Paying Down the Mortgage Debt Vs. Assuming a New Mortgage

To reduce your mortgage interest and the length of time that you will pay on your mortgage, you have two options. You can pay down your mortgage by making additional payments, or you can refinance at a lower interest rate. Your personal budget will have an impact on how much you can pay down your mortgage, while credit worthiness and prevailing interest rates will impact your ability to refinance and assume a new mortgage at a lower rate.

Reducing the Term

By paying additional principal payments each month on your mortgage, you will reduce the length of the time that you will pay on it. Small extra payments will have more of an effect when you are earlier in your loan, in terms of shortening the term of the loan. By paying extra instead of refinancing at a shorter term, you will achieve some of the same benefits without paying the extra closing costs to refinance.

Goals

Your goal may be to pay off your mortgage to be debt free, or to pay your home off before you retire. If your interest rate is already low, and you would not get a lower rate by refinancing, your best plan is to just pay extra on the mortgage without refinancing. Your lender can help you determine how much extra you will need to pay on your loan in order to meet your goal for a timely payoff.

Interest Savings

If you can get a better interest rate on a new mortgage, refinancing by assuming a new mortgage makes sense. Your true amount of savings depends on how long you plan to stay in your home. Since most new mortgages will require closing costs, you must stay in your home long enough to recover the money in interest savings that you pay in closing costs. In many cases, this is around three years, but if you are getting a significantly lower interest rate on your new mortgage, the payback period may be considerably shorter.

Cash Out

Refinancing into a new mortgage may give you the opportunity to borrow additional cash against your existing home equity. Your lender's requirements for a cash-out refinance may vary, but you usually will need to have at least 20 percent equity in your home with the new mortgage balance to get the best rates and avoid private mortgage insurance. For example, if your home appraises at $200,000, and you owe $100,000 on your existing mortgage, the most that a lender will loan you under these guidelines is $160,000 total, or 80 percent of the value of the home. You could pay off your existing mortgage of $100,000, and borrow the additional $60,000 in cash under this scenario.

Combining the Methods

You may meet your financial goals more quickly by employing a combination of the two techniques. A refinance of your existing mortgage at a lower rate provides interest savings immediately. If you are worried about paying the higher payments required by a shorter term, you can refinance at a longer term, and make additional mortgage payments as you are able. By doing this, you leverage gains achieved by both paying down your mortgage and assuming a new loan by refinancing.