Dear Dr. Don,
I read your answer to another reader about additional principal being added to mortgage payments and how it shortens the life of the loan. It all made sense. If I plan to sell my house before paying off the mortgage — I got a great deal buying it last year and plan to sell once things pick back up — does having paid additional principal benefit me at all when I sell the house?
— Sean Seller
Making additional principal payments not only saves on interest expense, it reduces the loan balance. That means that when you sell this house, you’ll have more equity to use in buying the next house, or to use for other life goals.
While making additional principal payments improves your equity position, it doesn’t influence the profit or loss on the sale of your home. Reducing the loan-to-value means there’s less leverage, and a lower mortgage interest deduction on your income tax return. My rule of thumb is to make additional principal payments when you expect the after-tax return on investments to be less than the effective rate on the mortgage.
Bankrate’s Mortgage tax deduction calculator will help you calculate the effective rate on your mortgage.
Keep in mind that a quick flip can be costly when it comes to taxes. Assuming this home is a personal residence, you’d want to consider the tax impact of selling before meeting the standards for the capital gains exclusion. The Bankrate feature “Capital gains home-sale tax break a boon for owners” provides additional detail on the exclusion, as does IRS Publication 523, “Selling Your Home.”
Ask the adviser
To ask a question of Dr. Don, go to the “Ask the Experts” page, and select one of these topics: “Financing a home,” “Saving & Investing” or “Money.” Read more Dr. Don columns for additional personal finance advice.