Dan Green THE MORTGAGE REPORTS CONTRIBUTOR, June 7, 2019
Refinance Without “Restarting” Your Mortgage
Mortgage rates are still low and it’s a terrific time to refinance. But what if you don’t want to reset your loan to 30 years?
The good news is that you don’t have to. With a little bit of savvy, you can take advantage of today’s mortgage rates and shorten the number of years remaining on your loan. It all comes down to a financial term known as amortization (ah-mor-ti-ZAY-shun).
Amortization is the payment schedule by which your loan balance goes from its starting balance to $0 over time; and amortization can be manipulated for your benefit.
You’re in control of your mortgage and your schedule — you’re the homeowner, after all.
Current Mortgage Rates fall below 4%
According to Freddie Mac, the 30-year fixed-rate mortgages just fell below the 4% mark for the first time in a year and a half.
Homeowners are refinancing their loans to today’s low rates using a variety of programs including the FMERR loan, the FHA Streamline Refinance, and the VA Streamline Refinance.
The result of refinancing is new, lower monthly payments. These payments include a portion which goes to “loan payback” and a portion which pays interest on the loan to the bank. Respectively, these portions are known as “principal” and “interest.”
The size of your principal and interest portions change each month, based on the principles of amortization. Mortgage amortization will always favor the bank. The early years of a loan require large interest payments and include very little loan payback.
If you’ve ever looked at your mortgage statement after a few years and thought, “I haven’t paid this thing down a bit!”, you’re witnessing the effects of amortization.
If you were to borrow $300,000 from the bank at a mortgage rate of 4 percent, after 10 years,here is how much you would still owe:
A 15-year mortgage would have $123,000 remaining, or 41% of the original loan
A 20-year mortgage would have $180,000 remaining, or 60% of the original loan
A 30-year mortgage would have $237,000 remaining, or 79% of the original loan
With the 15-year home loan, your loan is more than half-way paid. With the 30-year mortgage, you’ve barely made a dent. This is one of the reasons why homeowners are increasingly thinking 15-year mortgages are better than 30-year mortgages.
It takes nearly 20 years to pay a 30-year mortgage down by half. Amortization can be bank-friendly.
Thankfully, you can use amortization to your personal advantage.
Two Ways To Avoid “Resetting” Your Mortgage To 30 Years.
As a homeowner, your mortgage is your choice and you there’s no rule that says you have to use a 30-year fixed-rate mortgage, with the exception of USDA loans which only provide 30-year financing; and jumbo loans which are typically available as ARMs only.
For everyone else, the loan you choose is up to you and, increasingly, homeowners are taking amortization into their own hands.
One way by which homeowners are avoiding the reset is by doing a refinance loan into a new, shorter term.
If your beginning loan was a 30-year loan, for example, you can refinance into a loan lasting 20 years or 15 years instead. Reducing the number of years in your mortgage will “accelerate” your amortization, and pay your loan off quicker.
At today’s mortgage rates, homeowners using 15-year loans pay 64% less interest than homeowners using 30-year loans.
That said, the payments on a 15-year loan are 45% higher as compared to a 30-year loan. This is because the loan repayment must be compressed into a lesser number of years. For many U.S. households, that kind of increase can be too much to stomach.
This is why some homeowners skip the refinance and opt to “prepay” their mortgage instead. You don’t get access to new, lower rates, but you take better control of your loan.
Prepaying your mortgage means to send “extra” payments to your lender each month, which chips away at the amount you owe faster than your amortization schedule prescribes.
If your mortgage payment is $1,750 per month, and you send $2,000 to your lender, you’ve reduced the amount owed on your loan by $250. This will cause your loan to reach its “end date” sooner.
The more you prepay, the more money you’ll save.
Best Option: “Refinance-To-Prepay” On Your Mortgage
There’s a third way to reduce your mortgage interest paid. It’s called “refinance-to-prepay”.
Refinance-to-prepay is exactly what it sounds like — you refinance your loan to a lower rate then prepay on your new loan. With refinance-to-prepay, you get access to current mortgage rates, and a quicker amortization schedule.
Here’s how to execute:
Refinance to a lower rate on your same mortgage program (e.g. 30-year fixed)
Apply your entire monthly savings to your new loan monthly as “extra payment”
Keep doing this until your loan is paid in full
The refinance-to-prepay system works because, although your mortgage rate is lower, you’re making the same payment to the bank each month. You’re paying less interest because of your lower rate and your sending bonus principal monthly.
When you refinance-to-prepay, your loan will “restart” to 30 years, but you’ll ultimately pay it off faster than had you never refinanced at all. It’s a math fact.
Here’s a real life example of how refinance-to-prepay work.
Say your current loan balance is $400,000 and you’re refinancing from the 4.75% mortgage rate you took two years ago to a zero-closing cost 4.00% mortgage rate available today. After the refinance, your payment will be $246 less per month.
Simply take that $246 savings and send it to your lender each month along with your “regular” payment.
Your “new” 30-year loan will pay off in 24 years. This is 4 years faster than if you hadn’t refinanced at all. Those four years of making “no payments” save $90,000.
Even with closing costs, the math works out. You’re spending a little, and saving a lot.
Get Today’s Mortgage Rates Now
Mortgage rates are at their lowest levels of 2019. There are millions of U.S. homeowners with mortgages “in the money.” If you refinance, you can likely do it without “losing years” on your loan.