If you find yourself in the unfortunate position of wanting to refinance your home mortgage but you have a mortgage pre payment penalty then you will need to analyze your situation rather closely to make the best decision for your needs and wants. Said in another way, you will need to analyze your situation from both a financial perspective as well as a emotional / tolerance perspective to come up with your best decision. This article is part 1 of a 2 part series.
Part 2 of this series considers the economy, your employment confidence, home values, interest rate uncertainty, type of mortgage you have. Review Pre Payment Penalty - Refinance Mortgage or Not? (Part 2)
In order to help you decide what to do here are few items to consider.
How Much Savings With Your New Mortgage Payment Versus Pre Payment Penalty?
Although this isn't a deal breaker, this is an important question to consider. Often when someone looks at getting a mortgage they consider paying points to get a lower rate and how long they plan to stay in the home. If the monthly savings with paying points can be "paid back" with a lower monthly payment before the homeowner plans to either move or get a new mortgage then paying points might be a good idea.
In the case of a prepayment penalty you can think with this line of thinking too. Let's say that a refinance will save you $400 a month on your payment yet you have a $9,000 prepayment penalty to refinance if you don't wait until your prepayment penalty expires.
Let's do the math and compare. How long do you have to wait until your prepayment penalty is no longer in effect? Let's say for example it is 1 year - 12 months times $400 a month in savings brings you to $4,800 in savings if you refinance now. This is over half of your prepayment penalty paid back to you in just one year.
Again, this factor alone might not be a deal maker or breaker, but now combine it with your tax return benefits and what reads below.
Paying The Pre Payment Penalty - Prepay Penalties Are Tax Deductible
In most cases, prepayment penalties, if you pay one, are tax deductible and the amount paid can be included in with your mortgage interest deduction. Depending on your tax bracket you can multiply the prepayment by your tax bracket which will give you a good indication of the tax write off you'll receive if you pay the prepayment penalty.
In our example, the tax deduction we'll pick is based on a 35% tax bracket - which means the actual deduction will be approximately $3,150. This will reduce the tax payer's taxable income by this amount - which will in turn - lower the tax due to the IRS based on some fraction of the $3,150. Not a bad "benefit" for having to pay this penalty and makes refinancing again worth considering.
Conclusion of Part 1 of Prepayment Penalty - Refinance Mortgage Or Not?
This article covered some of the financial considerations for you to think about as you decide whether you should pay a prepayment penalty or wait to refinance your mortgage until after your prepayment penalty expires.
Please continue to Part 2 of this series titled: Pre Payment Penalty - Refinance Mortgage or Not?
Please let us know if you have any questions about your mortgage refinancing questions. We'll do what we can to get you some answers.
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