11 must-knows about early mortgage payoff
Seniors close to retirement can boost return on investment
By Jack Guttentag
Q: Will I save money if I make my regular monthly payment early?
A: No, paying early merely allows the firm servicing your loan to earn interest on your money until the payment due date. This is not the case, however, if you have a simple interest mortgage (SIM). Because it accrues interest daily, the earlier you pay a SIM, the more interest you save.
Q: How do I know if my mortgage is "simple interest"?
A: Your note will say that interest accrues daily. Also, the monthly payment on a SIM varies month to month, so if your payment is always the same, you do not have a SIM.
Q: What is the best time of the month to make an extra payment?
A: If you include it with your regular payment and pay before the grace period, the extra payment will be applied to the current balance. If you make the extra payment after the grace period, it might be applied to the current balance, or it might not be credited until the following month, depending on the systems/policies of the servicer. You should find out where the servicer's cutoff is for receiving credit in the current month.
Q: If I make a large extra payment, will my future scheduled payments be lower?
A: On a fixed-rate mortgage, the scheduled payment is not affected by the extra payment. You just pay down the balance faster. On an adjustable-rate mortgage, the scheduled payment remains the same until the next rate adjustment. At that point, the payment is recalculated based on the reduced balance, the new rate and the original term. So unless it is offset by a rate increase, the payment will drop.
Q: Would I be better off investing excess funds rather than paying down the loan balance?
A: Not very likely. Paying down the loan balance is an investment carrying a yield equal to the mortgage rate, with no default risk. There are no riskless investments today that pay a yield that even comes close.
Q: Would this apply to a high-tax-bracket borrower who deducts mortgage interest payments?
A: Yes, what matters is the after-tax yield on the mortgage repayment relative to other investments, and the tax-rate adjustment affects them equally.
Q: Isn't it better to make extra payments in the early years of a mortgage when the regular payment goes largely to interest than in later years when most of it goes to principal?
A: No, the return on investment is not affected by where the mortgage is in its life cycle. While the allocation of scheduled payments between principal and interest changes over the life of the mortgage, extra payments go entirely to principal, no matter what stage of its life cycle the mortgage is in.
Q: Is there a way to escape a prepayment penalty clause?
A: No, the clause is there to protect the lender, or the ultimate investor if the loan was sold, which it probably was. Investors pay extra for the protection. I have never heard of a case where a prepayment penalty clause was voluntarily waived.
Q: Should seniors close to retirement pay off their mortgage?
A: It is a prudent move if they have the assets to do it, because the rate they are paying on their mortgage is higher than the return they can earn on assets having a high degree of safety. Paying off their mortgage also clears the way for a reverse mortgage in the future, should the need for additional income arise.
Q: If I have two mortgages, which do I pay down first?
A: In general, pay down the mortgage carrying the higher rate. However, if that mortgage is fixed-rate while the lower-rate mortgage is adjustable-rate, the decision must consider the possibility that the rate on the adjustable will increase in the future.
Q: Is a biweekly payment mortgage a painless way to pay it off sooner?
A: Making half the monthly payment every two weeks is not painless, because it requires an extra monthly payment every year, and the lender will charge you for the privilege. An alternative approach that is equally effective, and which is entirely within your control, is to increase your scheduled monthly payment by 1/12 of the payment.
If you would like expert advise and representation in your next move, please contact me.
Thursday, December 22, 2011
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