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Lower Your Mortgage Payments — Without Any Fees?

Instead of a refinancing, consider a home equity loan

by Sid Kirchheimer, AARP Bulletin, March 22, 2012

En español  |  Q. How can I refinance my mortgage at today's lower rates without paying thousands in settlement fees?A. Instead of a mortgage refinance — with settlement costs that are typically 3 to 6 percent of the loan amount — consider a home equity loan (HEL) if you've accumulated substantial equity. Qualified borrowers can use this kind of loan to pay off a mortgage balance and enjoy an interest rate comparable to what would result from a mortgage refinance but with no, or very low, settlement costs.

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That's what my wife and I did recently. We wanted to refinance the $52,000 balance of our existing mortgage, a 15-year loan at 5½ percent that we got in 2005. Our monthly principal and interest payment was just over $1,200, and in recent years we've been adding a few hundred dollars extra most months to pay down the loan so we could be free and clear three years early — 2017.

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To meet that same payoff goal, we compared a five-year mortgage refinance with a five-year home equity loan. We qualified for a mortgage refinance at 3.25 percent — but it had $2,600 in closing costs (5 percent of the loan amount is typical in our area). Adding those charges into the borrowed amount, our monthly P&I payment would have been about $987 — certainly a significant savings over what we were paying on the old loan. (You need to keep in mind, though, that a lower interest rate means a lower tax deduction, letting Uncle Sam take back some of your savings.)

But we instead opted for a $52,000 home equity loan from our credit union with no closing costs. By opting for automatic withdrawals of monthly payments from our checking account, an additional ¼ percent was shaved from the 3.74 percent rate for a fixed rate of 3.49 percent. The result: Monthly payments of $946 for five years, saving an additional $41 a month compared to a mortgage refinance at a slightly better rate — with the same payoff goal of 2017.

So now, we're saving $260 a month compared to our former P&I payments at 5½ percent — and can use that extra money to feed our IRAs (and maybe enjoy dinner and a movie now and then).

Another option is a home equity line of credit (HELOC), which may have no closing costs or only very low ones.

The differences: With a home equity loan, you receive a one-time lump sum and have a fixed monthly payment over the loan period. With a HELOC, you get a line of credit — and can draw funds up to a predetermined limit, whenever you need money (say, for college tuition costs or to pay off medical bills).

There is generally a minimum payment due each month, but the loan amount and terms vary depending on how much you borrow and how much and quickly you pay it back. A HELOC usually carries a lower initial rate than a home equity loan — recently around 1.99 percent for the first 12 months — but typically has a variable rate.

It's important to note that your home is the collateral for both a HELOC and a HEL. As with a regular mortgage, if you can't make your payments, you risk losing your home.

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Sid Kirchheimer writes about consumer and health issues for AARP.org.