is it better to refinance or just pay extra principal

Is It Better to Refinance or Just Pay Extra Principal?

Many homeowners face the dilemma of whether it is better to refinance their mortgage or just pay extra towards the principal balance. With mortgage rates fluctuating and home values rising, it can be a challenging decision. This article will examine the key factors to consider when deciding between these two options.

The Benefits of Refinancing

Refinancing to a lower interest rate is one of the main reasons homeowners choose to refinance their mortgage. By securing a lower rate you can significantly reduce your monthly payments and total interest paid over the life of the loan. This is especially beneficial if you plan on staying in your home long-term.

Here are some other potential benefits of refinancing:

• Shortening your loan term – You may be able to refinance into a 15 or 20 year loan from a 30 year loan to pay off your mortgage faster This can save you thousands in interest

• Tapping home equity – Cash-out refinancing allows you to access your home’s equity to pay off high-interest debt, fund home improvements, or for other uses.

• Changing loan types – You may be able to refinance out of an adjustable rate or interest-only loan into a more stable fixed-rate mortgage.

• Removing PMI – If you’ve built up at least 20% equity, refinancing provides an opportunity to cancel private mortgage insurance and save on your monthly payment.

• Getting rid of debt: A cash-out refinance lets you combine high-interest credit card debt or other debts into one lower mortgage rate.

The Drawbacks of Refinancing

While refinancing offers many potential rewards, there are some downsides to consider as well:

• Closing costs – Refinancing comes with upfront closing costs, which can range from 2% to 5% of your loan amount. These fees include origination charges, appraisal fees, and more. The costs can take several years to recoup through lower monthly payments.

• The process is long—on average, it takes 30 to 45 days to finish a refinance. The process involves extensive paperwork, underwriting, and appraisals.

• Interest rates may rise – There’s always a risk that mortgage rates will increase while you’re going through the refinance process. This could eliminate any savings you hoped to achieve.

• Impact on credit – Applying for a refinance triggers a hard inquiry on your credit report, resulting in a small temporary drop in your credit scores.

• Break-even timeframe – If you plan to move within the next few years, you may not stay in the home long enough to recoup refinancing costs and achieve savings.

The Benefits of Paying Extra Principal

As an alternative to refinancing, one option is to make additional principal payments on your existing mortgage. Here are some potential advantages:

• Pay off your mortgage faster – Additional principal payments directly reduce your loan balance, helping you shave years off your loan term. This allows you to build equity and own your home outright sooner.

• Save right away: Since extra payments go straight toward lowering the principal, you start saving right away on interest. There are no closing costs or breaks-even points.

• Flexibility: You can choose to make extra payments all at once or over time. Over time, you can change the amount further.

• No credit impact – Extra principal payments don’t require a hard credit check or application process. So they don’t affect your credit score.

• Keep your current rate – Paying extra principal allows you to maintain your existing interest rate and loan terms. This provides stability.

The Downsides of Extra Principal Payments

However, there are some potential disadvantages to be aware of with making extra mortgage payments:

• Affordability – Large extra payments may not fit everyone’s budget. Adding too much to your monthly housing costs could impact your finances.

• Accessing home equity – Paying down principal faster gives you less opportunity to tap your available home equity if needed.

• Lower savings over time – While extra payments provide immediate interest savings, over the long haul they typically save less than refinancing at a meaningfully lower rate.

• Still tied to current mortgage – Extra payments won’t allow you to adjust your loan term, type, or rate like you can with a refinance.

• Prepays interest – Some of your extra payment prepays future interest rather than just reducing principal. So savings are not dollar-for-dollar.

Key Factors in the Refi vs. Extra Payment Decision

When trying to decide whether it’s better to refinance or make extra mortgage payments, there are several key factors to take into account:

• Your current interest rate – If rates are significantly lower now, refinancing is likely to produce larger savings. But if there’s little difference, extra payments may be preferable.

• How long you plan to stay – The longer you stay in the home, the more a refinance can pay off. If you’ll move soon, extra payments often make more sense.

• Your financial goals – Refinancing offers more flexibility to tap equity or change loan terms. Extra payments focus on rapid principal reduction.

• Loan recasting options – Some lenders let you re-amortize your mortgage after making a large extra payment. This can provide rate/term changes without refinancing.

• Closing costs – Estimate your total refi costs to see how long it will take to break even through lower monthly payments.

• Affordability – Make sure you can fit higher payments from a refi or extra principal amounts into your budget.

• Rate trends – Falling rates favor refinancing, while rising rates make sticking with your current loan more appealing.

Running the Numbers

To make the soundest decision for your situation, it helps to calculate and compare actual numbers between your refinance and extra payment options.

Online calculators can provide estimates of potential interest savings, time to break even on costs, and years paid off mortgage by making extra payments. Get quotes from multiple lenders to identify the best refinance loan offer.

You can also work with a mortgage professional or financial advisor to run the numbers and provide personalized advice based on your financial circumstances.

In some cases, a hybrid approach makes the most sense – refinancing to lower your rate while also making consistent extra principal payments on the new loan. Crunching the numbers helps determine the optimal strategy.

The Bottom Line

There’s no one-size-fits-all answer to whether you should refinance or pay extra principal. It’s a very individual decision based on your current finances, future plans, and personal goals.

Doing a thorough comparison of all factors allows you to make the optimal choice. This ensures you maximize savings, pay off your mortgage on the fastest timeline, and make the most efficient use of your housing budget.