Total interest paying minimum	$ 279,013
Total interest paying extra $50/month	242,586
BIG SAVINGS =	$ 36,427

Presto! Deb is able to save $36,427 over the 30-year life of the loan just by sending in 50 bucks extra per month. Surely, you can find an extra $50 lying around somewhere. How does so little achieve so much?

Here’s how it works. When you pay your monthly mortgage, you send in extra money and specify that it is to go toward reducing your loan amount—the principal. The bank bases its interest charges on that principal, so by reducing the amount of principal, there is less for it to charge you interest on. Another way of putting it: The extra $50 you sent in is $50 the bank will never get to charge you interest on. Not now. Not over the 30 years of your loan. Never.

Make Sure You Get Credit for Your Mortgage Payment

Some banks intentionally overlook on-time mortgage payments so they can charge you late fees. I once did a television investigation about this. A major national bank was routinely failing to record people’s payments, so some consumers started sending them certified mail out of desperation. This is where it might be worth having an automated payment set up through online banking. That way you know you’ve paid on time each month and there’s a written record.

When you send in extra money to pay down your principal, it doesn’t change your monthly payment (except with special mortgages). Rather, it comes off the back end of your loan. The bank doesn’t get to charge you interest for as long, because once the principal is paid off, there’s nothing left to charge interest on. So that extra $50 a month will save Deb time in addition to money. In fact, she will be finished paying her mortgage more than three years early!

But you don’t have to wait 27 years to see the benefit of mortgage prepayment. Every time you send in extra money for your mortgage, you will save, even if you don’t keep the loan for long, because each extra payment causes less money to go toward interest and more to go toward principal.

Let’s say Deb sells after 10 years. Here’s how prepayment would still benefit her:

Deb’s 10-Year Mortgage Prepayment Plan

Loan balance left after paying the minimum	$ 171,624
Loan balance left after paying an extra $50/month	162,970
BIG SAVINGS =	$ 8,654

In just 10 years, Deb will have saved $8,654 by paying just $50 extra per month. That’s all additional equity she can put toward her next home. It’s kind of fun to plug in different prepayment numbers and time frames and see how much you can save by prepaying your mortgage. I’ve posted an excellent prepayment calculator at my website, www.ElisabethLeamy.com.

Silencing the Naysayers

I know I’ve made mortgage prepayment sound like a no-brainer, but there are plenty of eminent experts who raise doubts. Here are their agitated arguments and my reasoned comebacks.

Their argument: “You can make more by investing the money.”

My response: Yup, you can. But you can also lose more money. When you invest in the market, your investment has the potential to go up, but it can also go down. There’s risk there. Mortgage prepayment has a guaranteed return. No other investment does. And the higher your mortgage rate, the more competitive an investment prepayment is.

I’m not sure why, but whenever financial whizzes debate this topic, they always frame it as an absolute, like you either have to put all your money in the market or all of it into prepaying your mortgage. Why can’t you do a bit of both? Prepaying your mortgage could be one of many investments you make, a way of diversifying your portfolio. Or you could switch back and forth over time, putting your money in the market when it’s hot and in your mortgage when it’s not.

There’s also the discipline factor. Yes, if you have extra money, you can make a greater return by investing it, but many of us will just spend the money instead. Investing takes willpower and effort. You have to hire a financial adviser, find a stock to invest in, and hope it’s a good choice. Any idiot can prepay their mortgage—and I mean that as a good thing!

Their argument: “You should save for retirement and college first.”

My response: Okay, go for it. But, being the savvy consumer that you are, you can probably pay down your mortgage while saving for retirement and college. Yes, max out your retirement plans before prepaying your mortgage. You should at least make sure you are contributing enough to get your company’s 401(k) match, if it offers one, because that is a 100 percent return. There are great college savings plans with lucrative tax benefits as well. But remember, any amount—$100, $50, or even $25—you send in to pay your mortgage off early makes an impact. Besides, you have to pay your mortgage off eventually. It’s a debt you took on. You can either pay it early—and SAVE BIG—or pay it later and save nothing.

Their argument: “You lose part of the mortgage interest tax break.”

My response: Yes, you do. When you spend less on interest, you have less to write off. But please, people, by prepaying your mortgage, you are slashing tens of thousands off of your interest payments. By contrast, the mortgage interest tax deduction only saves you a fraction of those thousands. It’s always better to save the whole thing than part of the thing.

Their argument: “You should save up six months’ worth of living expenses first.”

My response: Good idea. Do that . . . and also prepay your mortgage. After all, if you lose your job but you have paid your mortgage off early, those living expenses will be next to nothing because you won’t have a mortgage payment to make. This is exactly what happened to the “Most Frugal Mom in America” whom I mentioned in the Introduction to this book. She lost her job, but managed to putter along for two years without one because she had no mortgage payment.

