Hi, Gary,
I got the gist of your mortgage article, but I do have I question. I can see the advantage to paying extra on the principal when you plan to keep your house until it's paid off, but what if you only expect to keep it 5 - 10 years? Is it still to your advantage? I can see that you'd have more equity in it, but will the interest savings be significant for that brief period?
--Carol
Carol asks a good question. Is it wise to prepay your mortgage when you expect to sell your home in just a few years? Since most of the savings from prepayment is in the form of interest in the last years, why bother if you're only going to have the mortgage for a few years.
Let's examine what happens under a couple of different scenerios. We'll assume that you have a $100,000 mortgage for 30 years at 9% fixed annual interest and could afford to add $100 each month to your payment. Of course each mortgage is different, but the principles will hold true for any size mortgage or rate of interest.
Suppose you move in two years. Maybe you're downsized or that baby arrives and you need a bigger house. Two years is a pretty short period. Have you done yourself any good by putting that extra $100 away each month?
If you had done nothing you would still owe $98,569.32 in principal after two years. You would have reduced the amount you owe by an average of $59.61 each month. (By the way, the payment for principal and interest is $804 without any prepayments.) Hard to believe that you could write checks to your mortgage company for $19,296 and only reduce the amount you owe by $1,430.
What would have happened if you prepaid that extra $100 each month? Simple math tells us that we would have sent in $2,400. But the principal due at the end of two years is now $95,950.48. That's $2,618 less than if we hadn't prepaid. For those of you who are wondering, the extra money earned 9% (the interest rate on the mortgage).
Let's try a different scenerio. Suppose you stay in your house for five more years and faithfully send in an extra $100 for principal reduction each month. You would have sent the mortgage company an extra $6,000 during that time. But the principal due on your mortgage has dropped to $88,337. If you had just made the regular payments you would still owe $95,879 in principal. Just like before your prepayment is earning the interest rate on your mortgage.
We could do this for any period, but you get the idea. Before we compare to other options, let's this about what we're trying to accomplish. First, we're saving money. We want the amount we saved to be safe and earn the greatest return possible without compromising the safety of the principal. Depending on our situation, we might want the savings to be available to us to be used for something else. Maybe to buy a car or pay for college education.
How does prepaying your mortgage rate against those criteria? Well, the amount we saved is safe. Barring some truly bizarre circumstances, any money you put into your home is yours when you sell your house. It's almost impossible to lose that money.
Your rate of return is very predictable if you have a fixed rate mortgage. You'll earn what the mortgage interest rate is. If you have a variable rate mortgage there is some room for change. But, you do know what the rules are for changes.
How available is your money? Not as liquid as you might want. To get at the money you'll either need to sell the house, refinance your mortgage, take a second mortgage or borrow on a home equity loan.
Now let's compare to some other choices you might have. You could put that money in a money market fund. Your principal is safe, but the return is typically less than half of what the mortgage interest rate is. If you were selling your house in two years and didn't expect to need the money before then it would earn a better return by prepaying the mortgage.
OK, how about another choice. You could invest it in stocks, bonds, mutual funds or some other investment that could return more than your mortgage rate. If the investment works out and does have a nice return in two years, that's great. But you might find that it's even lost money when you want to move and buy a new house. This option is fine if you understand the risks and are in a position to take those risks.
One general rule when you're considering investments is that you get a greater return if you either commit your money for a longer period of time or if you take more risks with your principal. So it's going to be harder to find an investment that will 'outperform' prepaying your mortgage for a few years than for a longer period of time.
Another option for the money would be to spend it. But unless your spending the money for some needed home fixing before selling it, consider yourself chastised if you just blow the money!
Ultimately, only you can decide what looks best for your situation. But unless you expect to need that money before you sell your house, it's going to be fairly hard to find an investment that will pay more than a prepayment without putting your hard earned money at risk. In any case, congratulations on putting yourself in a position to benefit from these positive choices.
All the Best!
|
Your ultimate resource for free shopping. Hundreds of exclusive offers, such as gardening, music, home office supplies, free samples, subscriptions, computers, self improvement, software and much more...Everything in the Free Forum is absolutely free .
|
Subscribe to "The Dollar Stretcher" free weekly email newsletter
visit the Problem Solving Center
look through the 'by subject' index
check out Past Issues of Newsletter
drop by 'Tips, Quips & Quotes'
send email to the Editor of "The Dollar Stretcher"
Copyright 1998 "The Dollar Stretcher, Inc.". All rights reserved unless specifically noted.
Write to the Dollar Stretcher at:
Dollar Stretcher
PO Box 23785
Ft. Lauderdale,
FL 33307
