Should you prepay your mortgage?
Prepaying your home mortgage can significantly decrease the interest you pay on your home loan. While mortgage interest is tax-deductible, you only receive a portion of your payment back in the form of tax savings.
Consider This Example:
Suppose you take out a $100,000, 30-year fixed-rate mortgage with a 7% interest rate. The monthly payment would be $665. If you added an additional $234 to each payment, you could pay off the loan in half the time: 15 years. You would reduce your total interest expense by $7,719.
Why not take out a 15 year mortgage in the first place? While the interest rate on a typical 30 year loan is usually higher than it is on a 15 year mortgage, the monthly payment is less. That gives you the flexibility to make extra payments when you can afford to, but fall back to the minimum payment when unforeseen events occur, such as an illness or the need to replace a big-ticket item.
Before you begin making additional payments on your mortgage, you should review all your debts. If you have outstanding credit card balances or other high-interest personal debt, it probably doesn't make sense to pay down your tax-deductible lower interest mortgage until those debts are retired.
You should also consider establishing an adequate emergency fund-generally three to six months of living expenses, before you prepay your mortgage. That's because it may be difficult to tap into your home's equity without selling your home if you become unemployed or disabled.
Look Before You Leap Into Refinancing
Often, the Federal Reserve will cut interest rates. Refinancing your debt at a lower interest rate may give you extra money to invest, let you payoff your debt sooner, or simply give you some extra spending money. However, your decision to refinance should be based on more than a lower monthly payment. Before you refinance, take a hard look at these areas:
Calculate your breakeven period: the length of time it takes you to recover the costs a lender typically charges to refinance your mortgage. To do this, divide your closing costs by your monthly savings (your current loan payment minus your new loan payment). If you plan on selling your home in the near future, it may not save you money to refinance because it usually takes several years to recover your closing costs.
Before you payoff your existing loan, check for an early payment penalty clause. Your note agreement will spell out the exact terms of the prepayment penalty, if any, or you can check with your lender. A prepayment penalty will lengthen your breakeven period.
Term Remaining On Your Loan
To save interest, avoid stretching out your total loan period when you refinance. If you've been paying for ten years on a 30 year loan, and you take out a new loan with a 30 year term, you will increase your total payoff period to 40 years. Instead, consider making your new loan term coincide with the remaining term of your old loan, in this example 20 years.
Another alternative is to continue making the same monthly payment toward your new 30 year loan. If you do that, you'll pay off your loan in a shorter period of time. Either way, you'll save a substantial amount of interest on the combined loans.
Whether refinancing makes sense in your particular situation depends on a number of factors. Give us a call to review how refinancing may affect your financial plan.