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Should You Prepay Your Mortgage? The Pros and Cons

August 14, 2019

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Should you prepay your mortgage? For some homeowners it’s a financially savvy move—but for others, beefing up their loan payments just doesn’t make sense. To help you figure out whether prepayment is right for you, here are the pros and cons cited by financial experts.

Pro: You’ll cut down on the interest you owe

Interest is the extra fee you pay your lender for loaning you the cash you needed to buy a home. After all, lenders don’t just hand out dough for free—they’re in the business to make money.

By increasing your monthly mortgage payments—also called “prepaying” your mortgage—you’ll effectively save money in interest charges. Those savings can add up big-time.

For example, let’s say you take out a $200,000 mortgage with a 4% fixed interest rate and a 30-year term. If you continue to make your minimum monthly payments, you’d be forking over $143,739 in interest over 30 years until the debt is paid off. But, by paying an extra $100 per month, you’d pay only $116,702 in interest over a 25-year time span—a savings of $27,037.

Pro: You’ll get your mortgage paid off sooner

By accelerating your mortgage payments, you’ll also be shortening how long it takes to pay off the loan, which would increase your cash flow in the future. That’s a huge incentive for some borrowers.

“For families with young children, where the parents are concerned about paying for their children’s college tuition, sometimes we will recommend they increase mortgage payments so that when their kids head off to college their mortgage obligation is gone,” says Joe Pitzl, a certified financial planner for Pitzl Financial, in Arden Hills, MN.

Paying more money each month toward your mortgage’s principal can also give you peace of mind, says Marguerita Cheng, a certified financial planner at Blue Ocean Global Wealth in Gaithersburg, MD.

“Emotionally, it’s gratifying knowing that you’re paying your mortgage sooner than you originally planned to do,” Cheng says.

Pro: You’ll build equity faster

No matter how much money you put down on your mortgage, your home equity is the current market value of your home minus the amount you owe on your loan. So say your home is worth $250,000 and your mortgage balance is $200,000. In this case, you’d have $50,000, or 20%, in home equity.

Making larger mortgage payments toward your loan’s principal would enable you to build equity faster. Having more home equity can be a tremendous boon if you’re looking to get a home equity loan or home equity line of credit, such as to pay for home improvements, says Tendayi Kapfidze, chief economist at Lending Tree.

Pro: It helps your credit score

Showing that you have less debt—and that you manage your debts responsibly, by paying your mortgage off early—can raise your credit score. That can help if you’re planning to apply for a car loan or a second mortgage on a vacation home, since your credit score would affect the interest rate you qualify for.

Con: Prepaying reduces mortgage interest, which is tax-deductible

Because prepaying your mortgage reduces your mortgage interest, it may not make sense from a tax-savings perspective. Mortgages are structured so that you start off paying more interest than principal.

For example, in the first year of a $300,000, 30-year loan at a fixed 4% interest rate, you’d be deducting $10,920. (To find out how much you paid in mortgage interest last year, punch your numbers into our online mortgage calculator.)

Nonetheless, taking a mortgage interest deduction under the new tax law requires itemizing deductions—and itemizing may no longer make sense for many homeowners, since the standard deduction jumped under the new tax plan to $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly.

Another thing to consider: In the past, you could deduct the interest from up to $1 million in mortgage debt (or $500,000 if you filed singly). However, for loans taken out from December 15, 2017, onward, only the interest on the first $750,000 of mortgage debt is deductible, says William L. Hughes, a certified public accountant in Stuart, FL.

Con: You could miss out on more lucrative investment opportunities

Every dollar you put toward your mortgage principal is a dollar you can’t invest in higher-yield ventures, such as stocks, high-yield bonds, or real estate investment trusts, Pitzl says.

That being said, “you’d be assuming more risk by investing your money in, say, the stock market instead of putting the money toward your mortgage,” Pitzl points out.

“You have to consider your risk tolerance before you decide where to put your extra cash,” says Cheng.

Con: You may miss paying off higher-interest debts

For many homeowners, paying off higher-interest debt—such as from a credit card or private student loan—is more important than prepaying their mortgage, Cheng says.

Think about it: If you’re carrying a $400 debt on a credit card from month to month with a 20% interest rate, the amount of money you’re paying in credit card interest is $80 per month—that would be leaps and bounds higher than what you’d be paying in mortgage interest on a home loan with a 4% interest rate.

Con: Prepaying a mortgage could hamper achieving other financial goals

Building your retirement savings is crucial, of course. However, some people make the mistake of prepaying their mortgage instead of maxing out their retirement contributions, Cheng laments.

“At the bare minimum, I recommend my clients do a full 401(k) match with their employer,” she says.

Moreover, Pitzl encourages people to build a sufficient emergency fund—typically, a fund large enough to cover three to six months of their essential expenses—before they focus on prepaying their mortgage.

“If you get into a bind, you can’t sell off windows and doors to make ends meet,” Pitzl says.

Con: There may penalties for prepaying your mortgage

Some lenders charge a fee if a client’s mortgage is paid in full before the loan term ends. That’s why it’s important to check with your mortgage lender—or look for the term “prepayment disclosure” in your mortgage agreement—to see if there’s a penalty and, if so, how much it is.

