Homeowner seeks advantages by prepaying the mortgage
Q: I read that making an extra payment once a year will help reduce interest payments on a mortgage. Can you explain how this works? Is it better to pay a little extra every month that add up to an extra payment over the course of a year, or just pay it all in one lump sum?
R.M.G., via e-mail
A: It's true; with just a little extra money, you can shave tens of thousands of dollars from your mortgage. How much? Audrey O'Dell, educational editor at True Credit, a financial-education company in Chicago, calculates that you could pay off a 30-year mortgage in 24 years and 9 months by kicking in one prepayment each year.
Your regular monthly mortgage check usually is divided up several ways - to cover not only interest and principal, but home insurance and tax payments as well. But any extra payment, which Ms. O'Dell calls a "mortgage prepayment," goes entirely toward paying off principal.
There are several ways to accomplish this. You can pay a little extra in with each monthly payment, or just send in a 13th payment once a year. You also might be able to make arrangements with the lender to pay biweekly, which accomplishes the same task. Check with the lender for its calculation on which method works best. And ask about any fees they might charge to either set up or maintain this service.
Q: An analyst with my bank has recommended annuities, but I've also read a lot of negatives about them. Can you comment on the pros and cons, also on their safety?
J.G., via e-mail
A: There are two general types of annuities - immediate and deferred. From there they separate into endless varieties.
With an immediate annuity, you pay a lump sum of cash to an insurance company and it promises to provide you with a monthly income for a period of time, such as 10 or 20 years, or your lifetime.
From there, you will find two main subcategories: fixed and variable.
An immediate fixed annuity gives you a the same amount of money for the duration of the contract. But this income does not increase with the cost of living. According to Bert Langdon, a certified financial planner in Houston, now is probably not a good time to purchase an immediate fixed annuity, because you would be locking in an income stream based on today's low interest rates.
With an immediate variable annuity, payments change depending on the performance of underlying investments in the account. In this case, your income stream has the potential to keep up with, or outpace, inflation. But your monthly payment can shrink if the investments falter. These annuities also carry higher expenses that will reduce your returns.
Then there are deferred annuities, also available in fixed and variable form. Here, you can invest over time or with a lump sum, and let the money grow on a tax-deferred basis.
Mr. Langdon says pros here include tax-deferred compounding, plus control over when income taxes on investment earnings are paid. On the other hand, he notes that earnings are taxed at ordinary income-tax rates, which can be considerably higher than the 15 percent rate on dividends and long-term capital gains from stock ownership.
Fixed annuities are generally considered safer than variable annuities because the issuing insurer guarantees them.
But Langdon notes that variable-annuity subaccounts are segregated from insurers' general-account assets and are not subject to the claims of creditors should the company fail.