By Ilyce Glink and Samuel J. Tamkin
Q: I enjoy your articles, but I think you left out a couple of extremely important items when you wrote about questions to ask when taking out a mortgage loan. In some states, prepayment penalties are not allowed on mortgages or home equity loans.
A: Thanks for your suggestions. We're big fans of prepaying mortgages. For one, you save a ton of money on extra interest. Plus, you're forcing yourself to put more of your money into savings.
For many Americans, having less debt will be far better for them in the years to come. And we're already seeing millions of Americans deleverage the debt they had taken on during the first part of the last decade. For those who have difficulty saving money, who tend to spend every penny they make, and who never met a debt they didn't take on, your suggestion to prepay a mortgage is excellent.
But prepaying a mortgage isn't the right thing for everyone. If you borrow at today's historic low interest rates, you may want to pay off other debt -- such as a car loan -- before you pay off your mortgage. When student loans or credit card debt carry much higher interest rates, you'll want to use available cash to pay off those debts first. In some situations, you may want to put money into retirement accounts before paying off an existing mortgage.
However, if you have excess cash at the end of the month, and the decision is whether to keep that cash in a checking account or pay down your mortgage, prepaying is probably the best choice. Even if your mortgage is at a low rate of 3 percent, checking accounts are offering about a 0.25 percent, or virtually nothing. You'd have to find an investment that will earn you a higher return than your mortgage rate to come out ahead.
In the late 1990s, many Americans borrowed money from their homes to invest in stocks. We would receive letters from readers asking whether they were smart to refinance their homes, take money out and then invest that money in the stock market. Many people were burned when stocks lost money and they still had to pay back the money they had borrowed.
While many financial experts will tell you to have a diversified portfolio and invest in things you understand, many Americans don't understand basic investment choices. Without a good understanding of these investments, investors might take on a risk that is greater than they should. Perhaps you decided that being debt free was wiser than taking risks with the stock or bond markets.
If you own a home with a 30-year mortgage, you can significantly cut the number of years you will have that mortgage if you simply make an extra payment on that mortgage at the beginning of each year. That one move will save seven years of payments.
However, if you are able to swing a 15-year mortgage and make those same extra payments every year, you'll shave only a couple of years off the term of your loan. Still, you will pay off a loan in about 13 years instead of 15 and save even more off of the 30-year loan because the interest rate on a 15-year loan is lower than a longer-term mortgage.
Finally, you mention that some states prohibit prepayment penalties on mortgages. While that's true, you have many national lending companies that will ignore state laws and will only follow federal laws relating to lenders. Those national lenders may have prepayment penalties on their loans even though the states in which they lend money prohibit those prepayment penalties.
The good news is that many lenders today are giving out loans to borrowers without prepayment penalties.
(Ilyce R. Glink is the author of many books on real estate and host of "Real Estate Minute" on her YouTube.com/expertrealestatetips channel. Samuel J. Tamkin is a Chicago-based real estate attorney. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11a-1p EST. Contact Ilyce through her Web site, http://www.thinkglink.com.)