Should You Pay Down Your Mortgage to Refinance? It Depends on Your Rate of Return.
Many homeowners hate the idea of taking money out of the bank or other investments to pay down their Illinois mortgage to qualify for a refinance. But, if you do not qualify for a HARP refinance and you do not have enough equity (i.e. your loan to value is too high), this may be your only option.
As an example, a homeowner recently decided to withdraw money out of the stock market to pay down his mortgage to $330,000 from $360,000 to qualify for a new Illinois 15 year fixed rate refinance. The rate for this 15 year fixed, which included the cost of mortgage insurance since the new loan to value was 95%, was 3.25%. The rate on his existing loan was 5.50%. So what was his rate of return on the $30,000 he used to pay down his loan?
By refinancing, the total interest that he will pay in the first year of his new loan will be approximately $10,725 ($330,000 loan amount multiplied by his new rate of 3.25%). The annual interest that he would have paid on his current loan would have been approximately $19,800 (prior balance of $360,000 multiplied by old rate of 5.50%). The first year interest savings exceeds $9,000. So the rate of return on his $30,000 “investment” is 30% - $9,000 in interest savings divided by the $30,000 principal reduction required to qualify for the refinance.
Of course, there are other factors that can be taken into this equation such as tax implications as well as the potential return that the stock market could have generated on this $30,000 “investment”. However, considering that this return is guaranteed since it is a permanent reduction in a fixed interest rate, it is difficult to argue that this is not in a homeowner’s best interest. Oh, and eventually, we are supposed to pay these things off…
Illinois Mortgage Rates
IL 15 Year Fixed mortgage as of March 15, 2013 2.750%/2.819 APR
Please click this link for APR assumptions and more IL mortgage rates