There are several advantages for prepaying a mortgage. On a $200,000 mortgage for 30 years at 6%, the interest alone will come to $231676.00. When a borrower makes an additional principal payment every month, he can save a lot of interest on the mortgage. A mortgage amortization calculator can be found online.
There are some people who feel that prepaying the mortgage early is not beneficial since the borrower will lose on tax deductions on the interest paid on mortgage. This is like buying an extra pair of shoes on sale simply because the item was on sale. The 'savings' is not real. Generally a person can deduct 1/3rd of the interest from his taxes, so he can save 2/3rd of the interest by prepaying the mortgage.
A good investor is someone who allocate his assets wisely and prioritise on his investments. Although prepaying a mortgage is a good thing, there are some investments which should take precedence over mortgage prepayment. Also as discussed in the article 'What is mortgage prepayment?', a borrower should always consider the prepayment penalty before making mortgage prepayments. It doesn't make sense to pay the lender to prepay the mortgage.
To know more about the strategies for mortgage prepayment, read How to Prepay Mortgages Early?
Considering Mortgage Prepayment? Do these First
- Build an Emergency Fund- People who buy a home often consider the many advantages of owning one's own home, including the pride of ownership and building equity in the home. Buying a home brings a lot of responsibilities as well. While a renter can simply call his landlord if something is broke, a home owner needs to fix it with his own resources. So having an emergency fund is more important in the case of a home owner. Most financial advisers are of the opinion that three to six month's expenses should be kept in an emergency fund.
- Pay off Credit Card debt and other high interest debt- The return on a mortgage prepayment is the interest rate of the mortgage. The interest on a home mortgage is comparatively lower than credit card debt and car loans. It is advisable to pay off these debts before contributing extra principal to a home loan.
- Contribute to Roth IRA, 401K- Contributions to a Roth IRA account grow tax-free while in a Traditional IRA account and in a 401K, they grow tax-deferred. It is better to invest in these accounts first and enjoy the benefits of tax-deferred/tax-free accounts before prepaying the mortgage. Once a borrower has maxed out his contributions to his 401k, Roth and a college fund for his children, he can contribute his extra savings to his mortgage. IRAs and Coverdell accounts have a lost opportunity cost as well. Once an investor decides not to contribute to IRA or Coverdell accounts for a year, his opportunity to invest is lost forever. Since there is a yearly contribution limit, he cannot contribute that extra amount in the subsequent years. So he practically loses all the benefits of investing in a retirement account for that year. Read the article 'Traditional or Roth IRA?' to know more about Roth and Traditional IRA accounts.
After a borrower builds an emergency fund, pays off his high interest debt and maxes out his contributions to his retirement accounts, he can start prepaying his home mortgage. However mortgage prepayment may not be as advantageous for an investor in his thirties as it is for a senior. With 30 more productive years ahead of him, he can chose to invest in a diversified portfolio of common stock that would yield him 12-15% returns. Home loan prepayment has only a 6-8% return, so for an investor who is prepared to take reasonable risk, investments in stock may be a better option.
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