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Prepay Mortgage

July 29, 2011

Prepay Mortgage

 

Definition

Prepaying your mortgage loan involves applying additional funds to your outstanding mortgage balance over and above your required monthly payment. You can prepay in a lump sum, double up on your payments, or pay a bit more than the required amount each month. The result is that you reduce the amount of interest you pay over the life of the loan and ultimately own your home outright sooner than if you had not prepaid.

Prerequisites 

  • You own a home and have extra savings with which to prepay your mortgage

Key Strengths

  • The federal formula for financial aid does not consider equity in a family’s primary residence in determining a family’s total assets
  • Unique Strategy: You will own your home outright in less time and with a lower total interest cost

Key Tradeoffs 

  • The extra money used to prepay your mortgage is money that could possibly have been invested elsewhere at higher rate of return
  • You reduce or eliminate your income tax deduction for mortgage interest
  • Most private colleges consider home equity as an asset in deciding which of their students are most deserving of campus-based aid
  • Some lenders may charge a penalty for prepayment

Variations from State to State 

  • Lending institutions may vary on whether they charge a prepayment penalty

How Difficult Is It to Implement? 

  • Prepaying your mortgage is very easy to implement. Simply send in additional funds with your required monthly payment and instruct your lending institution to apply the additional funds to your outstanding principal.
  • Alternatively, you can prepay your mortgage in one lump sum.

What is it?

  • Prepaying your mortgage loan involves applying additional funds to your outstanding mortgage balance over and above your required monthly payment. You can prepay in a lump sum, double up on your payments, or pay a bit more than the required amount each month. The result is that you reduce the amount of interest you pay over the life of the loan and ultimately own your home outright sooner than if you had not prepaid.
  • In order to prepay your mortgage, you need extra money to apply to your outstanding balance. You can use cash on hand, or you can liquidate assets to obtain cash. A word of caution, though: Prepaying your mortgage does not change your monthly obligation to your lender (unless you pay off the entire mortgage balance). If you fail to make your normal monthly payments, the bank will consider your loan in default.
  • Under the federal aid formula, some assets are not included in the determination of your family’s ability to contribute to college costs. One of these assets is home equity in a family’s primary residence. Thus, if you take that spare $50,000 in your savings account and use it to prepay your mortgage, you will have reduced your counted assets by $50,000.
  • Of course, the main benefit of prepaying your mortgage is that you will own your home outright more quickly than if you had continued making only the required payments. Moreover, depending on the amount you prepay, your total interest costs will decrease.
  • Every dollar you spend to pay down your mortgage is a dollar you could invest elsewhere. If your mortgage rate is 6.5 percent and your expected after-tax rate of return in a different investment is 7 percent, you come out ahead, dollar for dollar, with the investment.
  • Mortgage interest is generally a deductible expense for federal income tax purposes (assuming you itemize deductions). When you prepay your mortgage, you reduce (or eliminate) your mortgage interest. Thus, your total deductions will decrease.
  • Private colleges often delve deeper into a family’s finances than the federal government, looking at things like home equity and retirement plans to determine which students are truly deserving of need. So, if you pay off your mortgage and your home is worth $300,000, the college might expect you to borrow against it.
  • Although federal credit unions are prohibited from charging prepayment penalties, other lending institutions may penalize you if your prepayment exceeds a certain amount (e.g., 20 percent per year), or if it occurs within a certain time period (e.g., in the first five years of the loan). Make sure to check your mortgage document.
  • Prepaying your mortgage doesn’t necessarily mean you have to pay off the entire remaining balance with one lump sum. Instead, you can double up your payments, or you can contribute a fixed additional sum each month and send it along to your mortgage company with your regular monthly payment.
  • When can it be used?
    You own a home and have extra money with which to prepay your mortgage
  • Strengths
    The federal formula for financial aid does not consider home equity in determining a family’s total assets
  • Caution: Most private colleges, however, do consider home equity in determining your child’s eligibility for campus-based financial aid. If you have a pricey home and no mortgage, a college may expect you to borrow against your home to help fund your child’s education.
  • You will own your home outright in less time and with a lower total interest cost
  • Tradeoffs
    The extra money used to prepay your mortgage is money that could possibly have been invested elsewhere at a higher rate of return
  • You lose the ability to deduct your mortgage interest
  • Most private colleges consider home equity as an asset in deciding which of their students are most deserving of campus-based aid
  • Some lenders may charge a penalty for prepayment
  • How to do it
    Send in extra money with your required mortgage payment each month
  • Tip: It is probably a good idea to follow up with your lending institution to make sure your payments are being properly applied.
  • Tip: One extra principal payment a year can reduce a 30-year mortgage by several years.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

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The Retirement Group is a Registered Investment Advisor not affiliated with  FSC Securities and may be reached at www.theretirementgroup.com.

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