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Is it worth prepaying my mortgage when rates are so low?

Posted by  on Jun 04, 2014
 

Q: I'm finally getting a chance to refinance, because I just got my loan out from underwater. I also just got a sizeable bonus from work that I was thinking of putting toward paying down some of my mortgage in advance. However, with mortgage rates so low, am I better off just refinancing the whole thing, to take full advantage of low rates?

A: To anyone familiar with where mortgage rates were prior to the unusual environment of the past few years, today's low mortgage rates naturally seem like too good a deal to pass up. However, as low as mortgage rates are, rates on deposit accounts are even lower.

According to the Mortgage Bankers Association, 30-year fixed mortgage rates averaged 4.33 percent in late May. At the same time, the FDIC reported that the average savings account was paying just 0.06 percent. So, for example, if you kept your bonus money in the bank rather than putting it toward your mortgage, you would be paying over 4 percent more than your money would be earning (assuming you refinanced at today's rates.) Unless you have a compelling investment opportunity that you are convinced will earn you better than that 4.33 percent mortgage rate, paying down your mortgage might give you the best bang for your buck.

One way you could really get some value out of that bonus money is if you used it to pay down principal while refinancing the remainder into a shorter mortgage. Fifteen-year mortgage rates are running about 90 basis points below 30-year rates, so you could lower your interest rate even farther with this approach.

A shorter loan means a steeper repayment schedule, but between the lower interest rate, the principal you could pay down with your bonus money, and the principal you have paid on your existing loan so far, you might just be able to keep those monthly payments reasonable, while saving interest expense in the long run by shortening your loan.



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