When homeowners look to answer the question "Should I prepay my mortgage?", the effects of recent market conditions come into play. We already know that millions of homeowners have very low-rate mortgages, and are said to be reluctant to sell or refinance since this would mean getting a higher rate and higher costs. But even if you're not inclined to sell or refinance, should you prepay a low-rate mortgage?

Like many financial questions, the answer is "yes, but" or "it depends." We already know that prepaying a mortgage is a guaranteed way to save money, and that there are other financially-beneficial options other than prepaying your mortgage that should first be considered.

## What can be considered to be a "low-rate" mortgage?

You may know that prepaying a mortgage brings the greatest return when the loan's interest rate is high and the term long, as routine prepayments have greater effect on total interest cost and term shortening. But what's less clear is a specific definition of a "low rate" mortgage, since technically, even the recent 7% rates we've seen are far lower than history has provided. That said, over the last 10 years (and adjusted to a zero-point "par" rate to facilitate comparison) 30-year fixed mortgage rates have ranged from as low as 2.83% to as high as 7.78%, but the dispersion of rates across this stretch of time is very unequal.

For all the headlines, over the last 10 years, mortgage rates only remained between two and three percent for about 21 weeks, held in the 3-4% range for 196 weeks and in the four-five range for 181 weeks. There were 74 weeks between six and seven percent, and the top end -- rates above 7% -- lasted only about as long as did the bottom end, with 28 weeks above the 7% mark. It's reasonable to think that considerably fewer people took mortgages when rates were more toward the high end of the spectrum, and even at their lows those rock-bottom rates were only available to the best possible borrowers, so it makes sense to use something more toward the middle as a benchmark.

Of the 520 weeks over the last 10 years, mortgage rates were below the 4% level for 220 of them, and the median rate (half of the time higher, half lower) over the same 10-year window is 4.09%, so for the purposes of discussion, we'll declare a low-rate mortgage to be one with a rate of 4% or below.

Ok, that decided -- and with the concept of "the higher the rate, the longer the remaining loan term, the greater the value prepaying brings", let's do some math.While the mortgage amount of course also matters in the prepayment equation, we'll use a $100,000 loan amount for the purpose of examples. Total interest costs can be easily multiplied to cover larger loan amounts -- you would double the total interest cost figures for a $200,000 loan, or multiply them by 3.47 for a $347,000 loan amount, for example.

## Prepaying: Higher rate, longer term is better

To help determine prepayment savings, let's first look at a loan's total interest cost.

On a $100,000, 30-year fixed-rate mortgage at 4%, a borrower would be slated to pay $71,868 in interest over the complete 30-year term.

Now, if the borrower started making a $50 per month prepayment with the very first payment, the total interest paid drops to $58,441, saving the borrower $13,457 in interest cost.

Now if same homeowner waited until five years had passed to start making the same $50 per month prepayment, beginning with the 61st month, the total interest to be paid would be $63,009, so the savings have dropped to just $8,859.

If the borrower never made any prepayments until they passed the 10-year mark and started with the 121st payment, they would be slated to pay $66,488, saving only $5,380. Still, more than five thousand dollars isn't nothing.

So there *are* savings to be had in prepaying a low-rate mortgage, but when you start prepaying becomes even more important to securing them. Wait too long and it's hard to catch up; in the case of prepaying starting at the 121st payment, you've already paid $36,336 of the $71,868 you were scheduled to pay, making total interest reduction harder to attain.

Can you start later and prepay with a higher loan amount to "catch up" with the savings you would have attained if you started with the very first payment? Yes. If you want to have the same $58,411 in total interest cost but start prepaying at the 61st month of the loan, you'll need to send in $85 per month as a prepayment -- about 70% more per payment that if you had started at the beginning of the loan. It's do-able, as they say, but not without cost.

## For prepayment savings, the loan term matters

High rates and long loan terms argue more favorably for prepaying your mortgage. Prepaynig a low rate loan with a shorter term loan can still produce some savings, but probably not enough to get excited about.

Using the same $100,000 loan but starting with a 15-year term, and using a rate of 3.5% (15-year rates are usually lower than are 30-year rates), the same $50 per month prepayment looks like this:

On a $100,000, 15-year fixed-rate mortgage at 3.5%, a borrower would be slated to pay only $28,679 in interest over the complete 15-year term.

