A Structured Prepayment System that Works

Interested in paying off your mortgage early? Most homeowners are, and it's a wise move. You've probably heard of a dozen or more "plans" that you can enroll in for that purpose – for a fee. But you can do it on your own. The following program is a favorite of many savvy real estate purchasers because it's simple to calculate, methodical, and won't break you financially. Using this prepayment option can provide you with significant payment and financial flexibility, while not saddling you with the higher payments of shorter-term loans.

However, before you begin any prepayment program, structured or not, it's advisable to make sure that your loan has no prepayment penalties, even if it means contacting the lender or loan servicer to find out. If you receive prepayment information from your lender over the phone, ask the lender to put the information in writing and forward it to you. At the very least, you should document the date you called and the name of the person that provided the information. Putting the lender on notice of the intention to make loan prepayments also alerts them to make sure that your advance payments are posted correctly. (Nevertheless, always mark on both your check and your loan payment coupon to apply any and all prepayments to the loan's principal balance.)

Here's what to do:

First, obtain an amortization schedule of your loan, showing each payment's principal and interest distribution for the life of the loan. You should be able to get a computer printout from the lender, a real estate professional or financial adviser.

Once you have the printout, find your next payment due, say January. When the January payment is made, include an additional amount to cover February's principal reduction. When you do this, you are, in essence, eliminating one full payment from the 30-year loan schedule because the loan balance after that payment will correspond to the loan balance shown at the end of February.

When the February payment is due, send in March's principal reduction amount along with it, and so on, every month thereafter. If you follow this procedure regularly every month, your 30-year loan will be paid off in just over 17 years. (Remember, however, that just because a principal prepayment has been made, it doesn't allow you to skip a payment! And, of course, missing payments would put the loan in default because prepayments have no bearing on scheduled payments.)

When implementing this (or any) prepayment strategy, be sure that you also take the following precautions:

• If using payment coupons, be sure to annotate the words "principal prepayment" and the amount on the face of the coupon.
• Make the prepayment on a separate check (or electronic payment) so that it can be tracked and shown as evidence if prepayments are later disputed by the lender. Also, when making prepayments separately, be sure to annotate the loan number and the words "principal prepayment" on the document.
• Request an annual accounting of your payments. Compare the lender's balance with your records to ensure that the prepayments were applied correctly.