Many people who are interested in paying off their mortgage wonder which is better for them: refinancing or making extra payments.
Knowing which would help you better in the long run can be confusing.
Fortunately, this article should help provide some much needed insight.
Most people refinance to take advantage of lower interest rates compared to their current rates.
Borrowers should typically refinance to reduce the rate if the rate they will get from their savings will cover more than the refinance costs over the time the borrower expects to be paying for the new loan.
If this isn’t the case, then making extra payments is absolutely recommended.
While refinancing helps people take advantage of better interest rates, prepayment decisions are often viewed as investment options.
The funds that could be put towards extra payments are/or could be invested in CDs, bonds, or other assets that would earn some return.
Instead of these options, extra funds are put towards a reduced mortgage debt in which the borrower can gain an equal return on said mortgage rate.
This might sound strange, but it is entirely possible.
Say if you are paying 5% on a debt, and you pay it off, the funds used towards that goal earn 5% back.
Typically, a borrower should make extra payments if the mortgage rate exceeds the rate of return on the assets the borrower would otherwise hold, such as CDs, bonds, etc.
As is the case with most situations concerning mortgages, your situation and the factors involving your loan should be considered individually before you make a decision.
It is my hope that you will find this article helpful in helping you find the right choice for your situation.
So, let’s go back to complete payoff versus refinancing.
Let’s take a look at our first situation.
If the borrower has a considerable amount of assets that they could put towards their mortgage payments, as well as an opportunity to lower their mortgage financing cost by refinancing, then they should pay off the loan with this logic:
If the return on the assets used to fund said payoff is below the rate on the mortgage after refinancing, they should pay off the loan.
However, if this is not the case, then they should more than likely look to refinancing their loan.
Let’s run through the numbers on this one:
Say the mortgage rate is 4%, and the assets used to fund the loan repayment plan give 3%.
Comparatively, the borrower could refinance to get a 3.25% on their interest rate that would be profitable over ten years.
In this case, it makes sense for the borrower to pay off the loan, as the 3% cost is less than the 3.25% offered on the refinancing.
However, if the borrower is earning 4% on the assets they might put towards the loan, these assets should stay untouched and they should consider refinancing.
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There are cases where a borrower can consider doing both early payoffs and refinancing on their mortgages.
In this case, it depends on the profitability of either scenario.
It should be noted that doing both can affect the other, and borrowers should educate themselves before attempting both in the same setting.
A refinance option that lowers the rate of return on future payments could entice the borrower to stop early payments, as they feel they are getting a better deal.
The main point of extra payments, however, is to get of debt more quickly.
A refinance will not accomplish this feat, even if you do get a much better deal on your mortgage interest rates.
Any planned extra payments that borrowers expect to be making in the future should be considered in the refinance decision process.
Extra payments are a great way to reduce the life of the loan in total.
This can reduce the benefits of a refinance for many, unfortunately.
Calculating the pros of a refinance, you should be ready to calculate the new length of the loan to help you better plan on the benefits of extra payments.
Let’s say you plan on refinancing on a 30-year loan.
Extra payments would make it so that loan could be paid off in 20 years, instead of the initial time period expected.
In that case, you would plan on 20 years as your loan period.
On the other hand, if the lower refinance rate does incense you to stop making extra payments, you would need to expect the longer loan period.
When it comes down to it, the question of extra payments versus refinancing comes down to your individual situation.
Whether you have assets you can put towards paying off your mortgage faster, could benefit from a lower interest rate, or both, you do have options.
Ultimately, it comes down to the profit you could be making off the situation as well as how quickly you want to get out of debt.
The profitability on your assets can either be a huge benefit towards making extra payments, or could be put towards other ends.
As you now well know, refinancing can mean lower mortgage interest rates, though it won’t get you out of debt any faster than your initial loan period.
Determining what will work best for you can be challenging.
I sincerely hope this article points you in the right direction.
What do you think?
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