Does Prepaying a Mortgage Make Sense?
Or not?

Repaying a mortgage has a financial effect much like buying a bond -- with your return being the after-tax interest cost you avoid paying on the mortgage, instead of the after-tax interest you receive from a bond.

Example: If you are in the 30% tax bracket and use $1,000 to...Prepay $1,000 on a 6% mortgage, you will avoid having to pay $42 after tax annually ($60 x 70%) on the $1,000 for the remaining term of the mortgage. So your return is $42 a year.Purchase a $1,000 taxable bond paying 6% annually, you will receive $42 of interest annually after tax ($60 x 70%) for the bond's term. So your return is the same $42 a year.

Before prepaying a mortgage consider...If you have other, higher-cost debt outstanding -- such as on credit cards or consumer loans that accrue nondeductible interest -- you'll save more by paying them first.

If your choice is between using money to prepay a mortgage and making another investment with it, realize that prepaying a mortgage provides a secure return while most other investments are riskier. To justify investing in the riskier investment, you should expect a significantly higher return from it than from a mortgage prepayment.

After-tax return is what matters, so contributions to tax-favored retirement accounts may be better than prepaying a mortgage due to the various tax advantages they can offer.
Prepayment risk. There is downside to prepaying a mortgage in that it costs you liquidity -- you lose use of the cash used to prepay the loan, which you could otherwise keep in a savings account or liquid investments.

If it later turns out that you need that cash, and interest rates have risen from today's low level in the meantime, you may have to take out a new loan at a higher rate to get it.

And you may pay more taxes, too -- because only $100,000 of home-equity borrowing qualifies for the mortgage interest deduction. Thus, if you prepay your mortgage, the maximum amount of deductible borrowing against your home will be reduced.

Example: Your home is worth $225,000 and your outstanding acquisition loan (mortgage) is $100,000. If a need to raise cash arises, you can use a home-equity loan to borrow an additional $100,000 -- for a total (with your mortgage) of $200,000 against your home, which will produce deductible mortgage interest.

But if you prepay the mortgage balance down to only $50,000, then no more than $150,000 of total borrowing against the home ($50,000 mortgage plus $100,000 home equity) will produce deductible mortgage interest.