How And Why To Prepay Your Mortgage

One of the best ways to have more cash, retire early, and enjoy debt-free living is to prepay your mortgage, an option which even lenders increasingly applaud.

We live in a society where home debt is generally mounting. The Consumer Federation of America reported this month that between 1989 and 1999 declined by $1,500, in part because of a greater willingness to increase mortgage debt.

But for financial reasons and as a matter of personal preference, many people favor a home with less debt. Why wait 30 years to be mortgage-free, they reason, when the same goal can be accomplished years earlier without refinancing or new closing costs.

If prepaying a loan seems attractive, the first question to ask is whether prepayments are permitted without penalty. Some loans punish borrowers for the crime of debt reduction by insisting on a penalty if some or all of the loan is paid in advance.

The good news regarding prepayment penalties is that they seem less frequent and less harsh than in the past. In some cases today, penalties expire after several years. With other loans, prepayment penalties only kick-in after a certain point, say when there has been an annual loan reduction of more than 20 percent.

In some cases there are loans which lack penalties but have specialized prepayment rules. For instance, under the FHA program if a prepayment is made after the monthly payment due date it will not be credited to the account until the next month. In essence, the borrower could lose the benefit of a prepayment for as much as several weeks.

In practice what you're likely to find now is that lenders want your money as soon as possible. Forget penalties, say lenders, write bigger checks.

The change of heart (yes, lenders have hearts) relates to a new view of risk. It's nice to get extra money from penalties, but lender portfolios are more secure when borrowers owe less.

You don't have to prepay much to significantly reduce loan payoff times. For example, suppose you have a $200,000 mortgage at 8 percent interest. Pay $1,467.53 for principal and interest and the loan will be repaid in 30 years. Pay an additional $100 a month and the debt will be retired six years early. Pay $200 a month extra and you can be out in a little more than 20 years.

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