By Linda Stern
WASHINGTON, March 20 Wouldn't it be great if you
could simply refinance your own high-interest mortgage, without
going through a bank or paying closing costs?
In a way, you can, says Keith Gumbinger of HSH.com, a
Riverdale, New Jersey, mortgage research firm. His theory is
that you can lower your effective interest rate by pre-paying
the loan. That's a strategy that might be especially useful for
homeowners who can't refinance or who have a low balance left on
their loans and can't find a refi deal that is worth its closing
Gumbinger has devised a couple of new calculators that can
help homeowners figure out how to do this and whether they want
to. One, the PreFi Calculator () will calculate the effective interest rate that results from
paying a fixed extra amount every month. The second, called the
LowerRate prepayment calculator, can determine the exact amount
of extra principal to prepay monthly if you want to hit a
particular interest rate).
To be clear, pre-paying your mortgage doesn't really lower
your interest rate. But what it does do is reduce the actual
dollar amount you pay in interest over the life of the loan, so
you end up paying the same amount in interest that you would if
you had a lower interest rate.
Here's an example: Say you have 12 years left to pay off a
30-year fixed-rate mortgage that started out at $250,000 and
carries a 6 percent interest rate. You've already paid off
$227,355 and only have $62,241 left to pay.
With such a small amount left, you'd have a hard time
finding a lender willing to write you a refi loan. Furthermore,
with closing costs running into the thousands, you'd have
trouble saving enough interest on the refinance to justify the
But if you paid an extra $200 a month, you'd burn the
mortgage two years early and save $10,925 in total interest
costs. The total amount of interest you would pay - $51,318 -
would be equivalent to the interest you would pay if your
interest rate for the remaining 12 years were 5.36 percent
instead of 6 percent.
So, you're not technically lowering the interest rate, but
you are reaping similar savings. The question is, do you want to
do that? Here are some considerations.
-- The strategy fits a narrow category of homeowner. Picture
someone who can't refinance an older mortgage, has a high
interest rate and wants to get out from under the loan to free
up cash for college or retirement.
-- The same old calculus applies: If you can make more money
investing than you can save by paying down the mortgage, you're
probably better off not paying off the mortgage early. Even a 6
percent mortgage costs only 4.5 percent a year if you're in the
25 percent tax bracket and deduct interest, says Greg McBride,
senior financial analyst at Bankrate.com. The final cost of the
loan would be even less after the deduction reduced state income
-- You will lose some financial flexibility. "When you take
liquid cash or sell other investments to pay off a mortgage,
that money's gone," says McBride. "You can't get to it if you
need it for an emergency."
-- There may be better things to do with your money. If
you've already maxed out contributions to your 401(k), your
individual retirement plan, your kids' 529 college savings plan
and your emergency fund, and you have no credit card balances,
then by all means think about pre-paying your mortgage. But all
of those are likely to be higher priorities for that extra $250
-- Having the data helps either way. It's worth using the
HSH calculator or a similar prepayment calculator to determine
how much you would save by prepaying extra principal every
month. Once you get that information, you can compare it to the
savings you would see if you refinanced instead. Ultimately,
that's what Gumbinger decided to do with his own home loan -
after running all the numbers, of course.