Mortgage prepayment may be unwise

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Dear Dr. Don,
I have a 4.25 percent mortgage. I am trying to decide if paying an additional annual $8,400 principal payment on the loan is more advantageous than making the $700 monthly additional on the principal. I have no income tax or earnings tax where I live, so that is not an issue.

I’m thinking I can put the funds monthly into my credit union account, which will earn 6 percent with easy access in case of any emergency. So, paying principal annually makes sense as I would have realized the interest earnings, too. Your opinion is greatly appreciated.
— Maggie Mortgage

Dear Maggie,
You haven’t identified where it is that you live, but it sounds great. You don’t pay taxes on earnings or income, and you earn 6 percent on a credit union account with easy access to funds. Let’s just call this place “Brigadoon.”

My rule of thumb is that if you can expect to earn more after-tax on your investments than you pay after-tax on your mortgage, there’s no particular rush to pay down your mortgage. One exception I make to that rule involves retirement — for most people, it’s a good goal to try to pay off your mortgage before you retire.

It’s easy to figure out the difference in the interest expense between the two methods of making additional payments. Just use Bankrate’s Mortgage calculator to input your interest rate, outstanding loan balance and remaining terms. Then, go to the amortization schedule and find the total interest expense. You can then rerun the amortization schedule for each of your additional payment options and calculate the total interest expense from those approaches.

If you can borrow at 4.25 percent and invest at 6 percent — in a world without taxes on earnings or income — you should not prepay your mortgage and instead invest the $700 each month in your credit union share account. That’s assuming the “Brigadoon” Credit Union has deposit share insurance to cover the share balance of your account.

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