Kevin McCormally: I am Kevin McCormally of Kiplinger's and I am here with Pat Esswein, the Housing Editor of Kiplinger's Personal Finance Magazine, to talk about prepaying and mortgage. Pat, these days people are concerned about interest rates going up, a lot of home owners are strapped. They can't afford to pay their mortgage and you are talking about people paying extra. Who you talking about?
Pat Esswein: This might be people whose incomes have increased, maybe they have gotten a raise, maybe a spouse is going back to work. You can also prepay by making a lump sum prepayments. So if you have received a bonus or perhaps you have received an inheritance, you might think about prepaying.
Kevin McCormally: Okay, why would you want to prepay your mortgage. I mean why would you want to pay the bank sooner than you have to?
Pat Esswein: I think the basic idea behind prepaying is that by chipping away at the principal balance that you owe. You increase the speed with which you pay down your loan.
Kevin McCormally: So overall, you are going to pay less interest in the long run because the loan is going to be retired early.
Pat Esswein: Retired more quickly, exactly.
Kevin McCormally: How do you decide whether it makes sense to prepay a mortgage versus doing something else with that money.
Pat Esswein: The first thing you have to do is compare the interest rate that you are paying on your mortgage with alternative investments. If you are paying, let's say 5% on your mortgage, how can you do better with the money?
Kevin McCormally: So if I can invest at 8%, I would be better off investing the money somewhere else.
Pat Esswein: Exactly, assuming that you want to tolerate possibly increased risk.
Kevin McCormally: So there maybe something here involved other than financial return. There might be emotional issues involved in paying off the mortgage early?
Pat Esswein: Yes, there can be emotional issues, there can be consideration of your time in life. For example, if you are anticipating retirement and you would like to go into retirement without the burden of a monthly mortgage payment, then prepaying your mortgage might be a very good idea.
Kevin McCormally: Okay, you have sold me, how do I do it?
Pat Esswein: Basically, you just add an extra amount each month to your mortgage payment, it could be $25, it could a $100 or as I mentioned earlier, you can make a lump sum prepayment.
Kevin McCormally: And it's completely voluntary, so if I decide to do it this month, I don't have to do it next month?
Pat Esswein: Exactly. The only thing that you may want to do is to advise your lender that you want this money applied to the principal balance, otherwise they might just put it in your escrow account.
Kevin McCormally: Okay.
