The debate over which benefits the loan holder more, “Refinance or Extra Mortgage Payments”, is a very complex matter. Complex and unless the mortgagee has a good mathematics capabilities very over-whelming. The opinion of this side of the debate held by the author is to always make extra mortgage payments. Be the amount of the payment only a few dollars to a full extra payment of the total coupon amount.
Depending upon the discipline of the payee it can be said that keeping with existing or refinance is a better approach. Assuming you have poor habits when it comes to paying bills a fixed amount is best in a forced payment schedule. People who have a firm grasp of their finances will most times take advantage of accelerated payment schedule to more rapidly lower the outstanding balance.
Most importantly a plan involves calculating all different aspects of a payment plan to determine which best fits into your current and forecasted financial situation. Historically as we advance in a career path our income advances proportionately allowing for increased payments to satisfy all outstanding loans. Beginning first time home buyers will opt for lowest percentage interest (APR) allowing for a larger dollar value mortgage at a similar monthly payment. Starting with a low teaser rate in a “balloon” mortgage, where the interest rate can increase rapidly after a few years and/or the full amount is due and payable at the balloon date. Many loans allow for interest only payments in the beginning.
Refinancing a loan can be calculated and amounts of interest and principle determined over the life of the loan. It is normally found an improvement to a lower interest rate of 1% or more is beneficial. It must be documented and figured into the dollar value if closing costs and other fees are to be included.
Best advice is to use a computer program or a financial calculator to place all of the variables into the equations where all the values of interest and principle are shown. Many will illustrate each year of the loan term so it is easy to compare various percentage rates and term lengths.
To avoid getting trapped in a large loan payment should hard times befall should a job loss occur, the smallest payment level is advised at the longest term and smallest interest rate. So refinancing into those areas is well advised.
Example of lower rate: $10,000 at 3% = $25.00/month interest whereas at 4% = $33.33/month giving a difference of $8.33 at the first month so for a $100,000.00 mortgage would be $83.33 not removed from the principle or a difference of over $900.00 per year. If monthly payment were $500.00 the decrease in principle the first month would be $250.00 and $166.67 respectively resulting in a running balance of $99,750 versus $99,833.33. A calculator or computer driven program will process these numbers to the completion of the mortgage. To balance these numbers off an additional payment of 20% or $600.00 increases the deduction from the principle of $100 or $266.67 for the 4% rate lowering the balance to $99,733.33. The next month would have interest on the remaining balance to $249.38 versus $332.45 or a difference of $83.07 closing the gap by $0.26 over the $100.00 added payment, not much however this increases rapidly and the balance drops rapidly as well. If the closing costs were folded in to reduce the rate it may well be over $1,000.00 or ten to twelve added payments made to the existing loan. Continuing to show how the reduction accelerates the balance at month two is $99,499.38 versus $99465.78 respectively so the $200.00 added payments accelerated the balance reduction of $16.16 month #1 and total of $33.60 month #2. The magic of compounding can result in the loan being paid off fully in 6 to 9 or more years sooner depending upon the additional payment and difference in interest rate.
Quick calculations on my HP-10B Business Calculator present the following:
Loan Amount – $100,000 Interest Rate 4% 30 Years P&I $477.42/month. Equals a total payout of $171,871.20
Loan Amount – $100,000 Interest Rate 4% 30 Years P&I $577.42/month. Equals a total payout of $149,401.65
Adding $100.00 extra per month lowers the amount paid by $22,470.00 and only 21.5 years to pay off.
Loan Amount – $101,000 Interest Rate 3% 30 Years P&I $421.60/month. Equals a total payout of $151,776.00
So the 4% loan with an added $100 per month would save $2375.00 over the terms of the loan versus 3% at 30 years.
One reason we have added the $100 per month and why a 20 year loan at 3% could not be made is the numbers do not allow for the applicant to pay over $500.00 per month on the basis of their income. To really take advantage of the compounding of added payments refinance to a lower rate 1/2 to 1% and further pay down extra each month or 13 payments per year versus the standard 12 payments. Before signing any mortgage be sure you are open ended on advancing payment or early payoff without a penalty.
Any reputable finance servicing organization will gladly calculate any of these possibilities for an applicant. These are accomplished with a few minor key strokes and a printout possible. Information in a plain format as above will allow for informed decisions.