Prepaying mortgage principal offers best bang for buck

Savvy homeowner capitalizes on investment strategy
By: Ilyce R. Glink: Inman News
Q: I'm seriously considering paying off my mortgage. I've read several articles both pro and con, including a reply you wrote to someone with the same question. My situation may be a no-brainer, but I just want to be sure.

I'm 50 years old, unmarried with no dependents. I bought my house in 1993 for $63,000. My interest rate is 6.25 percent and I have a balance of $19,500.

My annual income is under $25,000 a year. I don't see it increasing much in the future. I still manage to save. I rarely have enough deductions to itemize on my federal income tax return. Therefore, I don't benefit much from the home mortgage interest deduction.

I've been pre-paying principal $100 monthly for about the past six years. I have enough cash on hand to pay off the balance and still have some cash left over.

Still, I hesitate to just go ahead and pay off the loan. Should I use my cash to invest in more real estate, which would increase my mortgage deduction (as well as my debt burden, of course)? I know I could invest the cash in other investment vehicles, but I'm very cynical about the stock market. What's your take?

A: First, congratulations on doing such a remarkable job of saving and building a solid net worth on less than $25,000 per year.

Your question is a good one. The primary reason people tend to pay off mortgages is to preserve cash flow. In other words, they need to free up more cash each month, and paying off the mortgage is a way to do it.

Another reason to pay off your loan is that your cash will earn a whole lot more than just sitting in a bank earning 1 percent or 2 percent interest. Why? Your interest rate is 6.25 percent. When you pay off the loan, your cash will actually earn your net rate of interest. You don't itemize, so each dollar earns 6.25 percent when you prepay your mortgage.

Once you pay off your balance, you will be able to rebuild your savings quickly by banking your mortgage payment (plus the $100 extra) each month.

On the other hand, some financial advisors would advise you not to pay off your mortgage because the interest rate is pretty low. Instead, they'd advise you to invest it in either stocks or real estate. The trick is, you'll have to find an investment that is earning in excess of 8 percent per year in order to get the same post-tax bang for your buck as prepaying your mortgage.

If you decide to invest in real estate, you'll want to find someplace relatively close by for your first property. Look for something you can fix up on your own, easily rent out, and that hopefully will appreciate in the future.

Investing in real estate now is kind of tricky in many areas because of the steep appreciation over the past 15 years. That could change in some areas, which would work to your advantage. If your neighbor is having financial trouble, for example, you may be able to buy his or her house for a little cash and take over the payments.

Q: My ex-husband and I purchased a timeshare many years ago. When we divorced, the timeshare was forgotten about and was therefore never addressed in our divorce mediation. We used our timeshare one time. I thought that he was keeping up with the payments but apparently not.

I received a summons today that a lawsuit is being filed against us and that we owe an amount close to $5,000. I cannot afford a lawyer. I did try to contact the timeshare's lawyer when we were first contacted, but did not get any response. I just want to know what can happen in my situation. Thank you so much.

A: It's unfortunate that neither you nor your husband remembered the timeshare in your divorce settlement, and that you never checked to see if the annual payments were being made.

Now, you've got a much bigger problem. You do owe this money and because the timeshare company has filed suit against you, it will start to affect your credit history and credit score - if it hasn't already. (You can check your credit history for free at AnnualCreditReport.com, and purchase your credit score there for around $6.95.)

You must answer the lawsuit and contact your ex-husband to work out how you are going to pay off this debt. You must also figure out how you and he will sell (or if you can't sell, then somehow unload) this timeshare.

The summons should tell you when you need to show up at court. If it doesn't, you can call or stop by the courthouse and look up when you need to be there. If you can't afford an attorney, you might want to consult with one for an hour or so, simply to learn what you'll have to do to defend yourself.

Or, if you truly don't have a dime, you may want to contact your local legal aid society.

So many people have written to me about timeshares over the years. Caught off-guard while seeking a free lunch, they sign papers thinking they'll use the timeshare for years to come. While some vacationers do like going back to the same place year after year (or can trade their timeshare for one in other places), many people regret their moment of financial indiscretion for the next 10 years.

The best advice I can give anyone about timeshares is this: If you're invited for a "free" lunch, leave your wallet, checkbook and credit cards in the hotel room safe - and don't sign anything.