Wednesday, September 11, 1996
Pre-Paying Your Mortgage Revisited
by MrtgLoans

Recently, I've heard some arguments for so-called "equity acceleration programs," and against refinancing. What's the right course for you? Let's look at the issue closely.

On Pre-Paying Your Mortgage

As generations of mortgage holders have discovered, making extra principal payments each month can greatly reduce the total amount of interest paid over the life of a mortgage loan (or any loan for that matter). The end results are always the same: 1) less interest is paid, and 2) the loan is paid off sooner. You do NOT need to sign up for a special "equity anticipation program" to enjoy the benefits of pre-paying any loan. All you have to do is make your monthly check (or electronic transfer) a little bigger. The extra money will automatically go to reduce your loan balance. Very simple.

On Refinancing a Mortgage

There is never a bad time to refinance IF you will keep your mortgage long enough to recover the closing costs AND realize a large enough savings to make it worth your while.

For example, if you have a $200,000 mortgage and refinance to a rate that is 1% lower than the rate on your existing mortgage, you will save approximately $2,000 in interest in the first year ($200,000 x 0.01). Closing costs should be less than $2,000 (unless the borrower chooses to pay points). Therefore, you will break-even in about one year. It is up to each borrower to determine how much money he needs to save after the break-even point to make refinancing worth his while.

It should also be noted that most lenders can pay your closing costs if you agree to take a slightly higher interest rate. In the previous example, if you were able to save 1% AND have the lender pay the closing costs, so much the better.

Conclusion

In the big picture, it is not necessarily a good idea for you to make pre-payments on your mortgage. Consider the case where you have a mortgage at 8% and a car loan (or credit card, etc) at 9%. It's not hard to figure out which loan should be pre-paid first -- the one with the higher after-tax interest rate. In most cases, you should pre-pay your highest interest rate debt first, then work your way down to your lowest interest rate debt, which is usually a mortgage. All this while Foolishly putting away money for retirement (compounding takes time).

Just the personal opinion of a Fool who also happens to be a mortgage loan officer (one who enjoys earning money by helping people save money). Cheers!

--- Chris Comella

[Editor's note: Chris has offered to e-mail an amortization schedule to anyone who writes to MrtgLoans and requests it. Please write directly to MrtgLoans rather than the Motley Fool staff.]

Transmitted: 9/11/96