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Should I prepay, refinance or both?

Homeowners who are eager to pay off their mortgage prepay extra amounts to hurry up the process. But prepaying can sometimes become most profitable is when it's combined with a refinance to accelerate the payoff even more.

3 prepaying, refinancing options

Keith Gumbinger, vice president at HSH.com in Riverdale, N.J., explains a few ways to get the benefits of refinancing and prepaying:

No. 1: Shortening the term. If you can afford a higher monthly payment, refinancing into a shorter term can help you save substantially on interest costs.

"Shortening your term is a prepayment methodology of its own, albeit a 'forced' rather than a "voluntary" prepayment method," Gumbinger says. "Once you've committed to the shorter term, you have no choice but to make the 'additional' payment, so some future flexibility might be lost."

No. 2: Pony up some cash. If you are in a negative equity position and not eligible for HARP and are looking to rid yourself of costly mortgage insurance or want to lower your payment even more, a "cash-in" refinance might be worth a look.

"Prepaying a few extra dollars each month will help build your equity, but it's still going to be a slow haul," Gumbinger says. "You might have to bite the bullet and put in another $5,000 now to get that refinancing opportunity."

No. 3: PreFi. If your current interest rate is already low relative to market rates, the inconvenience and cost might not make refinancing "a strong compelling argument," Gumbinger says. But if you still want to save money, prepaying can help you do that even without refinancing.

"If you have a fixed rate at 4.5 percent and the best you can find in the market is 4 percent, your savings will be slight. You could say, 'It's not worth refinancing, but I'd still like to achieve a savings equivalent to refinancing.' HSH.com's PreFi prepayment calculator does just that," Gumbinger says. Just a few extra dollars per month can bring the same savings as a refinance, lowering the effective rate you pay without all the effort and hassle.

Why do homeowners prepay?

A recent HSH.com survey found that nearly 50 percent of respondents said they planned to prepay their mortgage. Here's why:

  • 34 percent said they wanted to pay off their loan sooner
  • 32 percent said they wanted to cut their interest expense
  • 23 percent said they wanted to build equity more quickly
  • 5 percent said they already refinanced but wanted to save even more
  • 4 percent said they couldn't refinance, but planned to prepay so they could still save

Respondents in the 18-to-29 age range were more likely to say they planned to prepay so they could build equity more quickly. Respondents in the 40-to-49 and 50-to-64 age brackets were more likely to want to save on interest expense and pay off their loan faster.

Why don't homeowners prepay?

According to the survey, here's why homeowners don't prepay their mortgage:

  • 40 percent said they didn't have enough extra money each month
  • 22 percent said they were using any extra money to pay other monthly bills
  • 17 percent said they were using any extra money to fund savings or retirement accounts
  • 13 percent said paying off their mortgage sooner wasn't a priority
  • 8 percent said they thought paying off sooner wouldn't make much difference

Respondents in the 18-to-29 age bracket were more likely to say they didn't plan to prepay because they were putting any extra money toward other monthly bills. Those in the 40-to-49 and 50-to-64 age brackets were more likely to say they didn't plan to prepay because they didn't have enough extra money.

Prepayment calculator

Fifty-five percent of the respondents said they have never utilized a prepayment calculator to try to figure out if prepaying made sense.

With or without a prepayment calculator, it's always worthwhile to "have that conversation (about refinancing) with a mortgage broker," says Ronit Rogoszinski, a wealth advisor at Arch Financial Group on Long Island, N.Y.

"It may not make sense or it could be a wash. But if you have a high interest rate and a good credit score and you can bring the rate down, then we are talking about dramatic dollars," she says. "You want to run the numbers and see."

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