Paying down or paying off mortgage?
...an issue several people face as part of retirement planning
As the mortgage ages, or in the latter years of its life, more funds go towards the principal and less towards interest payments.

Recently, I had a telephone conversation with a client who is contemplating paying off her mortgage early. She plans to invest the savings from the mortgage payments for retirement, to supplement her pension plan.

This client is, however, 20 years from retirement and can comfortably make current mortgage payments. So what is the reason for mortgage cancellation at this time? She has a joint financed mortgage with the National Housing Trust (NHT) and a participating financial institution. The private mortgage company increased its mortgage rates recently.

Upon requesting a statement to close the mortgage loan with the private institution, the client was alarmed, as over a period of 10 years of monthly payments only $100,000 was applied to the $2-million loan. The explanation given was that most of the payments made were applied to the interest. How do mortgages work? In the early years of mortgage payments, most of the contributions made by the borrower go towards the interest payment and less towards the principal.

As the mortgage ages or in the latter years of its life more funds go towards the principal and less towards interest payments. The client in question has a 30-year mortgage. If she chooses to pay off the $2-million mortgage early she would save $5.5 million in future interest payments. When mortgage payments are made, funds are applied to interest first then principal. Mortgage payments are made up of interest, taxes, insurance, and principal. Late fees also are deducted from mortgage payments. The debt of the borrower can increase rapidly due to late fees. If a mortgagor wishes to pay down the principal to reduce monthly payments or to shorten the term of the loan, it is recommended that the mortgagor still make the usual monthly payments. Paying down on the principal only will reduce the principal balance but the interest and other charges will still accrue. The mortgagor should always indicate when funds are to be applied as pay down on principal only as distinct from a pre-payment of the mortgage. The prepaid mortgage covers interest, insurance, and principal whereas paying down on the mortgage apply to principal only.

When should you pay off your mortgage early?

If you purchased a home for a lifetime residence, financial experts recommend that the mortgage be paid off as soon as possible. Best-selling author of Women and Money, Suze Orman says "you will never have financial freedom if you have debt". As shown in the example of my client, the longer you take to pay off your mortgage the more debt you have. You should consider paying off your mortgage early if the following situations exist:

1) Other debts are paid off first, especially high-interest debts

2) Mortgage rates are high or oppressive

3) A well-resourced emergency fund in place. Three - six months of living expenses may not be enough should there be, for example, huge unforeseen medical expenses.

4) The client mentioned earlier can close her mortgage early because she has no other debts, and has adequate financial resources. She has been a prudent saver and avid investor all her working life. With a well-diversified portfolio of short-term and long-term investments she is in a position to invest more after closing her mortgage account; even in this harsh economic environment. Her goal is to have a lifestyle of comfort in retirement. If the funds saved from the monthly mortgage payments are invested in her Equity Portfolio at BPM Financial the returns can create financial freedom and wealth in retirement.

For seniors or adult workers who are nearing retirement and have huge mortgages on their homes, it may be best to work beyond the normal retirement age; maybe another five years, and pay down the debt. Making extra payments on the mortgage while working extra years will greatly reduce the mortgage.

The strategy of paying down on mortgage early is a useful one. The decision made by individuals to pay down their mortgages or pay off their mortgages will be dependent on each person's unique situation. In planning for retirement, homeowners should pay keen attention to mortgage payment strategies. No one wants to worry about mortgage payments in retirement.

BY GRACE G MCLEAN

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