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Do-it-yourself refinancing

 

If your goal is to pay off your mortgage early or reduce the amount of interest you're paying over the life of your loan, you may be better off making extra payments to your principal than starting over with a new loan.

HSH.com has developed two new calculators that can help you decide how prepayment can be valuable.

"The PreFi Calculator might be a compelling tool for someone who has a small loan balance, someone with less than 10 years left on their loan, or someone who can't qualify for a new mortgage," says Keith Gumbinger, vice president of HSH.com. "If you have a loan at 6 percent interest you might think you should refinance into a lower rate, but refinancing is not convenient and it's not free. You can use the calculator to compare how long it would take and how much you need to pay each month to kill off a chunk of interest and get nearly the same effect on total interest cost as refinancing."

If you're interested in achieving the effect of a specific lower rate, for example moving from a rate of 5.25 percent to 3.75 percent, you can use the LowerRate Prepayment Calculator to determine how much more you need to add to your monthly payment to reach the same level of interest savings.

Gumbinger says extra payments should be made separately and denoted as a prepayment with your loan number to be certain the payment is credited.

Your loan balance is too small

Doug Benner, a senior loan officer with Embrace Home Loans in Rockville, Md., says borrowers with a larger loan balance can often qualify for a "no-cost" refinance in which the lender pays the closing costs and you'll pay 0.125 or 0.25 more on your interest rate.

"If your loan balance is too small it's hard to find a lender who will do a no-cost refinance because they just won't make enough money off the loan," says Benner. "In that case, it makes more sense to prepay your loan instead of paying to refinance."

Refinancing costs about two percent of your loan amount or more in some areas, so even if you qualify to refinance you may not want to spend that cash, says Gumbinger.

"If you can't refinance because your balance is too low or for some other reason, then prepayment is a good idea," says Benner. "A prepayment calculator can help you figure out how much to pay each month to reach a specific goal."

It's just not worth it

Gumbinger says borrowers who refinanced into a 4 percent loan last year may be tempted by a 3.5 percent loan but decide it's not worth it to refinance.

"If you took the cash you were going to spend on closing costs and apply that to the principal balance, then you may be able to achieve close to the same impact as a refinance," he says.

For example, if you refinanced your $50,000 mortgage balance in May 2012 to 4 percent on a 15-year loan, it would cost approximately $946 to refinance. If you made a lump sum payment of $946 you could achieve the same effect as lowering your balance to 3.82 percent. If instead you paid that $946 over the remaining 167 loan payments at $5.67 per month, you could effectively lower your rate to 3.89 percent without refinancing.

Disadvantages of prepayment

"Prepaying your mortgage will indeed save interest costs, but it may negatively impact net worth," says Rich Arzaga, founder and CEO of Cornerstone Wealth Management in San Ramon, Calif. "You may be better off putting more money into your retirement investment rather than paying down your loan."

Arzaga says that prepayment of your loan provides a guaranteed return on investment equal to your interest rate, such as 5.5 percent on a loan with a 5.5 percent mortgage rate.

"But if a borrower's growth earned on additional 401(k) contributions is 7 percent, then the client has lost 1.5 percent by prepaying. Over time, this is significant."

Instead of putting extra cash toward your loan balance, Arzaga says homeowners should first consider whether they should be saving more for retirement, paying down credit card debt or buying life insurance, disability insurance or long-term care insurance with the money.

If, however, you have all those expenses covered and would like to retire your mortgage faster, then prepaying your loan could shave years off your loan and save you thousands.

"It may seem counterintuitive, but paying more each month to spend less over time can be a smart move," says Gumbinger.

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About the author:

Michele LernerMichele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.

 

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