Most strategies to pay off your home involve making radical principal prepayments or moving to a shorter-term debt structure. Here is a way to refinance your home using your lender’s money.
Quick Finance Lesson:
Lenders generate more revenue on higher interest rate loans. The catch is, the additional revenue is not kept by the lender, but, is passed onto the consumer. This is how a true no-cost refinance loan works. Rolling fees into the loan or a loan with a lender credit not equal to the closing fees amount is not no-cost.
For example if you were to take a market interest rate on a 30 year fixed rate loan at 3.875% vs. a no cost loan at 4.375% (lender paying the closing fees with lender credit generated by you taking the higher rate) you are using other people’s money (OPM) to your financial benefit.
How the strategy works:
Each time you refinance, focus on lowering your interest rate, even as little as .25% rate reduction, over time, still pencils. The numbers pencil because you only take a rate that generates enough overage (premium) to pay the junk fees, thereby keeping your loan amount unchanged. You heard it accurately; you can accomplish this without your loan balance increasing. Keeping the loan balance the same is critical. It is important to know this strategy utilizes taking a higher than market rate, allowing the lender to generate overage at the closing table. Each time you refinance your loan the clock does start over if you are keeping the same loan term. If you go from a 30 year fixed rate mortgage, to a 30 year fixed rate mortgage, you begin again. This makes the decision to refinance generally unattractive, but with one key exception, make the same payment. If you make the same payment on the new loan you had on the loan just paid off, the clock actually does not start over, and you continue to chip away at the loan over time! This refinance strategy compounded with reducing your interest rate at every available opportunity will save you thousands in interest while simultaneously accelerating your principal pay down. Moreover, you are effectively paying your loan off in half the time even with a 360 month term.
Here’s an example of this strategy at work with 30 Year Fixed Rate:
Year 2008 $400,000 loan taken out at 6.375%-payment $2,479.55
Year 2010 $390,000 loan taken out at 5.0%, lender pays the closing costs – payment $2,072.94
(Note continue to make the $2,479.55 payment throughout)
Year 2013 loan taken out for $356,000 at 4.625%, lender pays the closing costs- payment $1,808.20
(By continuing to make the $2,479 per month payment, now, $671.35 per month is going on top of the principle payment resulting in a compounded interest savings over time)
Year 2015 loan taken out for $327,000 at 4.375, lender pays the closing costs payment-$1609.49
Payment now reflects a whopping $870 per month going directly to principal. This scenario is equivalent to having the mortgage paid off just shy of 15 years, not too shabby using a 30 year loan with some financial discipline.
Key Tips:
- Each time you refinance your home, do it for at least a .25% reduction in your interest rate.
- If you can select a lower interest rate with a lender credit and move into a shorter-term debt structure such as a 25 your loan, 20 year loan or a more aggressive 15 year loan, the payoff benefits accelerate dramatically faster, but is not mandatory to realize the savings.
- Refinance your home as often you can as the lender is paying your closing costs, and your loan balance each time is equal to your current principal balance
- Make the same payment your otherwise are normally accustomed to. Put simply; prepay your loan on the principal by the difference of the savings generated.
- If you are a spender, then automate it, force yourself to save by setting up an automatic mortgage payment amount- your loan serivicier must apply the difference to principal
- Get used to the paperwork- electronically, save your tax returns, w2’s and pay stubs you’re ready to go each time the market reacts to your favor. You will need to provide the paperwork, so get over its just too hard excuse. Do yourself and lender a favor and have the financials ready to go at moment’s notice.
Looking to refinance? Need guidance for a specific mortgage loan problem? Begin by getting a free mortgage rate quote online.
