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NEW YORK (MainStreet) — As a way to invest in your home, prepaying a mortgage has its critics as well as proponents. But homeowners who spurn this strategy in their 30s and 40s should consider it when they’re nearing (or actually in) retirement, because at that point a modest return from a prepay could look pretty attractive.

A prepay means making extra principal payments to pay the mortgage off early, generating savings through reduced interest costs. (Use the BankingMyWay Mortgage Payoff calculator to see what a prepay could mean for your home loan.) But prepayments don’t always make sense, and given today’s remarkably low mortgage rates, it’s hard to tell whether or not refinancing to a new, low-rate loan is the better option.

There’s no perfect way to know which strategy works best, as each depends on unpredictable factors like future interest rates and investment returns, but considering a few key issues can help homebuyers clear the fog.

Either move – prepay or refinance – is generally preferable to keeping an older mortgage with an excessive rate, unless you’re close to paying it off. If you’re paying 7% or 8% on an older loan, a prepay would be like earning 7% or 8%, since it would allow you to avoid paying interest on the amount you prepay. On the other hand, a refinance allows you to slash interest expenses by cutting the interest rate itself. The 30-year fixed-rate mortgage averages just 4.77%, according to the BankingMyWay survey.

Interest rates and investment returns are really the two key factors in choosing between a prepay and refi. If you could earn 10% on an investment, for example, that would make more sense than putting extra money toward your mortgage at a prepay “return” under 5%. In effect, keeping the mortgage and making regular payments would be equivalent to borrowing the extra money at under 5% interest to invest it at a 10% return, a net gain of over 5% on the amount.

During the past couple of years, this strategy could have worked well as the stock market has doubled since its low in the spring of 2009, but during other periods you would have lost money on stocks, and that might happen again in the future. In contrast, a prepay offers a guaranteed return that is equal to the mortgage rate.

Most experts measure the prepay return against those of “risk-free” holdings like U.S. Treasury securities or FDIC-insured bank savings. By this measure, it’s better to earn 4.77% on a mortgage prepay than 3.1% on a 10-year Treasury bond or 1.64% on a five-year certificate of deposit.

On the other hand, risk-free holdings could be more generous in the future. If you put extra money into your mortgage, it will be hard to get it out to invest in a more profitable alternative down the road. And over the long run, stocks have typically returned about 10% a year despite their ups and downs, easily beating a mortgage prepay most of the time.

Your age, therefore, becomes an important consideration. Homeowners in their 20s, 30s and 40s have enough time to weather dips in the stock market. For them, it may be more profitable to continue paying their mortgages while putting extra cash into mutual funds or other long-term investments. That’s almost certainly the case if they can invest in a 401(k) or a similar plan that has an employer match.

But homeowners in their 50s, 60s and beyond tend to invest more conservatively. For them, a prepay earning 4.77% would be a good alternative to bonds or bank savings, so long as they can afford to tie their money up in their houses. Being free of mortgage payments is good for one’s peace of mind, and in a real pinch a retiree can tap home equity by downsizing to a cheaper home or taking out a reverse mortgage.

Of course, a mortgage prepayment does not make sense until you have a solid rainy-day fund in reserve, typically enough money to carry your for six to 12 months. Learn more about how to set up your emergency fund on MainStreet.

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