Posted by Mike Smith :: September 9, 2008 @ 5:55 am

There’s an ongoing debate about whether or not you should prepay your mortgage. The general consensus is that if extra payments could be invested elsewhere for better returns, then prepaying your mortgage actually costs you money. I’ve covered both sides: why prepaying is a good idea, and whether it’s a mistake.

When you prepay, you have a known rate of return because you basically save the interest that would have been charged if you hadn’t prepaid. You may be able to find a better return elsewhere, but must typically take on additional risk to get that better return. You also have to actually invest that extra money. If you decide not to prepay because you could get a better return elsewhere, that only makes sense if you actually do get a better return elsewhere. If you instead use that extra money to go on a shopping spree, vacation, etc., your logic will be seriously flawed.

Assuming you decide that prepaying your mortgage is a prudent option for you, the next question is how much to prepay. One simple method is to simply double the amount that you pay towards principal each month. The nice thing about this method is that the extra amount you pay each month will start small and grow over time. Presumably your income will grow over this period as well. Other methods, such as paying 1/12 extra each month, also reduce the amount you pay, but cost just as much at the beginning as they do at the end. Though payments would get easier as time goes by, making those first few payments could be rather difficult.

Paying double the principal amount has the nice effect of cutting the length of your loan in half. If you were sure that you could always make such payments, you might be better off getting a loan for half the term (a 15-year versus a 30-year mortgage, for example). While that would have the same effect, and may lower your interest rate, doing so would obligate you to pay that higher amount each month. Prepaying on a longer-term mortgage gives you many of the same benefits, but also the flexibility to stop making the extra payments if you should face financial hardship.

There are many schools of thought about how to prepay your mortgage and whether or not you should do it at all. If you decide that prepayment is right for you, then paying double principal will start simple and grow over time while allowing you to pay off your mortgage in roughly half the time.