Why Prepaying Your Mortgage Is Not Necessarily the Best Idea

LATimes.com
Liz Pulliam Weston

Question: I know that it is a good idea to pay extra on your mortgage because over time you will pay off the loan sooner and save a lot of money on the interest.

But what if you are planning to sell your house relatively soon, say within three to four years? Is it still worth it?

We owe about $138,000 on the house. We are contributing the maximum on our Roth IRAs but not saving any other money except the $150 per month that is deducted from my husband's paycheck for his 403(b) workplace retirement plan.

Because of medical reasons, my husband hopes to retire in about four years, at the age of 60, with a pension. At that point we plan to sell our house and move into a smaller one. Would paying extra on the principal be a good idea in our situation?

Answer: Let's challenge your first assumption. In fact, it may not be a good idea to pay extra on your mortgage, at least until all your other financial ducks are in a row.

Too many people are making extra payments on their low-rate, tax-deductible mortgages while carrying credit card debt, student loans and auto loans. Those non-mortgage debts should be retired long before you consider prepaying your mortgage.

You also should be taking maximum advantage of your retirement savings opportunities and making sure you have an adequate emergency fund. Early retirees need to think about building up a particularly large stash, because they typically have to cover all their own health insurance costs until Medicare kicks in at age 65.

If you've taken care of your other financial needs and still want to prepay your mortgage, there's nothing stopping you. But if you sell your house before you pay off the loan, you won't be saving yourself any interest on a fixed-rate loan. You will be building up more equity, though, which can be used to reduce the mortgage you'll need on your next home.

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How Well Do You Score? It All Depends

Q: My question deals with insurance scores. As you know, many insurance companies use credit information to determine the premiums they charge.

My insurer has told me that my score is 724, which gives me a 28% discount on the standard premium. The maximum you can apparently achieve is a 35% discount if you have a score of 800 and above.

I know if you apply for a mortgage, a credit score in excess of 720 typically gives you the best rate possible. Why is this not so with an insurance score? And how can I improve my score?

A: Credit scores and insurance scores are both based on the information in your credit reports, including your payment history, the number and type of accounts you have and how much of your available credit you're using.

But the weight of each of these factors may differ. For example, the insurance scoring formula sold by Fair Isaac Co. gives slightly more weight to payment history than does the company's FICO credit score, which is typically used by retailers and mortgage lenders.

Another difference is that there is far more variation among insurers in how they use credit information. Although Fair Isaac's FICO credit score is the gold standard in the lending industry, the company doesn't dominate insurance scoring in the same way. Many leading insurers have their own custom insurance scores.

Although a 724 would be a good FICO credit score, it may be only fair to middling on the scale used by your insurance company.

You can ask your insurer if it's willing to reveal ways you could boost your score. If that doesn't work, you'll have to rely on the old credit standbys, including paying all your bills on time, not running up big balances on your credit cards, paying down the debt you owe and not applying for credit you don't need.

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