| The motivation for prepaying
a mortgage is simple -- you save money on interest.
And, it can add up to a lot of money.
If you want an example, visit our mortgage prepayment
calculator.
There are two basic ways of prepaying a mortgage:
• You can create a prepayment schedule
yourself. Each month send a separate, second check
to your lender, indicating that the money is for
prepaying the principal. Watch out for, and inquire
about, prepayment penalties for paying down principal
in the early years of the loan. Don’t start
prepaying without contacting your mortgage servicer
first to find out exactly how the payment should
be handled.
Example: Let's say you have a 30-year fixed mortgage
of $100,000. The interest rate is 7 percent. The
monthly principal and interest payments would
be about $665, and you would pay $139,508 in interest
over the life of the loan. By adding $25 a month,
you could shorten the term by more than three
years and save $18,214 in interest. For an extra
$100 a month, you would save $50,506 in interest
and shorten the term by nearly 10 years.
• The mortgage servicer can set up a formal
biweekly prepayment plan, but there will be an
initial fee, usually a few hundred dollars, plus
a processing fee for each payment. You pay half
the monthly mortgage amount every two weeks. At
the end of the year, the extra money is sent to
the lender to pay down the principal.
Example: On a 30-year fixed mortgage of $100,000,
instead of 12 monthly payments of $665, or $7,980
a year, you would make 26 biweekly payments of
$332.50, or $8,654 annually. The total interest
would be reduced $34,130 and the loan term would
be shortened to about 24 years.
Be sure to consider the tax implications of prepayment.
Prepaying reduces mortgage interest, which is
tax deductible. That may not be beneficial in
your tax bracket. It also might be more profitable
to put that extra cash in an investment account.
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