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Should You Pay Off Your Mortgage Early?

Physician's Money Digest, July 2005, Volume 12, Issue 10

In the last month alone, I've receivedtwo offers for biweekly mortgagepayment programs. This is where acompany, for a fee, offers to change yourmortgage payment to biweekly insteadof monthly. As a result, you end up payingone extra payment each year, resultingin a faster payoff of your mortgageand reduced total interest payments.

Extra Payments

The promoters suggest these mortgageacceleration programs are a greatdeal. But are they really? Remember thatmoney is nothing more than a commoditythat you should put to its greatest use.If you have an extra dollar, you can spendit, invest it, or pay down debt with it.Assuming that you choose not to spendit, you will want to use this commodityfor your best financial advantage. Inmany cases, choosing to invest will yieldbetter results for wealth accumulationthan choosing to pay down your debt. Inother cases, paying down your debt willyield better results. For example, if youowe $1000 on a credit card with an 18%interest rate, your money would almostcertainly be best used paying down thatdebt. In fact, you wouldn't want to starta biweekly mortgage payment programif you have consumer debt with higherinterest rates than your mortgage. Don'tforget that you are receiving a tax deductionfor your home mortgage interest,which means it is costing you even less.

The advantage of signing up for abiweekly payment program is thateverything is automated. Paymentsautomatically transfer from your bankaccount to your mortgage companyevery other week. If you love the idea ofpaying off your mortgage early butwould like to avoid the extra chargesthat come with it, you can simply makeone extra payment per year. No matterwhat you decide, you are responsible formaking sure that your mortgage companyaccurately credits your paymentsagainst your account. Consider runningan amortization schedule and contactyour mortgage company at least once ayear to confirm that all payments havebeen accurately recorded.

If you are determined to pay off yourmortgage early, an even better strategyis to set up an investment account andcontribute your extra mortgage paymentsinto it each month. At the pointthat your investment account value isequal to your mortgage balance youshould sell your investments and pay offyour mortgage completely.

Payment Situations

Let's consider an example. You have a30-year mortgage for $500,000 at 6%with monthly payments of $2998. Underthese circumstances, you have the followingthree options to mull over:

•Scenario 1. If you make your regularmortgage payments for 30 years, you willpay a total of $1,079,000, of which$579,000 will be interest.

•Scenario 2. If you decide to pay anextra $250 per month (ie, the equivalentof about one extra mortgage paymentper year), your mortgage will be paid off65 months early, which reduces yourtotal costs to $958,000, of which$458,000 will be interest.

• Scenario 3. If you invest $250 permonth in the Vanguard Index 500 mutualfund and earn an average of 9%, youwill accumulate enough money to paythe tax on your gains and pay off yourmortgage 81 months early, reducing yourtotal cost to $906,000, of which $534,000will be interest.

Note that with this strategy, your totalpayments are lower but your tax-deductibleinterest payments are largerand you create extra tax benefits.Obviously this strategy poses some marketrisks, but they're diminished throughoutthe 20-year time horizon. You willalso have access to your money shouldyou have an emergency.

®, AEP,

is the founder of the Welch

Group, LLC, which specializes in

providing fee-only wealth management

services to affluent retirees

and health care professionals

throughout the United States. He is the

coauthor of J.K. Lasser's New Rules for Estate

and Tax Planning (John Wiley & Sons, Inc;

2001). He welcomes questions or comments at

800-709-7100 or visit www.welchgroup.com.

This article was reprinted with permission from

the Birmingham Post Herald.

Stewart H. Welch III, CFP