Let’s begin by defining a prepaid mortgage – on the face of it, a remarkable oxymoron. A prepaid mortgage is actually a behavior pattern that some of us engage in as an alternative to investing expendable income in the stock market, securities, treasury bonds or other financial instruments. Prepaying a mortgage is actually just making monthly mortgage payments that exceed the minimum requirements of the mortgage loan itself
The Financial Value
People who engage in this practice generally make a couple of points. The first is that with the stock market in unstable or downward trend, why put money into it when it’s at least an even chance that you’ll lose your investment? Mortgage prepayments – or overpayments – are not subject to the interest charges attached to a normal mortgage payment. Thus, says the financial reasoning, you are gaining an investment at the rate of your mortgage interest by avoiding payment of it on your prepayment sum.
If you make a $10,000 mortgage prepayment and your interest rate is 8%, you will have realized an $800 return on this investment – because it’s $800 you don’t have to pay in interest. If Treasury bills are offering 5% interest, which is the better investment? So goes the reasoning. However you also have to factor in the loss of the income tax deduction due to the one time reduction in interest. That may reduce your $800 gain to something in the neighborhood of $550 - $600, if you are among the homeowners that fall into 27% to 33% tax bracket.
So the relative value of a mortgage prepayment depends on the securities market and on your interest rate. In some circumstances it might indeed be a marginally better investment than T-bills and a much safer investment than the stock market. Six months later, the opposite may be true.
The Human Intangibles
But the second point mortgage prepayers often raise is that getting ahead on mortgage payments is a rainy day hedge. That’s an intangible that has a different value for each of us. If the family income picture is uncertain over the long term, it’s a relevant concern. Fear has been described as much like stealing, because of what it does to your well being. If the knowledge that you’ve bought some protection from monthly mortgage obligations is important to you, then that’s an investment of value as well. You won’t find a “sleepless night quotient” in any of the market analyses discussing investment options. But you’ll find it in every household that manages debt obligations, and it should carry substantial weight in your decision making.
The Decision Making Environment
In the last five years there has been a remarkable housing boom, in new purchases and in value appreciation. Prior to that, there was a similar run-up in the stock market. The gambling mentality that developed in many of us as a result of those phenomena may no longer be the healthiest way to look at your investment dollars. Prepaid mortgages have two inherent investment factors: the relative rate of return on the dollars, and the rate of return on personal comfort level. Both are valuable commodities.
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