Interest Rate When you prepay your mortgage, you in effect earn the mortgage rate on the extra money you pay. For example, if your interest rate is 9 percentand you decide to add extra money to your monthly payment, your pre-tax earnings on that extra payment would effectively be 9 percent. This meansthat you would be better off prepaying your 9 percent mortgage unless you could earn more than a 9 percent taxable rate of return by investing that extra money elsewhere. So, compare your mortgage rate to the rate youcould receive from an alternative investment before prepaying.

Tax Consequences If you itemize income-tax deductions and fully deduct your mortgage interest, you might not want to prepay your mortgage. By paying extraeach month, you will be paying less interest overall and, as a result, your interest deductions and corresponding income will be reduced as discussed previously. In deciding whether to prepay your mortgage, you’llhave to consider the effect of lower interest deductions and corresponding income on your income taxes.

Other Financial Conditions Even if you decide that you can’t get a better return by investing your extra money elsewhere and you don’t mind a smaller interest deduction, there are still other factors to consider before prepaying your mortgage.

Everyday Expenses. Make sure you have enough money for your everydayliving expenses. Only money that you have in excess of your living costsshould be used to prepay your mortgage.

Other Debts. If you have other debts at a higher interest rate than yourmortgage, such as credit card balances, personal bank loans, and auto loans, you should pay off the other debts before your mortgage, especially since the interest on those debts is generally not deductible.

Emergency Fund/Savings. You should have an emergency fund set upbefore you prepay your mortgage. If you will have to finance yourchildren’s college education or you are planning to retire soon, you may also want to build up your savings instead of prepaying your mortgage.

Other Options. You might consider refinancing your mortgage. If you cansecure an interest rate lower than your current mortgage interest rate (a rule of thumb is two percentage points lower and plans to stay in the home for at least two years), refinancing could save you a substantial amount in interest charges and reduce your monthly payment. Of courseyou will need to consider the costs of refinancing and any potential restrictions to determine if it is the best option for you. Be sure tocontact your mortgage company and your tax advisor regarding your specific situation.

(Alan S. Moore is a financial advisor of Legg Mason Wood Walker Inc., adiversified financial services and securities brokerage firm that is a member of the New York Stock Exchange, Inc. and SIPC.)

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