Their argument: “Money prepaid into a mortgage is not liquid.”

My response: This is the most compelling argument against mortgage prepayment. I suppose it is the one risk of prepayment as an investment. A couple of thoughts: I always believe in taking the sure savings over the possible problem. You may never have an emergency that forces you to tap the cash that is stashed in your house. If you suddenly do, you will have to refinance or take out a home equity loan and your chances of approval are much greater if you have substantial equity in the home—which you can get by, you guessed it, prepaying your mortgage.

Home Equity Loans Are the Best of the Worst

I am anti debt, because credit costs money, but if you need to take on debt, a home equity loan is the best kind because the interest on it is tax deductible. For example, if you are in the 28 percent tax bracket and you take out a home equity loan at 10 percent interest, your after-tax cost is only about 7 percent.

Their argument: “What if the homeowner doesn’t plan to keep this house anyway?”

My response: That’s fine. There is no rule that says you can’t sell a home that is already paid off. It gives you more equity to put toward the next one. And remember, I already proved to you that prepayment creates substantial savings even if you sell early.

Their argument: “Real estate prices are falling.”

My response: That’s irrelevant. The amount of money you invested in real estate was determined back when you made an offer on the home. If values have fallen, you still owe the same amount, whether you pay it now or pay it later when you sell. By prepaying your mortgage, you can save thousands in interest payments and at least cut your losses.

Their argument: “You could lose your equity through foreclosure.”

My response: If you get behind on your house payments and you have no equity, that’s when you are forced into foreclosure. If you get behind on your payments and you have equity—especially the extra equity you gain by prepaying—you can sell the house before the bank forecloses.

Where’s the Money Going to Come From?

If I’ve convinced you that prepaying your mortgage is a savvy move, then let me help you find the money to do it. The nice thing is, as I’ve shown, even a tiny amount of money makes a significant difference through the power of time and reverse compounding.

Using Free Money to Save Money

Remember the Four Walls of Home Ownership that I shared with you in Chapter 2? The fourth point was this:

Wall 4: Tax deduction = Mortgage prepayment fund. The final wall of your sound financial structure is using the “free money” you get from your mortgage interest tax deduction to prepay your mortgage, saving thousands and paying the loan off years early.

Yes! I’ve been planning this for several chapters now. Many people use the mortgage interest tax deduction to stretch and strain for a fancier house. But in my four-part plan, you make your mortgage equal your rent, which means this tax deduction is found money—money you didn’t have when you were a renter—that you can use to SAVE BIG.

Back to Deb in California. Remember, she has a $200,000 mortgage at 7 percent. Her mortgage interest tax deduction is roughly $3,000 a year for the first decade of her loan; $2,000 a year for the second decade; and $1,000 a year for the third decade. Again, I’ve rounded for easy math. I’ve posted an easy -to-use calculator to help you determine the amount of your mortgage interest tax deduction at my website, www.ElisabethLeamy.com.

Let’s see how much Deb could save if she put her annual mortgage interest tax deduction toward prepayment. This is going to be mind blowing!

Using Deb’s Tax Deduction to Prepay Her Mortgage

Interest owed making minimum payment	$ 279,013
Interest owed adding tax deduction funds	164,435
BIG SAVINGS =	$ 114,578

Woo-hoo! $114,578 is serious money that Deb saved by using free money—the mortgage interest tax deduction the government gives us just for buying a house—to prepay her mortgage. Not only that, she will get her mortgage paid off 10 years early! Imagine the financial freedom of not having a house payment, your single biggest expense.

Only Make Renovations That Make You Money Until Your House Is Paid Off

If you are ultradisciplined about paying your mortgage off early, one tactic is not to spend any money decorating or remodeling your home until it is paid off. The only exception: upgrades like new energy-saving windows or a fuel efficient furnace that make you money. Honestly, I’m a home improvement nut, so I wouldn’t be able to pull this off! But that’s how the most frugal mom in America did it. You met her at the beginning of the book. Her name is Kathy S. She lives in Illinois. And she paid off her mortgage in just five years!

Paying Your Mortgage Biweekly

The most popular mortgage prepayment system is to pay biweekly. It’s simple: You make half a mortgage payment every two weeks instead of the full payment once a month. You end up making 13 mortgage payments a year this way, rather than 12, because there are more than four weeks in some months. This appeals to folks because so many of us are paid biweekly, so you can plan your mortgage payments around your paychecks. Biweekly payments are especially easy to arrange in the era of online banking because you can set it up with a few clicks. Here’s the math if Deb were to pay her mortgage biweekly:

If Deb Pays Biweekly Instead of Monthly

Interest owed paying monthly (12 payments)	$279,013
Interest owed paying biweekly (13 payments)	208,115
BIG SAVINGS =	$ 70,898

Another round of impressive savings, just by tweaking your habits so you can afford to pay a little bit of extra money toward your mortgage. You can pay off your loan about six and a half years early by doing it this way.

