Prepay mortgage principal, not interest

Don Taylorq_v2.gifDear Dr. Don,
I have a 15-year mortgage which I pay every two weeks. I want to make a lump-sum payment of $10,000 on my loan. Should I apply it to interest or principal?
-- Tyrone Treatment

a_v2.gifDear Tyrone,
Additional principal payments are the best way to pay down your mortgage faster. By reducing the loan balance, you reduce the interest expense on the loan, thereby shortening the loan term. However, you want to make sure the lump-sum payment doesn't trigger a prepayment penalty on the loan.

A conventional 15-year mortgage, converted to biweekly payments, already has a loan life of less than 15 years. The interest rate and outstanding loan balance determine how much the $10,000 lump-sum payment reduces the loan term and interest expense.

The Mortgage Professor's Web site has a "Mortgage prepayment calculator" that will allow you to calculate the savings on your existing loan by making the one-time additional principal payment.

In general, the only time it can make sense to prepay interest is at closing when paying discount points on the loan buys you a lower interest rate on the mortgage. Prepaying interest on a seasoned loan just gives the lender use of your money early. You haven't paid down principal, so you haven't reduced the interest expense on the loan.

Bankrate also provides an array of mortgage calculators and can help you find the best mortgage rate.

Read more Dr. Don columns for additional personal finance advice.

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