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Savings Guide 2006

Savvy savers

  There's more to saving than stuffing your extra cash in a mattress.
Mortgage rate high? Get same rate on savings

Think it's a raw deal that you pay far more interest on your mortgage than you receive on your savings?

There's a quick way to wipe out that gap and get the same earnings -- in some cases even higher -- that you pay out: Take the amount of money you would put into a savings account and pay extra principal on your mortgage, instead.

In other words, if you have a 6.5 percent mortgage and you make an extra payment against principal, you have an investment that yields 6.5 percent.

While prepaying isn't for everyone, financial advisers say it's often a smart savings strategy. Among the advantages: low risk, flexibility and easily measured savings. Plus, there's a reward at the end.

Such payments, directly reducing outstanding debt, have long ranked as a popular technique to accelerate the journey to owning a home outright by shortening the life span of a mortgage.

"You get to actually own your house -- which is a lot more comfortable position to be in than a stock certificate or bond if times get tough," says Marc Eisenson, co-founder of Good Advice Press, a publisher of debt reduction books. "Also, your savings are liquid. You can get a home equity line of credit or loan if you need it."

Calculated over many years, small payments add up to substantial savings. A homeowner with a 30-year mortgage for $200,000 at 6.5 percent interest, for example, could save $56,000 in interest costs over the life of the loan by forking over just $100 extra every month. While prepayment amounts vary, a common approach is to pay the equivalent about one extra monthly payment each year. Doing this annually would allow someone to pay off a 30-year mortgage in 25 years.

Consider it an investment
The best way to determine if prepaying is a wise financial move is to compare it to all other investment options.

That's the advice of Jack Guttentag, professor of finance emeritus at the Wharton School of Business and founder of the Mortgage Professor's Web site. He tells homeowners to view prepayments as investments bearing interest equivalent to their mortgage rate -- a prepayment on a 6-percent mortgage is the same as an investment that yields 6 percent.

"If you can earn 6 percent, and it's a sure 6 percent, and there's no risk involved, then the question is whether you can do better somewhere else," Guttentag says. "For most people, the answer is no."

But there are exceptions. Younger homeowners might be better off funneling savings into a diversified stock portfolio. While that's risky in the short run, over the long term it's likely to prove to be more lucrative, Guttentag says.

Donna Wood, a CPA and financial planner in Haymarket, Va., advises clients often to put money into 401(k) plans before prepaying on a mortgage. In many cases, employers' will match 401(k) contributions up to a certain limit. Wood tells clients to contribute at least to that limit and secure the money in a diversified portfolio before exploring others savings strategies, such as prepaying. Eisenson also advises homeowners with outstanding credit card balances to concentrate on eliminating their high interest-bearing debts before paying off mortgage principal.

Prepay options on nontraditional loans
Today, fewer homeowners hold only traditional 15-year and 30-year mortgages. Alternate debt instruments, such as adjustable-rate mortgages, or ARMs, home equity credit lines, and interest-only loans, have proliferated. As use of these alternate loans grow, so do homeowners' prepayment options.
-- Posted: Oct. 1, 2006

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