Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, November 1, 1993 TAG: 9310300013
SECTION: MONEY PAGE: A-10 EDITION: METRO
SOURCE: JANE BRYANT QUINN THE WASHINGTON POST
DATELINE: NEW YORK LENGTH: Medium
But here's the question: With mortgage interest rates so low, is it still a good idea to prepay?
Your return on investment from mortgage prepayments is equal to your mortgage rate, regardless of whether your house is going up or down in value. When mortgages were at 12 percent, prepayment offered a guaranteed 12 percent return. Now, however, prepaying a fixed-rate mortgage may yield only a 7 percent return. That's better than certificates of deposit but not as good as growth investments.
Prepaying a mortgage is a life choice as well as a personal-finance decision. Many of us feel more comfortable knowing that our largest debt is shrinking fast. But if you fit any of the following cases, mortgage prepayment may not be the best use of your money:
You're living from paycheck to paycheck and don't have a financial cushion. It's far more important to build a fund of ready cash, even at low bank interest rates, than to put extra payments into your house.
You're nearing retirement and haven't saved as much as you'd hoped. Prepaying your mortgage ties up your cash. Prior to retirement, you need to add to your liquid savings. After retirement, you need to stretch out what money you have, so you can continue to pay your bills. Don't deliberately make yourself house rich, cash poor.
You can - and will - invest your money for a higher long-term return. You might earn 10 percent or more in stock-owning mutual funds that are invested in both the U.S. and abroad. Even better are tax-sheltered Individual Retirement Accounts and Keogh plans (for the self-employed) invested in stock funds.
Best of all is a 401(k) plan that you might be lucky enough to have at work. If your company adds $1 for every $2 you invest, you get a 50 percent return on your money just for showing up. That's in addition to your tax savings and the money that your investment earns.
You have a lot of credit-card debt. Repaying consumer debts at 17 percent interest effectively gives you a guaranteed 17 percent return. That's better than almost any investment except an employer-matched 401(k) plan. When repaying debt, try to do away with your highest-cost borrowing first.
You have to start paying for college within a few years. This one is a tougher call. Reducing your mortgage, then borrowing against your home equity, might net you more after taxes than you'd get from a bank CD. But if your house declined in value, or if you lost your job, you'd lose some of your borrowing power. For safety, a college fund for a teen-ager might better be invested in Series EE Savings Bonds.
That said, there are still many instances when mortgage prepayments make excellent sense. You might put extra cash into your house if:
You want the psychological comfort of owning your house by the time you retire. You should also have enough liquid savings and investments to pay your bills throughout your old age.
You're nearing retirement without enough savings, but expect to move into a smaller house or condominium. Prepaying a 7 percent mortgage is a better investment than a 3 percent CD. You'll cash out your equity when the house is sold, so you're not locking up your cash. If your house drops in value you lose net worth, whether your spare cash is in the mortgage or in the bank.
You have a variety of growth investments as well as some truly high-risk ventures. You need something conservative for balance, and what better than a guaranteed 7 percent that also lowers your level of debt?
Your house is worth less than the mortgage against it. If you don't gradually prepay, you'll owe the lender a lot of money when the house is sold.
You will otherwise spend the money. Better cash locked into your house than cash sprayed into the willing hands of someone else.
by CNB