Financial TipsAlan S. Moore / L’Observateur / April 5, 2000Could you afford to add a little more to your mortgage payment each month? It might be a good financial strategy for you. Typically, paying extra on yourmortgage each month can save you interest and help you pay off the loan sooner. But, before you increase your mortgage payments, look closely atyour loan’s interest rate, your tax situation, and your complete financial picture.
Published 12:00 am Wednesday, April 5, 2000
Interest Rate When you prepay your mortgage, in effect, you earn the mortgage rate on the extra money you pay. For example, if your interest rate is 9% and youdecide to add extra money to your monthly payment, your pre-tax earnings on that extra payment would effectively be 9%. This means that you wouldbe better off prepaying your 9% mortgage unless you could earn more than 9% by investing that extra money elsewhere. Before prepaying, compareyour mortgage rate to the pre-tax rate you could earn from an alternative investment to determine which is the best option.
Tax Consequences If you itemize income tax deductions and fully deduct your mortgage interest, you might not want to prepay your mortgage. By paying extra eachmonth, you will be paying less interest overall and, as a result, your interest deductions will be reduced. In deciding whether to prepay your mortgage,you’ll have to consider the effect of lower interest deductions on your income taxes.
Other Financial Conditions Even if you decide that you can’t earn a better return by investing your extra money elsewhere and you don’t mind a smaller interest deduction, there are other factors to consider before prepaying your mortgage.
Everyday Expenses. Ensure that 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 up beforeyou prepay your mortgage. If you will have to finance your children’s collegeeducation 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, refinancing could save you a substantial amount in interest charges and reduce your monthly payment.
Alan S. Moore is a Financial Advisor of Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc.
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