Why you shouldn't prepay your mortgage
Regulators recently filed suit against two companies for falsely promising quick savings from mortgage prepayments while charging fees that more than offset the benefits. Even when you're not paying fat fees, though, you should be skeptical of the idea that prepaying your mortgage is a good idea.
The Consumer Financial Protection Bureau said Monday that the Ohio-based companies, Nationwide Biweekly Administration and Loan Payment Administration, misled consumers about the cost and benefits of the "Interest Minimizer" program. Nationwide charged people as much as $995 to initiate a biweekly payment plan and $84 and $101 in payment processing fees each year, the CFPB said.
Typically, borrowers don't need to pay a third party to prepay their mortgage. Instead, they can divide their monthly payment in two and send half every two weeks, effectively making one extra payment each year.
And making one extra mortgage payment annually can shave nearly five years off a 30-year, $250,000 mortgage, assuming an interest rate of 3.75 percent. Borrowers would save nearly $24,000 in interest.
Sounds like a great deal, right? And it would be, if you didn't have better things to do with your money. Such as:
Taking full advantage of retirement savings options. It's a no-brainer to contribute at least enough to your 401(k) or other workplace retirement plan to get the full company match. Additional contributions to such plans win you tax breaks plus all that lovely future tax-deferred compounding.
Paying off every other debt. Mortgages are one of the cheapest debts around. If you can get a deduction for the home loan interest you pay, your effective rate is even cheaper. Higher-rate loans should be retired before you pay extra on your mortgage, and you should consider paying off even lower-rate debt if the rate is variable (which means it could someday soar higher).
Making sure you're properly insured. A smaller mortgage won't be much comfort if you lose your home because of medical bills, a lawsuit, a disability or a death. You should have adequate health, liability, disability and life insurance for your situation before prepaying a mortgage.
Building your financial flexibility. Every dollar paid early to a lender is a dollar you don't have in case of job loss or other emergency. Yes, you may be able to get a home equity line of credit (that is, if you do so before you lose your job), but the amount you can borrow may be limited and you'll have to pay fees and interest for the privilege of borrowing back your equity. Before prepaying a mortgage you should have at least three months' worth of expenses saved in an emergency fund.
If you've taken care of all these higher-priority financial tasks and still want to pay your mortgage off fast, go right ahead. Just make sure your extra payments will be properly credited against the principal. Your mortgage servicer can tell you the best way to make payments so that happens.