Cancel PMI and Pay It toward Your Mortgage

As you know, I recommend making a 20 percent down payment on your home, but if you just couldn’t do it then you are paying private mortgage insurance. You’re entitled to drop PMI when you have 22 percent equity in the home. That means you own 22 percent of its value and the bank owns the rest. You get to the 22 percent point either by diligently making payments (and prepayments!) or because home values have risen in your area, giving you more equity.

When your bank drops the PMI premium, you should keep paying that amount, but not toward PMI—toward paying your mortgage off early. You are used to paying this amount anyway, so it’s one of those great painless strategies.

Petition Your Bank to Drop PMI

Lenders are required by law to stop charging you for private mortgage insurance when you have 22 percent equity in your home, but some have been known to conveniently forget. What’s more, if you reach the 22 percent threshold because real estate prices have gone up, you’ re going to have to prove your case. Ask your bank what proof it requires. You may have to gather comparable sales figures or hire an appraiser to determine the new value of your home. Do it! Dropping PMI is worth it.

Let’s see how this repurposed payment helps you SAVE BIG. The PMI premium on a $225,000 loan is about $100 a month. Let’s say you get to drop PMI after year 5. What would that extra $100 a month do for you if you used it to prepay your mortgage? Take a look:

Putting PMI Premium toward Prepayment

Total interest making minimum payment	$ 252,072
Total interest adding PMI funds	228,029
BIG SAVINGS =	$ 24,042

Not too shabby. By applying your previously used PMI premium to your mortgage, you save $24,042. That is pretty darn good, considering that in this example you didn’t get started making extra payments until year 6 of your mortgage.

The Logistics of Prepaying Your Mortgage

There’s no right or wrong answer if you’re choosing when to prepay your mortgage or how to come up with the extra money. Starting at any time in any amount will help you. However, there is a right and wrong way of sending in the actual payment.

Don’t Pay Somebody Else to Be Your Conscience

Your lender or an outside company may offer to help you prepay your mortgage by enrolling you in a biweekly payment program. Yes, paying biweekly is a great system, but you don’t need anybody’s help to do it. Don’t fall for this rip-off! Here’s the catch: The company charges you $400 to $600 to enroll in the program, plus as much as $40 for each payment!

Worse yet, these corporate con artists don’t send in the extra payments as you make them. They hold them either until the end of the month, or until the end of the year, all the while earning interest on your money. Plus, do you really want to send your mortgage payment—the biggest chunk of your income—to some outside company? What if the company is tardy in making your payment, wrecking your credit? What if the company doesn’t forward your payment at all? What if the company folds?

Online banking makes it so easy to create your own prepayment program. If you still use paper checks, that’s doable, too. Just add extra to your payment each month. Bottom line: Never pay somebody else for what you can do for free.

Protecting Your Extra Payments

Banks are notorious for crediting people’s prepayments wrong. What a nightmare. You make this huge push to send in extra money and then they screw it up? They are losing tens of thousands of dollars when you prepay, so don’t expect bankers to be the best stewards of your extra payments. Here’s what you can do to protect yourself.

• Contact your bank to see how it prefers that you make your prepayments. You may be required to make a special notation on your check or online payment noting that the extra is for principal.

• It’s safer to send an identical extra payment every month. That makes it easier for the bank to understand what you’re doing and easier for you to track.

• You may want to consider making your extra payment via a separate check or separate online transaction, so that it is not lumped in with your base mortgage payment.

• You should print out an amortization table from the Internet that shows how each extra payment affects your principal and interest, then check it whenever you get a new statement to make sure the bank’s calculations are in line with yours. There is an excellent amortization calculator at www.DecisionAide.com.

• Keep your online banking summaries (or canceled checks) as proof of your extra payments.

• If you do have a dispute, don’t send it where you send your payments. That’s just an automated processing center. Call the bank and get a proper address where real human beings read mail.

BIG TIPS

• Use your mortgage interest tax deduction to prepay your mortgage.

• If you are paying PMI, cancel it as soon as possible and use that amount to prepay your mortgage.

• Don’t pay some service to prepay your mortgage for you.

• Check with your mortgage company to see if it has any rules about how your prepayment must be made in order to be credited accurately.

A Guaranteed Gain