To Pre Pay or Not to Pre Pay - That is the Question

Q: I took a short-term job with a substantial increase in pay and would like to apply the extra money to my mortgage. Is it more beneficial to pay an extra amount each month or should I hold onto the cash and pay a large lump sum each year?

And if I make one lump sum payment annually, does it matter when I send in the payment?

A: Here's the short answer: When it comes to paying down any sort of debt, the sooner you make an extra payment to your loan, the less interest you'll pay over the life of your loan and the faster you'll pay it off. Let's take a look at how this works:

Let's assume you have $6,000 extra in cash each year to prepay your mortgage, and you have just closed on a 30-year, $200,000 fixed-rate mortgage at 6.5 percent. If you prepay your mortgage by $500 per month, you'll pay off your mortgage in 15 years, and pay $110,940 in interest. But if you make a $6,000 payment once a year, at the end of the year, it will take a few months longer to pay off the loan and you'll shell out an extra $5,000 in interest. If you make the payment in the middle of the year, you'll just about break even with the monthly prepayments. And if you pay the lump sum each year at the beginning of the year, you'll save a few thousand dollars extra.

Of course, if you have that much extra cash to prepay your mortgage and you are shopping for a new mortgage, you're best off getting a 15-year loan to start off with, because the interest rate you'll pay will generally be lower than you could get on a 30-year mortgage. But if you have a great rate now, and don't want to incur the costs of refinancing, then you should start adding an extra amount to your mortgage check each month. Just be sure you tick off the box that indicates the overage is to be put toward the remaining balance (the prepayment of the loan).

Q: I recently took out a home equity line of credit (HELOC) with a national mortgage bank. I was approved for a $25,000 line of credit but have a balance of only $3,750.

Now the HELOC is listed as a "2nd mortgage" on my home according to my homeowners insurance. That scares me, as I owe only $55,000 on my house.

Does the HELOC really have to be listed as "2nd mortgage" on my account?

A: Yes. A home equity line of credit (HELOC) is a loan that uses the property as collateral. The lender correctly took out a lien against the property, and is listed as the second mortgage holder, meaning that if you default against both of your loans, the primary mortgage lender gets first dibs on any equity. Once the primary mortgage lender is paid off, the second mortgage lender gets to dip into the equity generated by a sale to get paid.

I'm sure your loan specifies this. Please read your loan documents and be sure you understand them.

Q and A By Ilyce Glink