Resources: Newsletter Articles: Just A Few Extra Dollars A Month Can Save Thousands In Mortgage Interest

Thinking about paying off your mortgage and saving thousands of dollars? Experts say most people can accomplish this by sending their mortgage lenders a few extra dollars each month. There are some things to consider before taking that step but, once the decision is made, just forty dollars a month can knock five years off the life of a loan.

Mortgage prepayment, or "accelerated payment" as it is sometimes called, may be executed in any number of ways but has one basic rule of thumb: a borrower pays money sooner than required.

With a 30-year, fixed $100,000 mortgage at an interest rate of 7%, for example, a borrower would have monthly principal and interest payments of about $665 and accrue $139,502 in interest over the life of the loan. By adding $25 a month, the same borrower would shorten the term by just over three years, and save $18,212 in interest. With an extra $200 every 30 days, interest savings would total $72,690, and the loan would be paid off in about 16 years.

Borrowers wanting to take advantage of prepayments should watch out for costly plans touted as alternatives to doing it on their own, consumer advocates say.

These unnecessary formal plans typically charge a one-time membership fee of around $400, plus $3 in service costs every two weeks. Once enrolled, a person either mails biweekly payments to the company, or has them automatically deducted from an account. In return, the plan ends up sending the customer's lender one extra monthly payment a year - something a borrower could easily do by dividing the monthly payment by 12 and sending in that amount without help.

So how does a borrower accomplish this on their own? First, contact the lender to find out how to ensure the money ends up in the right place. Some customers may need to write "Principal Only" on their checks. Others may have to send separate checks each month, or mark off special boxes on their statements.

Also, be aware of "prepayment penalties". They typically come into effect only when a borrower refinances, but some are activated if a person pays more than 20% of the loan's principal during any one year in the loan. The penalty can be as much as six month's interest on the amount paid that exceeds the lender's allowed prepayment.

For all of its ease, however, prepaying isn't always a consumer's best bet. Consider a few simple points: When borrowers prepay, they save interest, which is like earning money at a certain rate of return. That return equals their mortgage interest rate, minus any benefit from the tax deduction they would have been entitled to because they paid that interest.

For example, a person with a 7% interest rate and 28% federal tax rate earns about 5% after factoring in the tax deduction. That's less than the stock market's historical average return of 8 -10%, and far below the numbers seen of late.

In this case, there's a good argument for not paying off your principal because every dollar you prepay on a mortgage is earning only the face interest rate on that mortgage. You'd be better off taking the money and opening a mutual fund. At the end of 10 or 15 years, you would have more than enough to pay off your mortgage.

However, prepaying remains a great way to retire debt and build home equity quickly, all the while earning a reasonable rate of return, experts say. And that doesn't take into account rewards which can't be measured in dollars and cents - owning your own home.

sherrybenninger@grubbco.com

The GRUBB Co., 1960 Mountain Blvd., Oakland, CA 94611

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