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Paying your mortgage down faster can save you money in the long run. However, this may mean forgoing other savings goals such as retirement savings and an emergency fund. Alternatively, you might choose to invest your extra cash instead of paying down your mortgage. But which option is the best?
Refinancing
Refinancing a debt is a financial strategy that can have many benefits, including saving money and paying off loan amounts faster. However, refinancing is not a one-size-fits-all solution. A variety of refinancing options exist for different kinds of loans and debts, and understanding how each works is important to deciding whether or not it may be right for you.
One of the most common reasons to refinance debt is to lower interest rates. This can help to save on costs over time, especially for mortgages, which have a fixed interest rate, or for credit card debt, which is typically variable and often has high interest rates.
It is also possible to consolidate debt through refinancing. This can be helpful for borrowers who find it difficult to keep track of multiple payments, and can allow them to pay off their debt at lower mortgage rates over a longer term.
Mortgage refinancing is a process through which borrowers replace their existing loan with a new loan, ideally with better terms. This is a popular option for homeowners who want to lower their interest rate, shorten their mortgage term or free up cash. Borrowers can use the equity they have earned through their home to accomplish this, but it is important to remember that refinancing a mortgage comes with a cost, such as loan origination fees, title insurance, appraisals and taxes.
Other types of refinancing include loan modification, debt consolidation and cash-out refinance. Loan modification combines multiple debts into a single payment, usually with a fixed interest rate and shorter term. This is a great option for borrowers who are struggling with payments, and can often be done at no additional cost to the borrower.
Cash-in refinance allows borrowers to take out a larger loan than their current balance, which can be used to pay off other debts or make investments. This type of refinance can be risky, as it requires you to put up your house as collateral, and can have a negative impact on your credit score since lenders will run a hard inquiry on your credit to evaluate your eligibility for the new loan.
Home Equity Loans or Lines of Credit
Home equity loans and home equity lines of credit (HELOCs) allow homeowners to borrow against the equity in their homes. Borrowers can use this money for a variety of reasons, including financing home renovation projects, consolidating debt or paying for education expenses. They can also save on interest charges because these types of loans typically offer lower rates than credit cards. However, it’s important to consider the risks of borrowing against your home and to make sure the amount borrowed makes sense for both your long- and short-term financial goals.
When determining the amount of equity you have in your home, lenders use an appraisal of your property to determine its current value. You can then subtract the amount you still owe on your mortgage from this number to arrive at the amount of equity you have.
Both home equity loans and HELOCs offer a certain amount of money in a lump sum that must be paid back within a set period of time. Using your home as collateral means that if you are unable to repay what you have borrowed, your lender may take ownership of your property through a process known as foreclosure.
As a general rule, lenders will only let you borrow up to 80 percent or 85 percent — or even 90 percent in some cases — of your home’s equity value, minus the outstanding balance on your mortgage. This is called your loan-to-value (LTV) ratio.
Home equity loans have fixed payments and a fixed interest rate, which can make them more manageable for borrowers who want to know exactly how much they will owe each month. However, if you are planning to use your home equity for major renovations, it’s best to take out the loan at the time of purchase so that you can make the necessary plans in advance and avoid any unexpected costs down the road. With HELOCs, on the other hand, borrowers can withdraw funds as needed and pay only interest for the amount they use. This flexibility can be risky for borrowers who don’t have a well-established budget and spending plan.
Tax Deductions
Homeowners can save money on their tax bills by claiming mortgage interest deductions. This can lower a borrower’s taxable income and, in some cases, move him into a different tax bracket. But homeowners must understand how to claim this valuable deduction.
The home mortgage interest deduction allows taxpayers who itemize to deduct mortgage interest paid on up to $750,000 in loan principal. The TCJA reduced this limit from $1 million when it passed in 2017. However, the mortgage interest deduction isn’t available to everyone. It’s only available to those who itemize, which requires filing Form 1040 and listing all your deductions on Schedule A.
Only a small percentage of Americans itemize their taxes. And even for those who do, it’s usually not worth the effort to claim mortgage interest deductions. That’s because the standard deduction, which is currently $6,500 for single filers and $12,400 for married couples filing jointly, more than covers most of the interest that people pay on their homes.
To qualify for the mortgage interest deduction, a person must have a valid, enforceable loan secured by real property. That can be a house, condo, co-op, mobile home, house trailer or an apartment. The property also must have sleeping, cooking and toilet facilities. It’s also important to know that a mortgage used to buy, build or improve a home qualifies. But loans that are used to buy a car or to pay down credit card debt don’t qualify.
Mortgage discount points, which are fees paid at closing to get a lower interest rate on the mortgage, also are deductible. Typically, the IRS allows you to deduct them in the year that you purchase the home, but they can also be deducted over the life of the loan if you choose. In addition, a portion of the interest payments on mortgages secured by second homes or rental properties can qualify for the deduction. But you must be able to prove that you use the property as a primary residence for 15 days or more during the year or more than 10% of the total number of days that you rent it out during the year.
Interest Rates
Even fractions of a percentage point make a difference, so it’s crucial to shop around and find the lowest rates possible when you’re buying a home or refinancing. To do so, get preapproved and ask lenders to compare personalized rates based on your credit score, debt-to-income ratio, loan amount and down payment. NerdWallet’s rate tables can help you compare rates across lenders. *NerdWallet’s mortgage rates are sourced from our advertising partners and are accurate as of this writing.
