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Dear Credible Money Coach,
Three years ago I moved to a new home. Took me 10 months to sell my previous home, so I had to take out a mortgage to buy the new home. Interest rates were higher then. Once my old home sold, I used the proceeds to pay off most of the mortgage on my new house.
My new mortgage now is $53,000. No one will give me a refinance because it’s such a low amount. Every finance company wants $250,000 and up. — Maria Heffernan
Thanks for your question, Maria. First, congratulations on paying down your mortgage!
Three years ago, the average rate on a 30-year mortgage was close to 5%. You almost certainly could get a lower rate by refinancing today. However, a $53,000 mortgage is a relatively small amount of money, which could be why lenders haven’t been jumping at the chance to work with you. Unfortunately, it can be difficult to get a rate-and-term refinance for less than $100,000.
But here are other options worth considering.
Make the most of your home’s equity
With a loan balance of just $53,000, you likely have a nice amount of equity built up in your home. There are two possible ways you could leverage your equity to refinance into a lower interest rate.
Potentially good option: Home equity loan
When you have enough equity in your home, a lender may allow you to borrow against it. Depending on your home's loan to value ratio, or LTV, you may be able to borrow enough on a home equity loan to pay off your mortgage. Your home equity loan would then become your primary home debt.
LTV compares your loan balance to the market value of your home. For example, if your home is worth $250,000 and your mortgage balance is $53,000, your LTV is around 21% ($53,000 divided by $250,000). That would mean your mortgage accounts for 21% of the value of your home.
In general, lenders allow you to borrow about 80% of your home's value. For a $250,000 home, you could typically borrow up to $200,000 — which is far more than you need to pay off your $53,000 mortgage.
But be careful here. There's a broad range of interest rates for home equity loans. If you have good to excellent credit, you'll have the best opportunity to get a loan rate that's lower than your current mortgage rate.
Not as good, but still an OK option: Cash-out refinance
With a cash-out refinance, you draw against your home's equity. You take out a new loan for more than the balance you owe on your existing mortgage. Then, you use a portion of the funds to pay off the old loan and receive the remaining balance in cash.
If you can borrow enough to meet a lender's minimum borrowing requirement, a cash-out refinance could be a way to secure a lower interest rate. But this approach has a lot of potential pitfalls.
First, you increase the amount you owe. Instead of having a $53,000 mortgage balance, you'd owe $53,000 plus the amount of equity you pull out in cash. You could also end up with a larger monthly payment, even though your interest rate is lower.
This approach might make the most sense if you could use the cash wisely, such as for making home improvements you need or that would increase your home's value.
Not a good idea: 401(k) loan
If you have a substantial amount in a workplace retirement plan, such as a 401(k), you might be thinking about tapping it with a loan. But I don't recommend it.
First, not all 401(k) plans allow loans. If yours does, the maximum you can borrow is 50% of your vested balance up to $50,000. So, you'd still have an outstanding mortgage balance of $3,000.
What's more, the potential tax impact of a 401(k) loan can be daunting. You're subject to hefty taxes and a penalty if you don't repay it with interest according to the loan terms. Unpaid amounts get treated as early withdrawals, subject to federal (and possibly state) income tax and a 10% penalty if you're younger than age 59½ (unless you qualify for an exemption).
If you lose your job or leave voluntarily while you’re repaying a 401(k) loan, it typically must be repaid in full within a short period, such as 60 or 90 days. So, borrowing from your retirement plan isn’t a good move if your job is unsecure.
The upside of borrowing from your workplace retirement plan is getting a relatively low interest rate, not needing good credit to qualify and repaying yourself with interest. However, on balance, the benefits of a 401(k) loan rarely outweigh the downsides.
Another way to save on your mortgage
Refinancing isn't the only way to cut your total mortgage costs, although it may feel the most rewarding. If your goal is to pay as little for your mortgage as possible and you can't refinance into a lower interest rate, consider paying off the loan as soon as possible. By paying off the mortgage ahead of schedule, you'll reduce your total interest costs. Making an extra payment each month can help you pay off the mortgage faster.
I'm guessing with a $53,000 mortgage, you probably have low monthly payments, even with a higher interest rate. If you can afford to double up on your monthly payments, you'll be able to save a significant amount of interest over the long run.
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About the author: Laura Adams is a personal finance and small business expert, award-winning author, and host of Money Girl, a top-rated weekly audio podcast and blog. She’s frequently quoted in the national media, and millions of readers and listeners benefit from her practical financial advice. Laura’s mission is to empower consumers to live richer lives through her speaking, spokesperson, and advocacy work. She received an MBA from the University of Florida and lives in Vero Beach, Florida. Follow her on LauraDAdams.com, Instagram, Facebook, Twitter, and LinkedIn.