If the borrower started making a $50 per month prepayment with the very first payment, the total interest paid drops to $26,106, saving the borrower just $2,573 in interest cost.

Now if same homeowner waited until five years had passed to start making the same $50 per month prepayment, beginning with the 61st month, the total interest to be paid would be $27,593, so the interest savings have dropped to just $1.086.

Send in an additional $5,500 over 110 months (starting with the 61st month until the loan ends as payment 171) and save about $1,100. Really not all that compelling a reward for the routine discipline needed to prepay this particular mortgage.

## Low-rate prepaying: Just okay savings, but fewer payments

While the interest savings may not be as compelling as they would be if the mortgage on which prepayments are being made had a much higher rate, there still can be some ancillary value to prepaying: A shorter total mortgage term.

In the first set of examples above (30-year FRM, 4% rate), prepaying the mortgage by $50 per month starting with the very first payment would trim the total term to just 301 months, just a month shy of cutting five years' worth of mortgage payments off the loan.

Start the same $50 prepayment at the 61st month and the total loan term would end up being 315 months -- just a little short of four years of having no mortgage payments to make. Even starting that $50 prepayment with the 121st payment (after the 10th year) still trims 32 months off the total loan term.

More payment now can mean no payments at all later, and that can have some beneficial effects on your finances later in life.

With a shorter-term loan, well, since you're already making accelerated payments (compared to a 30-year term), the term-shortening isn't as considerable. For a 15-year loan at 3.5%, the start-at-the-beginning, $50-per-month prepayment only shortens the loan term by 15 months, cutting off about 7% of the total time you'll make payments.

Start that prepayment on a 15-year term with the 61st month and the term reduction is just nine months, leaving a 171-month term total loan term.

## Low-rate prepaying: Greater value with higher loan amounts

While we mentioned previously that you can multiply total loan interest costs of $100,000 for calculating purposes, the same isn't true with prepayment savings. A higher loan amount means a higher monthly payment, and sending a small fixed dollar amount means prepaying only a little additional principal instead of a lot.

By way of example, and using our $100,000, 4% 30-year example above, a $50 prepayment is about 10.5% more than the total required payment of $477.42 per month -- but the additional $50 prepayment is actually nearly 35% more principal than the amount that is required ($144.09), at least for using the first payment on the loan as an example. The percentage of your required payment that goes toward principal reduction increases over time as the loan progresses; in this example, it starts at about 1.44% of the remaining balance in the first payment and end up at just about 100% by the 360th.

On a $1,000,000 loan amount, that same $50 prepayment represents not a 35% additional principal payment but only about 3.5%. As such, to get the same kind of percentage-based interest savings on a $1,000,000 mortgage as you would only a $100,000 loan, you'll need to send a prepayment that is 10 times more -- $500 per month rather than $50.

Of course, $500 per month isn't a modest amount, even for someone with an income that will support a million-dollar mortgage. However, even taking small nibbles each month out of that large pile of debt can bring over $16,349 in interest savings and trim 7 months off the total term. Considering total interest costs for this loan will be over $700,000, it's not much -- but even a little more than a 2% reduction in cost may still be better than nothing.

## So should you prepay a low-rate mortgage?

We've already mentioned that prepaying your mortgage is a guaranteed way to achieve savings. It is also true that prepaying a low-rate mortgage won't return the same savings as would a loan with a higher interest rate. But only some savings doesn't mean no savings, either, and to get some of those, you don't even need to commit the amounts we've discussed here.

You can round up your mortgage payment to make routine, small-dollar prepayments over time to beneficial effect.

While the answer to the question above is still "yes, but" or "it depends", those are still positive answers, so the answer is yes, you should prepay a low-rate mortgage. Even though your mortgage is likely to carry the lowest interest rate in your portfolio of debt, it could possibly have the longest term -- aka compounding period -- of those debts, so prepaying can have beneficial effect.

Of course, this is provided you have no other financial issues that would benefit from an application of more dollars, including paying down any credit card debts, investing in your (or your children's) future and more. We consider these (and other options) in "Choices Other Than Prepaying Your Mortgage", part of HSH's comprehensive Guide to Prepaying Your Mortgage.

Building home equity faster by prepaying your mortgage can help your future self. If you would like see where you are in your mortgage and reckon how much equity you have now (or will in the future), check out HSH's KnowEquity^{sm} home equity calculator and projector.