Pay a Lump Sum to Cut Mortgage Time Frame?

By Dr. Don Taylor, Ph.D., CFA,

Dear Dr. Don, We have a 15-year mortgage and want to know the effect of making a lump-sum payment of, say, $25,000 on a $76,000 note. The loan is in its first year of a refinance with 14 years remaining at an interest rate of 3.25%. The reason we are considering this mortgage prepayment is to make the elimination of the mortgage coincide with retirement in 2020. Please, share your thoughts.

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Thank you, -- Chris Conundrum

Dear Chris, I think it's a great goal to have your home loan paid off by the time you retire. Making a big additional principal payment, as long as you don't have a mortgage prepayment penalty, will shorten your loan substantially and reduce your total interest expense. You can use the amortization schedule on Bankrate's mortgage payment calculator to determine both the new loan term and the interest savings.

Since you just refinanced last year, you have a great interest rate on your loan -- only 21 basis points more than Bankrate's national average of 3.04% for a 15-year fixed-rate mortgage. A basis point is one-hundredth of 1 percentage point. My rule of thumb in making additional principal payments is to do it when you expect to earn less after-tax on your current investments with the money than you would pay after-tax on your mortgage.

How's that $25,000 invested? If it's in a bank earning next to nothing, then it can make sense to make the lump-sum payment. If you're doing all right in the market or elsewhere, then consider making smaller additional principal payments each month versus writing that $25,000 check now. Adding $275 per month in mortgage prepayment will get you to about the same place that writing that $25,000 check will do, although by my estimate, both would have the mortgage paid off in 2021, not 2020.

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