Many mortgage borrowers are unsure of which option would benefit them more, considering both refinancing and additional payments as options. This article is directed to them.
Deciding whether to refinance or pay extra principal on your mortgage can be a complex decision, and the answer depends on several factors. Here’s a breakdown of the pros and cons of each option to help you make an informed choice.
Refinancing: Pros and Cons
Pros:
- Lower interest rate: Refinancing to a lower interest rate can save you a significant amount of money over the life of your loan. This is especially true if you have good credit and can qualify for a low rate.
- Shorter loan term: Refinancing to a shorter loan term can help you pay off your mortgage faster and save on interest. However, this will also increase your monthly payments.
- Lower monthly payments: Refinancing to a longer loan term can lower your monthly payments, making it easier to manage your budget. However, this will also increase the total amount of interest you pay over the life of the loan.
- Cash-out option: Some refinances allow you to take out cash from your home equity. This can be a good option if you need money for a major expense, such as home renovations or debt consolidation.
Cons:
- Closing costs: Refinancing typically comes with closing costs, which can add up to thousands of dollars. These costs can offset the savings you get from a lower interest rate, so it’s important to factor them in when making your decision.
- Credit score impact: Refinancing can have a small negative impact on your credit score. This is because it involves a hard inquiry on your credit report.
- Risk of higher interest rates: If interest rates rise after you refinance, you could end up paying more in the long run.
Paying Extra Principal: Pros and Cons
Pros:
- Save on interest: Paying extra principal on your mortgage can save you a significant amount of money on interest over the life of your loan. This is because you’ll be paying off the principal balance faster, which means you’ll be accruing less interest.
- Pay off your mortgage faster: Paying extra principal can help you pay off your mortgage faster, which can save you money and give you peace of mind.
- No closing costs: There are no closing costs associated with paying extra principal on your mortgage. This means that you can start saving money right away.
- No impact on your credit score: Paying extra principal on your mortgage will not have any impact on your credit score.
Cons:
- Less flexibility: Paying extra principal on your mortgage can make it more difficult to access your home equity if you need it in the future. This is because you’ll have less equity built up in your home.
- Higher monthly payments: If you choose to make larger extra principal payments, your monthly payments will increase. This may not be feasible for everyone’s budget.
Which Option is Right for You?
The best option for you depends on your individual circumstances. Here are some factors to consider:
- Your current interest rate: If your current interest rate is high, refinancing to a lower rate could save you a significant amount of money.
- Your credit score: If you have good credit, you’ll be more likely to qualify for a lower interest rate when refinancing.
- Your financial goals: If you want to pay off your mortgage faster, paying extra principal is a good option.
- Your budget: If you can afford to make larger monthly payments, refinancing to a shorter loan term could be a good option.
- Your risk tolerance: If you’re not comfortable with the risk of interest rates rising, refinancing might not be the best option for you.
It’s important to carefully consider all of your options before making a decision. You may also want to talk to a financial advisor to get personalized advice.
Additional Resources
- Bankrate: How Much Credit Do You Really Have?
- NerdWallet: How Much Credit Do You Need to Buy a House?
- Credit Karma: How Much Credit Do You Need to Buy a House?
Disclaimer
I am an AI chatbot and cannot provide financial advice. The information provided above is for general knowledge and informational purposes only, and does not constitute professional financial advice. It is essential to consult with a qualified financial advisor for any financial decisions.
Complete Payoff Versus
Refinance
One scenario is when the borrower has a sizable asset portfolio that could be utilized to fully pay off the mortgage and also has the option to refinance to reduce the cost of mortgage financing. If, after refinancing, the return on the assets used to fund the payoff is lower than the rate on the mortgage, he should pay off the loan. Otherwise, he should refinance.
Here are some illustrative numbers. The assets used to fund the loan repayment yielded a 3% yield, the mortgage rate is 4%, and the borrower could refinance into a 3% 25% mortgage that would be profitable over 10 years. In this instance, the borrower ought to settle the mortgage because the 3% interest rate is lower than the 203 25% rate on the mortgage after refinancing. On the other hand, if the borrower is earning 4 percent on the assets that were utilized to pay back the loan, he should keep the assets separate and refinance.
Extra Payment Decisions Versus
Refinance Decisions
Borrowers may refinance for a variety of reasons, but only refinancing to lower the interest rate is considered a viable option in comparison to making additional payments. If the savings from the rate reduction, over the term the borrower expects to hold the new loan, will more than cover the refinance costs, then borrowers should refinance to lower the rate. The extent of the rate reduction, the refinance costs as a percentage of the balance, and the length of the new loan are the three most crucial factors in this decision. Mortgage Refinance Calculator 3a pulls these and other factors together to quantify the savings and costs.
The prepayment decision, in contrast, is best viewed as an investment decision. The money used for additional payments is or could be invested in bonds, CDs, or other assets that yield returns. Rather, they are invested in less debt associated with mortgages, yielding a return to the borrower equivalent to the mortgage rate. Yes, you read that correctly. If you are making 5% payments on a debt and you pay it off, the money that was used for that purpose will earn you 5%. If the mortgage rate is higher than the rate of return on the borrower’s alternative assets, the borrower must make additional payments.
Because they are based on very different factors, extra payment decisions and refinance decisions should be assessed independently. Yet each may affect the other, which is why it is easy to become confused. Two situations arise where borrowers are seemingly faced with a choice between making extra payments and refinancing.
Should I Refinance Or Pay Extra On My Mortgage?
FAQ
Is it better to pay extra principal or refinance?
What happens if I pay an extra $100 a month on my mortgage principal?
When should you not refinance?
Is paying additional principal a good idea?
Should I refinance or pay extra on my mortgage?
Mortgage rates are too high to generate savings. If you can’t lower your existing mortgage rate, a refinance likely won’t make sense. In this case, paying extra on your mortgage is a better way to lower your interest costs and pay off the loan faster You want to own your home faster.
Should you pay extra principal on a mortgage?
Make extra payments each month, pay off your loan faster, and save thousands in overall interest. You will be surprised how fast the savings can add up by paying a bit more each month. So what is the effect of paying extra principal on a mortgage? 1. Save on interest
Should I make more principal-only payments on my mortgage?
One option is to make additional principal-only payments on your home loan. But you’ll need more than extra money and a desire to pay off your mortgage faster. You’ll also need to ensure that your lender allows you to make additional payments. If they do, tacking on extra payments can help with interest and shorten a mortgage’s lifespan.
Do extra payments count toward a loan principal?
Terms may apply to offers listed on this page. Payments made on a mortgage in addition to your regular monthly payment will count toward the loan principal. Extra payments can be beneficial because they apply directly to your loan principal, helping you pay off your loan faster and with fewer interest fees.