|The ins and outs of paying down a
Julie Garton-Good, GRI, DREI
have a new $100,000 (8 percent) mortgage and made a New Year's resolution to
pre-pay a certain principal amount every month. Is there a system that can help
us do this?
applying a mere $25 a week extra to your mortgage, you can pay it off a decade
early and save more than $62,000 in interest. Now that's frugal!
You are correct about finding a system and sticking to it.
People who do this religiously (not just when they have the extra funds) are
much more likely to reap the benefits, and be glad they did.
One system I find effective is to obtain a printout of your
mortgage payments (1-360), broken down into principal and interest amounts.
(Your lender, real estate professional or local bank can do one for you.)
Let's use your $100,000 loan with monthly payments of
$733.77 as an example. The first number on the amortization printout is the
payment number (#1), followed by the interest due for that month ($666.67), the
amount applied to principal ($67.10) , then the loan balance ($99,932.90). To
prepay, merely add the next month's principal payment ($67.55) to your regular
payment of $733.77 so that your loan balance is actually $99,865.35!
Not only will this system keep you committed to prepaying,
but you will have a running total of where your loan balance is at all times. In
addition, request an annual printout of your mortgage payments from the lender,
and compare your records to those of the lender.
can I alert the loan servicer to the fact that I'm making a prepayment on my
loan? There's no box to check on my payment coupon and they keep missing them.
"inventing" a prepayment box on your payment coupon, make the
prepayment in a separate check. Not only will that be tougher to miss, it will
give you a running record of your payments if the lenders does miss it. Be sure
to write on both the coupon and your separate check the words "principal
decided a year ago to make prepayments to our mortgage. When we tallied up the
checks at the end of the year, they had waited two months to credit the first
two. We want to sue!
unfortunate that you didn't get immediate credit for prepaying your mortgage.
But I doubt it's financially worth suing the lender over the added interest.
However, they should be willing to credit the mistake.
Your loan could specify a minimum prepayment amount, so they
were holding the first checks until they reached that minimum.
To insure that future prepayments will be properly applied
to your loan, here are some steps to take.
First, contact the lender via certified mail. Inform them of
the incident and ask the following questions: 1. When can prepayments be made
and what is the suggested way to do this? (e.g. separate check or itemization on
regular payment coupon); and 2. Is there a minimum prepayment amount? Also
request that you receive both a receipt back for the prepayment and an annual
printout showing the principal reduction on your loan. You may have to make
multiple requests and/or pay a small fee for this service, but it would be worth
just received some inheritance that would pay off my 7 percent mortgage. How can
I evaluate if this is a good financial move?
the surface, paying off a mortgage sounds like the answer to anyone's prayers.
But like any other business decision, it should be done only after careful
consideration of the following:
- Is the payment a financial burden? Have you ever missed a
payment or made several payments after the due date? It's wise to eliminate the
debt if it's a struggle to pay, could hurt your credit or risk you losing the
- Do you have substantial financial reserves that could carry
you through a financial downturn? Most financial advisors suggest you have
enough money to cover six months of living expenses;
- Do you have other high-interest rate loans or credit
accounts that should be paid off first? It makes little sense to pay off an
interest-deductible mortgage when you're paying interest on other
loans--probably higher--that's not deductible.
But you may decide not to pay off the loan based on answers
to these questions:
- Where could I invest the money that might give me a better
return? Would an investment generate enough return to help off-set the current
- What are the long-term cash needs for my family's future,
including college tuition and retirement?
- How long do I plan on keeping the property? Retiring a
mortgage at 7 percent may not make financial sense if you're going to buy
another house and replace the loan with a higher-rate one.
Lastly, don't forget the peace of mind afforded when a home
is free and clear. That may be tough to factor in, but shouldn't be discounted.
recently refinanced my 9 percent, $85,000 loan into one at 7 percent. Now that
my interest rate is lower, will it make sense to prepay the loan like I did
question brings up the point that there's less savings in prepaying a lower
interest rate loan; but even though you'll save less, you'll still save.
Here's an example. Prepayments of $75 per month on your old
9 percent loan would save you more than $60,000 in interest over the life of the
loan. But the same monthly prepayment on a 7 percent loan would reduce that
savings to less than $40,000.
Does this mean that prepaying is less valuable? Not really,
since what we're saving is not taxable, so our yield is actually greater than 7
percent, somewhere closer to 9 percent. Not a bad yield for such a low risk.
Don't forget that the extra equity you're building by
prepaying can provide added leverage in the future. It can mean a larger down
payment when you purchase again, the ability to qualify for a larger home -- all
silently compounding right now in your equity nest egg.