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A home is one of the largest investments most of us will ever make. Even without including real estate taxes, insurance, maintenance, utilities, and closing costs when you buy and sell, a $175,000 piece of the rock financed at 6.5% for 30 years could cost you $353,559 even more if you put less than 20% down!
But if you add just $25 to the required payment on the $140,000 loan you’ll have to take out, you'll save over $16,668. Not only are the savings substantial, but they're also guaranteed, tax-free, risk-free, and painless to achieve.
So why aren't the millions and millions of mortgage holders out there pre-paying their home loans? Too many are stopped by these myths:
MYTH: It sounds too good to be true.
TRUTH: I admit it. Anything that promises to save you $16,000 or more sounds like a get rich quick scheme. And we've all been warned to avoid deals like that. However, investing in your mortgage -- even a piddling amount -- really does reap great rewards. It's no gimmick. The more you pre-pay, the more you’ll save. For example, $50 a month will save you over $30,000 on our $140,000 example.
MYTH: I can't afford to pre-pay.
TRUTH: If you borrowed $140,000 at 6.5% for 30 years and just sent in an extra 25 cents a day, you'd save $5,416. Can’t afford quarters this month? Send in pennies, but get into the pre-payment habit! Figure out where you can cut back, even just a little. Then send in what you can, when you can, and turn your debts into profit.
MYTH: I'll lose my only tax deduction.
TRUTH: The more you spend, the less you'll keep.a) It never pays to send your lender $1.00 in the hopes of getting back 27 cents or so (depending on your tax bracket) from the IRS.
b) Higher standard deductions for 2002 mean that the first $4,700 spent on an individual’s, or $7850 spent on a couple's, mortgage interest could be saving ... $0!
c) Even if you itemize, pre-pay. Say you send in $25 a month more in just the first year of our sample $140,000 mortgage. You’ll save $1,718 in interest over the loan’s life. True, it’ll cost you $2.46 in tax write-offs (assuming you're in the 27% bracket). But where else can you invest $2.46, and get $1,718 back, guaranteed?
MYTH: My bank will be angry if I pre-pay.
TRUTH: Not so!a) Banks don't have feelings.
b) These days, banks make most of their money up front -- on points and closing costs.
c) When you pre-pay, the bank accumulates money to use to make new loans (which brings us back to b).
MYTH: I'll end up in a hassle with my bank.
TRUTH: Now that everything is computerized, lenders almost always credit pre-payments correctly. A data entry clerk enters your account number as well as the amount of your check. The bank's computer does the math, deducting any pre-payment from the outstanding balance of your loan.
MYTH: I'm probably going to be moving in the next few years, so pre-paying doesn't make sense.
TRUTH: While homeowners do tend to move every 5 to 7 years, they generally go from one mortgaged home to another, creating what I call a “serial mortgage.” Unique to each family, these loans are made up of the various mortgages a family takes out over the years.
If you keep pre-paying, no matter what particular mortgage you have at the moment, the ultimate result will be an early escape from mortgage debt -- meaning years of mortgage payments you'll never have to make. And some day, your home will actually be yours, free and clear!
Regardless of how often you move, every dollar you invest in your mortgage will earn you money at the rate you're paying. Have a 6.5% fixed rate loan? Your pre- payments will yield 6.5%. That's 6.5% tax-free. Why no taxes? Because they're savings, not income.
MYTH: I don't have the discipline.
TRUTH: You write out your mortgage check, don't you? It takes no more discipline to write a slightly larger check. In fact, it might be easier:a) You can round up your payment to a number that's a snap to remember and easier to write -- like $900 instead of $884.90 in our earlier example.
b) Knowing that your $15.10 pre-payment will end up saving you over $10,520 can be a real motivator. It sure gave me the incentive to pay off my loan early.
MYTH: I'll get hit with a pre-payment penalty.
TRUTH: Pre-payment penalties are rare, and when they are imposed generally only in the first couple of years for a home equity loan or new mortgage they usually apply to paying off the entire loan, rather than making small extra principal payments. Even when they can be imposed, penalties on small pre-payments are tiny, it’d cost the lender more than they’d collect to do the bookkeeping and billing, so many banks don’t bother.
MYTH: Pre-paying is so complicated, I'll need to hire someone to do it for me.
TRUTH: Nonsense! I know there are a lot of ads out there for “bi-weekly” or other mortgage acceleration programs. They're expensive and absolutely unnecessary. Send in what you can, when you can, and watch your equity grow!
MYTH: I can get a better return some place else.
TRUTH: After taxes? On $25 a month? In terms of traditional investments, I doubt it, unless you have a rock-solid 401(k) plan at work, with a significant employer match program. In general, though, remember, the greater the return, the greater the risk.
And there's nothing safer than the roof over your head ... or rather, the mortgage on it. Of course, you don't have to do one ... or the other. You could sock away some money in the stock market, for example, and still pre-pay $25 a month.
Important: There is one place where you're guaranteed to get a better return than pre-paying your mortgage -- paying down your credit card balance. To save the most, pay off your highest interest debts first. Send in an extra $25 every month on a $3,800 card balance at 17%, and save up to $5,756 ... while reducing your payoff period by over 27 years. (That’s not a typo.)
No matter what your investment strategy, I'll wager that there's $25 or so a month -- whatever pocket change you throw on the dresser every night -- that you'd never notice, invest, or miss. Pre-pay on your debts!
For the complete story on pre-paying, with lots of tables so you can see how much you'll save, read The Banker's Secret ($14.95) by Marc Eisenson. Often called the bible of mortgage pre-payment, it'll save you a pot full of money.
Also available: The Banker's Secret Loan Software ($39.95) lets you crunch the numbers yourself, and create pre-payment schedules that make the record keeping a snap.
The Pocket Change Windfall: Each of our 34 back issues offers painless ways to get out of debt and save on the many expenses that confront us all -- taxes, credit card bills, mortgages, insurance, food, you name it. You can get all 34 for just $29.95 -- that's less than $1 each. To order, you can use our secure server, call 845-657-8245, or write to us at:
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