Extra principal payments likely to bring peace of mind in retirement
Q: I'm 42 and have 27 years left on my mortgage. Based on the payment schedule, by the time I get down to $12,000, the payments will be almost entirely principal and most of the interest will have been paid off. Isn't this generally the case with all mortgages? I've struggled to understand whether it's advantageous to make extra principal payments and take years off the mortgage, but as far as I can tell, I pay the same interest either way. Is there any benefit in doing so?
S.H., Rockland, Maine
A: Yes, indeed, payments at the beginning of a mortgage mostly go toward interest with just small amounts of principal included. But with every payment, the amount of interest paid decreases and the amount of principal paid increases, says Bobbie Munroe, a certified financial planner in Atlanta. So at the end of your mortgage term, most of the payments will be principal with very little going to interest (because the loan balance on which you are paying interest is so much lower).
Additional principal payments during the life of the mortgage will reduce the number of payments you need to make, and your mortgage will be paid off sooner. This means you'll pay less interest over the life of the loan. The amount you save depends on how much you increase your principal payments. If you can afford to pay more, do so, advises Ms. Munroe. Many people might worry that they are losing a good deduction. But most people prefer the peace of mind afforded by a mortgage that is paid in full.
As it stands, you won't pay off the loan until you're 69 years old. Since income usually falls in retirement, it often is attractive to have the mortgage paid by then.
Caution: Sometimes, mortgage lenders don't properly apply additional payments. If you do make an additional payment, Munroe suggests that you monitor its application to be sure it's done correctly. Some financial websites, such as Bankrate.com, have online mortgage calculators, which allow you to print out an amortization schedule that shows you what the principal balance should be after every payment. Compare this to the numbers produced by your mortgage company to make sure they are on track.
Q: Can funds in an IRA be used for college education without incurring the penalty for early withdrawal or the tax effect?
P.S., College Station, Texas
A: Yes to the penalty, but no to the tax impact, says Wayne Starr, a certified financial planner in Kansas City.
Tapping IRA funds to pay for qualified higher education expenses is one of several exceptions to the 10 percent tax-penalty rule for withdrawals made before age 59-1/2. But the distribution is subject to ordinary income tax. If enough money is involved, you could jump into a higher tax bracket, he says.
The distribution can be used for qualified higher education expenses incurred by you, your spouse, your children, or your grandchildren. Those expenses include tuition, fees, books, supplies, and equipment required for the enrollment and attendance at an eligible educational institution. These institutions include colleges, universities, and vocational schools.
If your need for education funds does not occur for a few years, you could consider investing in a Coverdell education savings or custodial account, Mr. Starr says.
Coverdell accounts replaced the old Education IRA and allow contributions of up to $2,000 annually. Contributions can be made by anyone, but they're subject to earnings limitations and they are made with after-tax dollars. But withdrawals and the growth on the deposits are free of income tax when used for qualified higher education expenses.
You can open a Coverdell account at many banks and credit unions. And you can call your state treasurer for information on a 529 plan, another popular education investment account that allows tax-free withdrawal of earnings and, in some states, grants a tax break for contributions.