Experts: Prepaying mortgage not always best move

NEW YORK (AP) -- While some families are struggling to pay their mortgages, others are in the enviable position of considering whether to make an extra payment this year.

Experts say that while such a move can reduce interest payments over the life of the loan -- and speed up the date of a mortgage burning party -- it may not be the best use of consumers' money.

"My concern is that you may accomplish paying off your mortgage early, but if you're not doing any other saving, you'll enter retirement broke," said Ric Edelman, a financial adviser based in Fairfax, Virginia, and author of "The Truth About Money." "I think it's more important for people to create wealth than to eliminate debt."

There are benefits, of course, to speeding up the payment of a mortgage by adding extra money to each month's payment check, shifting to biweekly payments or making a 13th "monthly" payment before year's end.

Take the case of a family that takes out a $200,000 home loan with a fixed rate of 6 percent for 30 years. If that family makes an extra payment each year earmarked to reduce principal, it will save more than $47,000 in interest over the life of the loan and pay it off in less than 25 years, according to Bankrate.com, an online financial information service based in North Palm Beach, Florida.

Still, speeding up the payment of a mortgage may not be as beneficial as dealing with other debt, said Greg McBride, senior financial analyst with Bankrate.com. He noted debts such as credit cards often carry considerably higher interest rates than mortgages, and interest payments on such consumer loans are not tax deductible like mortgage interest is.

McBride also argued that a homeowner should never consider diverting more money to a mortgage until all other savings accounts are funded.

"Tying up more money in an illiquid asset such as a home is ill-advised if the homeowner doesn't have an adequate emergency savings cushion," McBride said. He added: "A much better use of the money would be to contribute to a 401(k) retirement account to maximize the employer match, or fund a Roth IRA that permits tax-free withdrawals in retirement."

Bob Walters, chief economist of Quicken Loans, an online mortgage lender based in Livonia, Michigan, said homeowners need to ask themselves what the very best use of a spare dollar could be.

Look at your mortgage interest rate, say 6 percent, he said. Then look at your possible tax deduction. If you're in a 28 percent tax bracket, your after-tax cost of borrowing is about 4.5 percent.

"The question is, from a purely financial standpoint, 'Can I do better than 4.5 percent after-tax somewhere else?"' he said. "The answer is generally 'yes."'

Walters suggests that consumers considering an extra mortgage payment review his checklist:

Do you have any debt that has an interest rate higher than the rate on your mortgage? If yes, you should be putting your extra dollars against that debt first.

If you have no debt, are there investments that are likely to give you a better after-tax return than your mortgage?

Do you have enough liquidity in your life?

If you don't have enough money squirreled away to cover at least six months of living expenses, create that "emergency fund" first, Walters said.

Walters said that people need to worry about being "house poor," meaning they have all their money tied up in their home.

"I see people who don't have a nickel in savings but they're paying extra against their mortgages," he said. "It's worrying."

Still, Walters and Bankrate.com's McBride say there are times when those extra mortgage payments should be considered.

"Prepaying a mortgage can be a very good decision for someone with a low mortgage balance and approaching retirement," McBride said. "In this situation, there is little if any tax benefit -- but the ability to eliminate a large monthly obligation in retirement is very appealing."

Walters said that others who might consider extra payments are those who find it impossible to save. But, beware of accelerated payment programs sponsored by mortgage lenders, which often add fees; you might be able to make extra payments on your own without penalty.

"Some kind of biweekly payment program -- assuming there's no fee for it -- might be the only way you can possibly save," he said. "It's maybe not the best economic solution, but it beats going out and spending the money on more shoes." E-mail to a friend

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