The bottom line: If you don’t have enough money to pad your savings before you begin paying off your mortgage early, prepaying your home loan may put you in a financial hole if an emergency crops up.

Still not sure what direction to go in? Consider sitting down with a financial planner to discuss your options based on your personal finances.

The post Should You Prepay Your Mortgage? The Pros and Cons appeared first on Real Estate News & Insights | realtor.com®.

What Is a Recast Mortgage? Way Easier Than Refinancing—Should You Try It?

October 4, 2018

What is a recast mortgage? While it sounds more like a fishing trip than a financing tool, it’s actually where you pay off a lump sum of your principal (that’s the money you owe), then have your lender “recast” or reamortize the rest so you can lower your monthly payments.

Recast mortgages are rare, at least compared with the more typical way homeowners reduce their mortgage payments by refinancing. Nonetheless, it’s well worth considering in certain circumstances.

Here’s everything you need to know to decide whether a recast or refinance is right for you.

What is a recast mortgage?

To make the idea of a recast simpler, imagine your Aunt Susan has died and left you $10,000, or you get a bonus at work. Sure, you could put that money in a CD or other investment, or spring for a kitchen remodel. However, if lowering your monthly mortgage payments sounds far sweeter, then a recast is the way to go.

“Recasting your mortgage is a great option if you want to lower your monthly payments and have the funds to make a lump sum payment to your lender,” says Randall Yates, founder and CEO of The Lenders Network.

The process of recasting is fairly simple: You head to your bank, fork over your money, and pay a small fee to recast your mortgage.

From there, your lender will use that money you’ve offered up to pay off your principal. It’s as if you’ve made a bigger down payment on your loan. If, say, you’d originally put down $50,000 and borrowed $200,000 to pay for a $250,000 house, after a recast, you’ve now put down $60,000 and owe only $190,000 (actually a bit less, if you’ve been paying your mortgage for a while already).

So now that you owe less, your lender will recalculate monthly payments over the life of your loan. For instance, if you owe $200,000 on a 30-year fixed loan with 5% interest, your monthly payment is $1,397. Recast so you owe only $190,000, your monthly payment will dip to $1,343, giving you an extra $54 a month (crunch your own numbers and see how much you’ll save with an online mortgage calculator).

Refinancing vs. recasting a mortgage: What’s the difference?

When you refinance a mortgage, your loan is actually closed, then reopened as a new loan with new terms (length of loan and/or interest rate). Refinancing also comes with a bunch of steps, including a home appraisal and related fees. As a result, a refinance also takes time to finish (typically 30 to 45 days).

A recast, in contrast, is much simpler: Your loan life, terms, and interest rate remain as is; the only thing that changes is you get to make lower monthly payments.

“Mortgage recasting is a much simpler process than refinancing,” says Yates. “There is no income verification or credit check needed. The entire recasting process can be completed in less than 30 days.”

A recast is also different from merely sending in a lump sum to prepay your mortgage early. In those cases, your monthly payments remain the same. You will just finish off paying your mortgage earlier.

Requirements for a recast mortgage

Mortgage recasting is not available to all. Here are a few requirements for a recast:

  • You must have a conventional loan. “Government-backed loans such as FHA or VA loans are not eligible for recasting,” says Yates.
  • Your bank must offer recasting. Most larger banks like Wells Fargo or Bank of America offer a recast, but smaller local banks or credit unions may not offer the option.
  • You must have enough money. Most lenders require a minimum $5,000 payment to recast a loan. As such, recasting can be a good option only with large lump sums, rather than smaller amounts arriving via paychecks if, say, you got a raise at work.

 

Recast or refinance? How to decide

If you are eligible for a recast, there are still some questions you should ask to determine whether a recast or refinance is right for you:

  • The cost: With a refinance, you are looking at a whole lot of fees. These include an appraisal fee of around $300 to $500 and closing costs between $1,800 and $4,000 depending on your credit score. If you’re depositing $10,000, refinance fees could take upward of $4,500, leaving only $5,500 to be applied to your loan.
  • Interest rates: “If present interest rates are lower than when the loan was opened, it often makes sense to refinance,” says Matt Hackett, operations manager of EquityNow. However, if present interest rates are higher, then a recast is more favorable since you get to keep your original lower rate. “In an environment where rates are on the rise for the first time in several years, mortgage recasts will most likely become a more popular option,” says Tammi Lindley, senior loan officer at the Lindley Team at Mortgage Express.
  • How long you plan to live there: If you sell your house within five years, a refinance may not be practical and a recast may be a better option.

 

Pros of a recast mortgage

  • Reduces monthly payments and principal
  • Easier than a refinance
  • Low fees
  • Less paperwork
  • No appraisal required
  • You keep your original loan and interest rate
  • No credit check
  • You don’t have to stay in home a certain amount of time to recoup refinance fees
  • You can do it more than once, whenever you receive lump sums above $5,000

 

Cons of a recast mortgage

  • Offered only by mostly larger banks
  • Available on loans from institutions such as Fannie Mae or Freddie Mac (not FHA or VA)
  • Doesn’t reduce the interest rate
  • Doesn’t shorten overall mortgage term
  • Liquid cash reduced and tied up in equity

 

The post What Is a Recast Mortgage? Way Easier Than Refinancing—Should You Try It? appeared first on Real Estate News & Insights | realtor.com®.