper move - and when it’s just plain dopey…
Prepaying a home loan potentially could save you tens of thousands of dollars in interest and years of monthly payments.
Here’s when the move can be smart:
If you’re taking care of your major financial responsibilities, you’re a good candidate for pre-paying your mortgage, according to Keith Gumbinger, vice president of mortgage information publisher HSH.
Especially if you think the extra money you put toward your mortgage will give you a better after-tax “return” than if you invested it in the stock and bond markets.
Here’s how Gumbinger recommends figuring out that after-tax return: Multiply your home loan rate (say it’s 8 percent) by the inverse of your tax bracket (if you’re in the 28 percent bracket, the inverse is 72 (100-28)).
In this case, therefore, prepaying your mortgage is like getting a guaranteed after-tax return of 5.76 percent (0.72 x 8).Here’s when the move can be less than ideal:
Neglecting important areas of your financial life just so you can have a mortgage-burning party sooner rather than later can erase the benefits of prepaying your mortgage, according to Gumbinger. So don’t do it if:
- You don’t have adequate emergency savings.
- You’re not saving enough for retirement. One study found that given the tax treatment of home mortgage interest and retirement contributions, 38 percent of households that prepay their mortgage would do better using the extra money toward maximizing their retirement savings.
- You don’t have disability or life insurance and you’re the main breadwinner in your family.
- You have high-rate credit card debt.
- By prepaying, you’re not able to take advantage of short-lived but important opportunities, such as traveling to see your aging parents.
“Your mortgage will persist for years regardless of how much additional principal you send,” Gumbinger notes in HSH’s A Homeowner’s Guide to Prepaying Your Mortgage.SOURCE: CNN Money