Should I prepay, refinance or both?

Homeowners who are eager to pay off their mortgage prepay extra amounts to hurry up the process. But prepaying can sometimes become most profitable is when it's combined with a refinance to accelerate the payoff even more.

Prepaying, refinancing options

Keith Gumbinger, vice president at HSH.com, explains a few ways to get the benefits of refinancing and prepaying:

No. 1: Shortening the term. If you can afford a higher monthly payment, refinancing into a shorter term can help you save substantially on interest costs.

"Shortening your term is a prepayment methodology of its own, albeit a 'forced' rather than a "voluntary" prepayment method," Gumbinger says. "Once you've committed to the shorter term, you have no choice but to make the 'additional' payment, so some future flexibility might be lost."

A shorter-term mortgage carries the additional advantage of having a lower interest rate compared to a longer-term one; a 20-year loan will usually have a lower rate than a 30-year, and a 15-year even lower. However, the shorter the term, the higher the monthly payment will be despite the lower rate.

For example, let's assume you're looking to refinance a four-year old mortgage, originally at 4% and $200,000. After four years, the remaining balance would be $182,147, and refinancing to a new 20-year at 3% would lift the monthly payment by $71.33; refinancing to a 15-year loan at 2.5% would see a $279 increase each month. Of course, you'll save over $51,000 in interest costs with the 20-year term and almost $76,000 with the 15-year term.

If being locked in to a higher payment isn't for you, but you are disciplined, you can always refinance to a new 30-year term and then make your mortgage any term you like by prepaying.

One other refi-and-prepay strategy to consider: Refinancing to a lower rate but a longer term and using the reduction in the required monthly payment as a prepayment. The same loan above refinanced from 4% to 3% with a new 30-year term would see the monthly payment decline by $174.30. Despite "adding" four years to your original loan (you'll be paying for the home for 34 total years, not 30), you would save $17,078 in interest without prepayment. However, adding the difference to your new mortgage payment means you'll have the same monthly payment as you have today but you'll save an additional $27,425 in interest cost -- and the total term of both your loans would still be only about 26 years.

Related: Should I refinance my mortgage? Calculator

No. 2: Pony up some cash. So-called "cash-in refinances" were pretty common during the last housing bust, as homeowners with small or even negative equity positions looked to take advantage of then-record-low mortgage rates.

Today, there can still be reasons to do a cash-in refinance. For some borrowers, it's a way to get out of paying for Private Mortgage Insurance more quickly; for others, it can mean lowering their loan balance to something below the conforming loan limit, allowing them to access lower-cost mortgages from Fannie Mae or Freddie Mac. Both choices mean putting up more cash today but can produce long-term benefits from lower interest rates or lower total monthly mortgage payments.

"Prepaying a few extra dollars each month will help build your equity, but it's still going to be a slow haul," Gumbinger says. "You might have to bite the bullet and put in another $5,000 or $10,000 now to get that refinancing opportunity."

No. 3: PreFi. If your current interest rate is already low relative to market rates, or if you have a small loan amount remaining on your existing loan, the inconvenience and cost might not make refinancing "a strong compelling argument," Gumbinger says. But if you still want to save money, prepaying can help you do that even without refinancing.

"If you have a fixed rate at 3.5 percent and the best rate you can find in the market is 3 percent, your savings will be slight. You could say, 'It's not worth refinancing, but I'd still like to achieve a savings equivalent to refinancing.' HSH.com's Prepayment::Refinance PreFi^sm prepayment calculator does just that," Gumbinger says. Just a few extra dollars per month can bring the same savings as a refinance, lowering the effective rate you pay without all the effort and hassle of an actual refinance.

Related: HSH's Comprehensive Guide to Prepaying your Mortgage

Why do homeowners prepay?

A few years back, HSH conducted a survey of more than 1,000 homeowners, and found that nearly 50 percent of respondents said they planned to prepay their mortgage. Here's why:

• 34 percent said they wanted to pay off their loan sooner
• 32 percent said they wanted to cut their interest expense
• 23 percent said they wanted to build equity more quickly
• 5 percent said they already refinanced but wanted to save even more
• 4 percent said they couldn't refinance, but planned to prepay so they could still save

Respondents in the 18-to-29 age range were more likely to say they planned to prepay so they could build equity more quickly. Respondents in the 40-to-49 and 50-to-64 age brackets were more likely to want to save on interest expense and pay off their loan faster.

Why don't homeowners prepay?

According to the same survey, here's why homeowners don't prepay their mortgage:

• 40 percent said they didn't have enough extra money each month
• 22 percent said they were using any extra money to pay other monthly bills
• 17 percent said they were using any extra money to fund savings or retirement accounts
• 13 percent said paying off their mortgage sooner wasn't a priority
• 8 percent said they thought paying off sooner wouldn't make much difference

Respondents in the 18-to-29 age bracket were more likely to say they didn't plan to prepay because they were putting any extra money toward other monthly bills. Those in the 40-to-49 and 50-to-64 age brackets were more likely to say they didn't plan to prepay because they didn't have enough extra money.

Prepayment calculator

Fifty-five percent of the respondents said they have never utilized a prepayment calculator to try to figure out if prepaying made sense.

With or without a prepayment calculator, it's always worthwhile to "have that conversation (about refinancing) with a mortgage broker," says Ronit Rogoszinski, a wealth advisor at Arch Financial Group on Long Island, N.Y.

"It may not make sense or it could be a wash. But if you have a high interest rate and a good credit score and you can bring the rate down, then we are talking about dramatic dollars," she says. "You want to run the numbers and see."

This article was updated by Keith Gumbinger.