Pros and Cons of Prepaying

Of course, owning your home free and clear is doubtless the goal of every homeowner (and would-be homeowner). But is it always a good idea to accelerate the process? If you're considering implementing a prepayment plan to pay off your mortgage, there are a number of points you'll want to ponder, and some questions that you'll need to answer in order to make the most financially advantageous decision for yourself and your family. For example:

• Is your current mortgage payment burdensome? Have you been late with or even missed some payments? If you receive a windfall of cash, paying off the mortgage may make sense, because erratic payments could damage your credit and put the loan (and your home) in jeopardy.
• What impact will the lack of interest deductions have on your overall tax picture? (Be mindful, though, that paying interest is not a valid reason for carrying a mortgage.) Consult a tax adviser to take advantage of the most prudent financial strategies.
• What are your long-term cash needs? Are your current savings sufficient to meet them? If your savings are minimal or nonexistent, it may be financially rash to use extra funds to prepay your mortgage.
• Is a major change looming in your financial future that would make it prudent to save more money instead of using your extra cash to pay off the loan? For instance, paying cash to put a child through college or aid an elderly parent might be better than borrowing through a nondeductible-interest consumer loan.
• How long do you plan to keep the property and the mortgage? Retiring the loan early may not be a wise financial move if you're going to sell the home or refinance soon.

Furthermore, here are a few more things to think about:

• You'll be giving away cash that could deplete your financial liquidity.
• You'll be using funds that could otherwise be used to make other financial investments, perhaps with higher yields.
• It doesn't make financial sense to prepay a mortgage before you retire nondeductible high-interest consumer debts.
• The lower the interest rate, the less you'll save when prepaying. Prepayments you made when your loan was at 8 percent won't have the same impact if you've refinanced into a 5 percent loan.
• Make sure you monitor your mortgage to guarantee that prepayments are being properly applied to reduce the principal balance (this has been a major problem with loan servicers over the years).

But, needless to say, there are definite advantages in prepaying:

• You can save tens of thousands of dollars in interest payments. For example, a 30-year, $100,000 loan at 8 percent interest would cost you over $264,000 just in interest if you kept the loan to maturity. But that same loan amount paid off in 15 years would cost only $172,000 in interest, or $92,000 less.
• Owning a home free and clear can be a very liberating feeling. If monthly cash flow lessened, you wouldn't need to be concerned over making the monthly mortgage payments and potentially losing your home. And their equity could always be a potential source of cash through refinancing or an equity line of credit.