Downsize Your Mortgage?

By Seth Fiegerman

Before the housing bust, homeowners often saw soaring real estate values as an opportunity to get cash out of their home by refinancing or taking out a home-equity loan. But now that home prices have headed in the other direction, homeowners are seeing the wisdom of the cash-in refi.

Many refinancers who want to lock in historically low rates (recently an average of 4.3% for a 30-year fixed-rate mortgage) are bringing extra funds -- beyond closing costs -- to the settlement table. They may be underwater on their mortgage and need to pony up cash in order to refinance. They may want to boost the equity in their home to avoid paying for private mortgage insurance. Or they may want a smaller monthly payment and lower interest payments over the life of the loan. Freddie Mac, which buys mortgages from lenders, says that 22% of households that refinanced in the second quarter of 2010 put extra cash into their homes.

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At the same time, shorter-term mortgages -- of 15 or 20 years -- are in vogue. They are especially popular with people nearing retirement who want to finish paying off the mortgage and trim interest costs as well. For example, if you refinance a $200,000 mortgage at 4.3% for 30 years, your monthly principal-and-interest payments will be $990, and you'll pay $156,307 in interest over the life of the loan. If you choose a 15-year loan at the going rate of 3.7%, your payments will be $1,449 a month -- but you'll pay only $60,908 in interest.

Some homeowners also see accelerated mortgage payments as an investment, earning the equivalent of the rate you pay on the loan. In that sense, paying down your mortgage beats money-market funds and CDs. And unlike an investment in the stock market, the returns are guaranteed. "Realizing that your money works harder paying down the mortgage than it does in savings is a powerful incentive," says Guy Cecala, publisher of the newsletter Inside Mortgage Finance.

Making the decision. Of course, higher monthly payments on your mortgage would decrease your cash flow. "You need to look at whether that money could be better spent elsewhere," says Keith Gumbinger, of HSH Associates. "Maybe it could be used to pay down credit-card debt or go toward your retirement plan."

Some financial planners think younger homeowners should not pay down their mortgage early. "Anyone under 40 should be funding a retirement plan, and anyone over 50 should be concentrating on paying off the house," says Rick Kahler, of the Kahler Financial Group, in Rapid City, S.D. However, if you're close to retirement and paying off the mortgage would mean raiding too much of your savings, it may not be a good idea.

Whenever you consider a refi, make sure it will really save you money. Although rules of thumb abound -- some say that refinancing makes sense when rates are one point lower than you're currently paying, others say two points -- you have to crunch the numbers to see when the lower payments will make up for your closing costs. You should also consider your tax situation -- remember that mortgage interest is deductible -- and how long you plan to stay in your home. (For help, use the calculator at http://zwicke.nber.org/refinance. It will estimate how far interest rates need to fall before you should refinance your fixed-rate mortgage with a new fixed-rate loan, and it takes your tax bracket into consideration.)

If committing to higher monthly payments concerns you, or you're worried about whether you will qualify for a new mortgage, you always have the option of making extra payments on your current loan. Doing so can potentially turn your existing loan into a 15-year mortgage, says Cecala, "although you must be pretty disciplined to do that."