Should I prepay my home mortgage or stretch out the deduction?

Prepaying can save you a substantial amount over the life of your mortgage by reducing the total interest owed. However, by doing so you also shorten the amount of time you can claim a mortgage interest deduction on your federal tax return. Let members of the Financial Planning Association of Greater Indiana help you decide what to do. Visit the group's Web site at www.fpagrindiana.org.

Nancy Cooper Pitt

Financial Partners Group

It depends. There are financial considerations, circumstances and personal values.

Financial:

• How much money will you save by prepaying the mortgage?

• What else would you do with the money you would use to prepay?

Prepaying your mortgage can result in a significant reduction in the amount of interest you would otherwise have to pay over the life of the loan.

Would you pay off other debts, such as credit-card debt, with a higher interest rate than your mortgage? Would you invest the money? You may be able to invest it in something that could generate a higher return than the interest you would save by prepaying. For many people, it might be wise to invest this money in a tax-deferred retirement plan.

Circumstances:

• What is your age? (Are you retired or close to retirement?)

• What is your income and do you expect it to increase or decrease?

• Is your investment perspective short-term or long-term?

• Do you have an adequate emergency fund?

Personal values:

Would prepayment bring you greater peace of mind?

Some people sleep better knowing they don't owe money to others. Some with low tolerance for risk would prefer to take the sure savings from prepayment rather than the risk of return associated with an investment.

Michael D. Fields

Comprehensive Retirement Solutions

Square one in deciding whether to prepay a mortgage is to understand the cost of the money you are borrowing -- the interest rate on the mortgage.

If the rate you are paying is lower than the rate of interest or gain you expect to receive in an alternate investment, then you should invest your extra money, rather than prepay your mortgage. Naturally, there are several other issues to consider as you approach this issue:

• Are you able to use your tax deductions? A home mortgage interest deduction typically allows taxpayers to itemize their deductions, rather than take the standard deduction. However, as you approach the end of your mortgage, the majority of your payments are toward principal, and your home interest may not be contributing as much as you expect.

• Are you comfortable with the risk you must assume in the alternative investment? All investments carry risk, and if you are unwilling to live through an uncertain market to reach higher returns, this might not be a good strategy for you.

• Is the interest rate on your mortgage variable? If so, you will have to evaluate this question each time your rate adjusts.

• Do you owe more on your mortgage than your house is worth? If so, then it is usually better to pay down the mortgage until it is less than the value of your home before considering alternative investments. Also, it is a good idea to seek the advice of a tax adviser about deductibility of interest.

Michael E. Wright

Edward Jones

The answer is a resounding "maybe."

Doing a financial comparison between prepaying a mortgage or using the extra money to invest in stocks or mutual funds is a good starting point. As a general rule, the return on prepaying a mortgage is the interest rate on that mortgage. So the prepayment decision would be based on the return you could get for other investments.

For example, assume you had a 6 percent mortgage and were earning a 9 percent return from a diversified portfolio. You might continue putting money in these investments rather than prepaying your mortgage. However, if you were thinking of buying a certificate of deposit that pays 4 percent, you might be better off using this money to pay down your mortgage.

For most people, the decision to prepay is rarely purely financial, so you will want to look at other advantages and disadvantages.

Advantages:

• You might feel better having a mortgage paid off sooner.

• Prepaying a mortgage shortens the loan term, saving you thousands of dollars in interest expense.

• Ability to focus on other financial goals once home is paid off.

Disadvantages:

• Loss of tax deductions you receive from the interest payments.

• Lack of liquidity to reach other financial goals.

To determine the best course of action, I would suggest a review with a financial adviser to fully evaluate your options.

• Michael F. Wright is a certified financial planning professional.