Change Mortgage Debt Into Retirement Equity

(MoneyWatch)  One of the simplest strategies you can use to help create more assets for your retirement plan is to make small and consistent prepayments on your mortgage. Since the home mortgage is usually the largest debt most families incur, a small change to your monthly mortgage payment may make a big difference to your retirement plan decades down the road.

Building assets for retirement is often about changing the momentum of your money. When you borrow money to buy a home, the interest payments are going to your lender. If you can cut those interest payments by just a little, then that savings can be added to your retirement plan. It's a pretty painless strategy that essentially converts debt payments to your lender into equity payments into your retirement plan.

Of course, you need to check to ensure you don't have any sort of prepayment penalty, but most mortgages don't.

Here's how it works:

• Assume you take out a $200,000, 30 year mortgage at 6.25 percent interest. The monthly payment is $1,231. If pay off your mortgage over 30 years, you would end up paying about $243,000 in interest on the $200,000 loan.
• Now assume you decide to make an extra $150 a month payment on your mortgage. That money goes directly to reducing the principal balance on the loan, which then reduces the total interest owed on the loan. By making these prepayments you'd get the loan paid off in about 23 years, and would save around $70,000 of interest.
• But that's not the end of the story. Once you get the house paid off, you can take the $1,231 that you were spending on your mortgage and put it into your retirement plan. Since you paid off the house about 7 years early, that gives you 7 years of extra funding for your retirement. If you just earned 6.25 percent on that money, you would accumulate about another $130,000 for your retirement.

The longer you have to go on your mortgage and the higher the interest payment, the bigger the bang you'll get on a prepayment strategy. Then once the mortgage is paid off, don't forget to ramp up the retirement savings.

You can play around with the numbers by using any of the online calculators for mortgage payments and savings accumulation. I like the ones available at www.dinkytown.net.

Bottom line: Preparing for retirement is about implementing long term strategies to consistently reduce debts and build assets. Prepaying your mortgage may help you do that. So run your numbers, and see if the strategy might be right for you.

As with all financial matters, consult your individual advisor prior to making any decisions.