# Lump Sum Payments on a Mortgage and Alternative Investments

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amortization of real estate loans early payoff based on a lump sum payment

This is one of the smart things you can do. Not necessarily the smartest, mind you, but smart. The question is if there's a better way to get a return on that money, wither by paying down a higher interest debt or by investing the money in a new asset. If you owe thousands of dollars on a credit card at twenty-four percent when your mortgage is at six, why would you want to pay down a tax deductible six percent instead of a non-deductible twenty four?

Similarly, if you've can earn ten percent somewhere else with the money, why do you want to pay your six percent loan down? Net of taxes, a six percent loan costs you about 4.5 percent, depending upon your tax bracket. Even if the return is not tax deferred, the net return on ten percent is somewhere over seven percent for most folks. Say you are in the twenty-eight percent tax bracket and the ten percent is completely taxed every year. \$10,000 over the course of 15 years will turn into \$28,374 if invested. If it's fully tax deferred, it turns into \$41,772. For comparison with other numbers later on in the essay, at twenty-seven years the numbers are \$65,352 and \$131,099, respectively. Not half bad.

But assuming there are no better alternatives, it is a smart idea to pay down your mortgage. Here's why: Let's say your balance is \$270,000 at six percent, and you pay your loan balance down by \$10,000. Your regular payment was \$1618.78, and it still is, but interest is \$1350 of that. Only \$268.78 would normally be applied to principal. Yeah, you've just sent them about six months of payments - but it just paid your loan down by three years of principal payments. Assuming you never sell and never refinance and never pay an extra penny again, you will be done in month 324 - saving yourself thirty-six payments for a total savings of \$58,276. Not to mention that if you do refinance, you'll pay lower fees. Not in the league of some of the alternatives above, but still a nice return on investment. Definitely beats spending the money.

Caveat Emptor

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This page contains a single entry by Dan Melson published on August 17, 2007 10:00 AM.

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