Let's assume first that you have a fixed-rate mortgage, and you want to send in extra money to pay your debt off faster than originally scheduled.

You can't do that with an adjustable rate loan, by the way. Yes, you can pay the debt off faster, and reduce the total amount of interest you owe, but you won't take any years off the term of an ARM. Instead, next time your loan is readjusted, you will indeed have a smaller debt, and your new payment will be set lower than it would otherwise have been.

But the term of your loan will remain the same. Even if at some point you owed only one dollar in principal, you'd be required to send in monthly payments, perhaps of five cents, or whatever it would take to stretch the term all the way to the end of your 25 or 30 years.

Of course at that point, and probably long before that, you'd have simply sent in the small remaining principal for an early payoff.

But with a fixed-rate mortgage, once you whittle down the principal, you owe less interest, and with your payments staying level, more can go toward reducing the remaining debt each month than was originally planned. Sending in the equivalent of one extra full payment each year, with instructions that it be used entirely to reduce principal, can cut a 30-year loan down to less than 23 years.

If you do send in extra prepayments, write them by separate check, clearly marked as principal reduction. Then double-check the statement you must receive at least once a year, to make sure the money was properly applied, and not just stashed in your escrow account.

Don't worry about losing some of your income tax deduction for mortgage interest. It's never worth spending money just to get a deduction.

So does it pay to invest your extra cash in your own mortgage? The answer depends on what you'd do with that money if you didn't send it to the lender.

Look at it this way: if you have an 8% loan, every extra $100 you use to reduce the principal saves you $8 a year from then on. Guaranteed 8% return, no risk, sure thing.

If money burns a hole in your pocket, and you'd only spend it otherwise, then it's an excellent form of enforced savings, because it'd be hard to lay your hands on that money in a hurry.

But if you think you could get a better return in the stock market, you might prefer that as an investment, provided the risk doesn't keep you up nights.

And if, on the other hand, you regularly carry a balance on your credit card, at a cost of 13% annually, then have I got a deal for you! Thirteen percent guaranteed return, probably the best place to invest your spare cash.

Related Articles:

Published: May 20, 1999

Use of this article without permission is a violation of federal copyright laws.