Mortgage Prepayment Can Save You a Bundle

Mortgage Prepayments Save You Money

Mortgage prepayments can shave years and thousands of dollars from the life of your home loan.

There’s no doubt that we live in rough economic times. It’s enough to make you want to stick money in a mattress — indeed, according to one survey that’s what 27 percent of us want to do.

The catch is that mattresses are a woeful investment option. Putting cash in a mattress earns no interest and if lost, stolen or destroyed is entirely uninsured.

But mattresses are in some ways attractive when you look at the alternatives: Saving accounts now pay close to zero interest, and a five-year CD at this writing will get you about 1.75 percent. If the rate of inflation is higher than the return on your investment it means your buying power is getting smaller. In real terms you’re losing money.

You could try the stock market but consider that the shares of many well-established companies have fallen.

The good news is that there is something you can do with your money which can make sense in tough times: Pay down debt.

Dealing With Debt

The beauty of debt reduction is that paying off bills is considered a savings — and while we tax income we do not tax people for quickly paying off their bills.

Credit cards are the No. 1 item to pay off. The reason is stiff interest rates, often above 20 percent. Figures from the Federal Reserve show that in 2006 American consumers had $871 billion in revolving credit card accounts, an amount that has since been reduced to $790 billion. That’s a huge drop, meaning lower interest costs and smaller monthly payments.

The situation with cars can be different. Auto loans can be based on simple interest where you pay interest on the debt outstanding. Some vehicle loans are different because the interest is charged up front and this reduces the benefit of prepaying the loan. The solution is to only buy a car or truck if it comes with simple-interest financing. If such financing is unavailable from a dealer, have an approved auto loan in place from a credit union or community bank before shopping.

Lastly, VA loans — unlike some mortgages — allow prepayments in whole or in part without penalty. Mortgage prepayment can be a very important financial tool, one that produces attractive financial results.

Paying Down Principal

Imagine that you borrow $150,000 with a fixed-rate, 4 percent mortgage over 30 years. The monthly cost for principal and interest is $716. Over 30 years interest for the loan will total $107,803.

Now look at what happens if you add $50 to your monthly check. You’ll pay $766 per month but instead of 360 payments you’ll only make 318 — the loan will end 42 months early and the total interest cost will be reduced by $14,285, a “savings” which is not taxable.

Mortgage prepayment on a fixed-rate loan is easy to chart, but this may not be the case with adjustable-rate mortgages (ARMs). ARM interest rates can rise or fall over the loan term meaning that payments are not always reduced even with prepayments. That said, the less you owe the smaller the debt on which interest is based, so prepayments can still have value.

Of course, if you sell or refinance before 30 years you’ll simply owe the lender less debt at closing. It’s not a big deal to prepay a VA mortgage. The monthly payment stub typically has a space for additional principal. Just add whatever number is comfortable.

Where to get $50 a month? Collect loose change at the end of the day, bring lunch to work once a week and pay bills early to avoid late fees. You’ll be surprised how it adds up.

Photo courtesy of Images_of_Money