Dear Marie: As an attorney, I'm a little confused by your recent column on mortgage pre-payments. If I keep pre-paying, do I ever have to pay any interest?

You are not the only one who has asked this question, so let me run through the process again. Pre-payment is legal and it does allow you to avoid some major interest payments, but oh, yes, you do have to pay interest. Just remember that as long as you pay off any part of the principal before the due date, you don't have to pay interest on those portions prepaid. For instance, if you decide to pay off the entire loan tomorrow, obviously, you wouldn't expect to pay 30 years of interest as well.

First, let me show you a typical amortization chart for a 30 year, $100,000 loan at 8.0% interest: (NOTE - the monthly payments shown below do not include taxes and insurance escrow amounts)

When you sign the note/mortgage, you are obligated to make 360 payments to the lender. You can make those payments monthly for the next 30 years, in which case, your payment will always include accrued interest on the unpaid balance of the loan, and you will have paid nearly $164,000 in interest alone. Or you can pre-pay some of the principal and avoid a lot of those interest charges.

Here's the trick to pre-payments: Make payment #1 of $733.66 which is the principal payment plus accrued interest. At the same time, include a separate check, marked Extra Principal Payment #2 for $67.54. You do not have to include interest on this payment because you are paying it in advance.

Next month, make your regular payment of $733.76 which is now Payment #3 and at the same time, include a separate check marked Extra Principal Payment #4 for the principal portion of 68.44.

At this point you have lived in the house for two months and made four payments totalling $1603.5.0 Under the traditional method of paying, you would have paid out $2935.04 over four months to accomplish the same thing. In both situations, your equity build-up (principal repayment) is $364.64. However, by pre-paying, you've saved $1331.54 of interest.

Even if you plan to live in your house just a few years, you'll realize a savings and a return on your investment. As you make payments, more money goes to paying the principal. Thus, it's to your advantage to advance into the payment schedule as quickly as possible in order to maximize the effectiveness of your regular monthly payment. Remember, you must always make that regular monthly payment of $733.76.

More than 90% of the real estate loans out there allow proper pre-payment. Notice that I said "proper pre-payment." Lenders have options which they can exercise to their benefit if you don't clearly indicate how to apply the extra money. Obviously, it is to your benefit to pre-pay on the front-end, not the back end of the loan.

Three Rules

1. You must write out 2 checks. Label one as "regular payment" and the other as "extra principal," (otherwise your lender might credit the additional amount to your escrow account).
2. You must pay in advance. So, if your regular payment is due on the 1st of the month, get in the habit of mailing your payments about the 25th of the preceding month.
3. You must keep copies of your checks for proof. Be sure to verify the lender's principal balance at least once per year. If your bank does not return cancelled checks you may need to open a new account that does.

The days of borrowing heavily are over. Paying off the mortgage loan not only reduces your indebtedness but it also increases your net worth.

Marie S. Spodek, DREI, GRI is a highly regarded real estate educator and author. Her seminars have been attended by thousands throughout the U.S.