Should borrowers prepay, refinance or recast their mortgage?

To many borrowers, a 30-year mortgage loan can look a lot like a bottomless pit: You keep shoveling money into that hole, but you don’t see it fill up much higher. While time and patience are needed to realize greater progress, of course, there are shortcuts you can take to get that hole filled faster or that require less money. These include making accelerated payments toward your principal (“prepaying” your mortgage), refinancing your loan and recasting your mortgage. Imagine you take out a mortgage loan in which you borrow $200,000 at a 4 percent fixed interest rate over 30 years. Your monthly principal and interest payment (not including property taxes or homeowners insurance) would be $954.83, and you’d pay $143,739 in total interest over the life of that loan. But say you decided to “prepay” an extra $954.83 payment once a year — applied toward your principal — equating to 13 mortgage payments annually instead of 12. This accelerated payment

strategy would result in you paying off the loan four years early and saving $22,428 in interest. “I often suggest to young buyers that making one extra payment a year can reduce their 30-year mortgage by several years and save a tremendous amount interest-wise,” says Mary Burak, Realtor with Berkshire Hathaway HomeServices California Properties in the Northridge area of Los Angeles. Pete Boomer, a mortgage executive with PNC Bank, is also a fan of prepaying your mortgage under the right circumstances. “With today’s mortgages, you have a lot of flexibility to prepay. If you can afford to do this and it doesn’t interfere with your other financial strategies, it’s not a bad idea,” he says. If you’re seeking to lower your monthly payments, a good option could be a mortgage recast. Here, you pay a single lump sum applied to your principal amount, which re-amortizes your loan, plus a small fee charged by the lender (often $200 and up). While recasting doesn’t alter your interest rate or change the length of your loan, it can result in paying less per month. For example, assume you inherited or saved up $30,000. Using the previous example, you apply that full $30,000 in one payment toward your $200,000 principal. Consequently, your monthly payment falls from $954.83 to $810.44 (more than $144 saved monthly), and you’ll pay around $20,900 less in interest over 30 years. Greg McBride, the chief financial analyst for Bankrate.com based in Palm Beach Gardens, Florida, says recasting can be a smart move for many. “Recasting allows you to translate a large prepayment into lower monthly payments without the expense of refinancing your loan,” McBride says. But it only makes sense, he adds, if you have a large prepayment amount saved up. An even better tactic could be a mortgage refinance, which involves getting a new loan to replace your current one and resetting the term. “Refinancing makes sense if you can reduce the interest rate on your loan and generate savings that offset the refinancing costs within a couple of years,” McBride suggests. “Refinancing also makes sense if you are looking to take equity out of your home in the form of a cash-out refinance or if you’re looking to remove one of the co-borrowers from the loan — such as in a divorce or breakup.” Using the scenario mentioned above ($200,000 borrowed at 4 percent), if you refinanced that amount at, say, a 3.5 percent interest rate over 30 years, your monthly payment would drop from about $955 to $898 ($57 less) and you’d save around $15,378 in interest over 30 years. Refinancing can also reduce your total interest payments if you choose to decrease your term. If you refinanced that $200,000 amount into a 20-year loan at 3.5 percent, your monthly payment would jump to $1,160, but you’d save more than $60,000 in total interest and shorten your loan by 10 years. But these strategies aren’t for everyone. Note, for example, that refinancing fees can add up to several thousand dollars, so it doesn’t make sense to pursue a refi unless you’re staying put for a few years and can recoup the associated costs. And using extra money to prepay or recast your mortgage may not be the best way to make that money work for you. “Mortgage debt is low-cost debt that ranks at or near the bottom on the pecking order of debt repayment,” McBride says. “A more efficient use of excess cash would be to pay off high-cost credit card debt, max out taxadvantaged retirement or college savings options, and even pad your emergency fund.” Chane Steiner, CEO of Crediful in Scottsdale, Arizona, echoes that recommendation. “It’s a good idea to invest money toward an emergency fund if you don’t already have one set up,” Steiner says. “If you have to make sacrifices in other areas of your budget, then you likely need to rethink paying down your mortgage early.” For better results, “meet with a financial planner and discuss savings and debt-reduction plans,” Boomer suggests.