Mortgage Prepayment May Not Be The Best Idea.
Q: Looking at the numbers, it seems to be a good idea to pay off my mortgage. We have 9 years remaining on a 15-year term at 5 percent and we owe $106,000. My home equity line is at prime.
We plan to stay in the house for 3 to 4 more years. I know that a spike in inflation will change the interest rate on the home equity loan but what do you think? Should we pay off our loan with the cash we have on hand?
A: Your idea to prepay your mortgage carries a risk. If interest rates skyrocket and your financial position changes you could wind up in a tight spot. You’ll have all of your cash in your house, but no cash to live on in case you or your spouse lose your jobs, have an unforeseen medical expense, or decide to make a change.
And in the current real estate and financial market, if you want to take out equity from your home, you may have trouble doing that. And once you have made the mortgage prepayment, you can’t get that money back.
Because you’re in a 15-year loan, you’ve already shaved down the interest rate you’re paying relative to what a 30-year loan would have been. Now, you’re mostly paying principal on the loan and very little interest.
Why not try to split the difference? Instead of paying off your loan entirely, why don’t you payoff part, but not your entire loan balance? If you write a check for $50,000, you’ll be left with just a $56,000 balance and should be able to pay that off with regular payments in perhaps 5 years or less.
A mortgage prepayment of part of the loan should leave you with a significant cash cushion, which I think is helpful in the current economy.
You didn’t mention the loan balance on your home equity line of credit, if you have a small balance, you should be fine keeping it and paying it off over time even if interest rates rise. If you have a large balance outstanding on your home equity line of credit, you might want to keep more cash available to use in case you decide you’d rather pay down the home equity line of credit than face the possibility of raising rates and not having the cash to pay it off.
In this economy, you should think twice before making that mortgage prepayment in full. You could be sorry if you prepay the mortgage and later need the money.
One final item, if you took out a loan in the last several years, make sure that loan does not have a prepayment penalty before you send the check to the lender. Some loans have such a hefty prepayment penalty that you would be better off keeping the money that paying off the loan in full. But many of those loans with prepayment penalties allow for a partial prepayment of the loan on a year to year basis. So you can prepay a part of the mortgage loan a bit at a time. Make sure you review your mortgage loan documents carefully.
Read more about other scenarios for mortgage prepayment. Will prepayment work better for your mortgage?