by Nancy Osborne, COO of ERATE®
Many financial experts will tell you that if you were to pre-pay your mortgage it would be the equivalent of investing your money at the same rate of interest you are currently paying out on the loan. However whether or not this makes sense for you requires close examination of your personal finances as well as how you manage debt. If you are considering using extra cash on hand for this purpose you might want to ask yourself the following questions first:
First ask yourself what you would do if your household experienced an unexpected job loss? Do you have enough cash set aside in a reserve or emergency fund? It is estimated that less than 30% of households have sufficient reserves set aside to cover monthly living expenses if they were to experience more than 2-3 months without a paycheck. Everyone should ideally have a 6 month reserve/emergency fund to cover all their monthly expenses if an unexpected crisis were to hit. However if you do have a reasonable cash reserve set aside for emergencies and you still find yourself in the comfortable position of having extra disposable income every month, then by all means use these funds to pay down your mortgage. Do not have a third party intermediary facilitate this for you, do it on your own. Simply write an additional check on a monthly basis to your lender and indicate that the funds are to be applied directly to principal. Do not commingle these funds with your normal monthly mortgage payment, it is best for tracking and mortgage accounting purposes to keep them separate so there is no questions as to the exact amount of annual principal pre-payments that were made.
Mortgage debt is perhaps the cheapest money available to consumers. This secured, low rate, tax deductible debt should be the last of your debts to be retired or paid off. Certainly paying down a high interest rate credit card, and the average credit card rate is 13%+ and is not deductible on your tax return, would be preferable to paying down a mortgage with a far lower interest rate. If you could find other investment vehicles such as stocks and mutual funds which offer a better rate of return than what you are paying in mortgage interest you might want to consider skipping the pre-payment and investing these funds instead. You also want to be certain that you are fully funding all of your retirement accounts and taking advantage of every retirement funding option available to you. Funding your retirement should almost always supercede pre-paying a mortgage on your list of financial priorities.
If you will earn more by pre-paying the mortgage and realizing the savings on the interest expense associated with the loan, then the loss of the tax deduction is a non-issue.
If you anticipate moving soon then pre-paying your mortgage now would only serve to forward funds to your lender which you would only receive back at the time of sale. Essentially advancing funds to your lender and forfeiting your cash flow for no real purpose or advantage to you.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.