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When Mortgage Lenders Won't Listen, Refinance On Your Own: Prepay

NEW YORK (TheStreet) -- With mortgage rates at record lows, millions of homeowners can cut their monthly payments by refinancing older loans that charged more. But there's a hitch: Lenders stung by the financial crisis are very picky about approving loans.

There's an alternative that doesn't take anyone's approval but your own, though: a program of mortgage prepayments -- paying more each month that required.

Consider it a poor man's refinancing, because it helps reduce interest charges, which, after all, is the main goal in most refinancing. And a diligent prepayment program will improve your chances of getting a real refinancing approved in the future.

Imagine you'd taken out a $300,000 mortgage in October 2007, when 30-year, fixed-rate loans averaged around 6.75%. By refinancing the remaining balance of $281,627 at today's rate, around 3.5 %, you could cut your monthly payment to $1,410 from $1,946.

You would save a whopping $160,800 in interest charges over the 25 years left on the loan.

But the slightest blemish in your credit history could prevent you from getting the new loan. You could be turned down if your income is from self-employment, or relies largely on bonuses and commissions. And, of course, refinancing will be next to impossible if your home has fallen in value so it's worth less than you owe on the current mortgage.

The irony is that the new loan with a lower rate and payment would be easier to handle, making you a safer bet than under the old loan. But the new lender may not see it that way, because a new loan would his risk, while the old loan is probably someone else's.

With the prepay alternative, you would simply boost your monthly payment by $100, or $200 or $500 -- whatever you can afford. That money reduces the principal, or remaining loan balance, and you'd no longer be charged interest on that amount. Pay $500, for example, and you'd effectively reduce the interest charge on that $500 to zero from 6.75%.

This isn't as good as a refinancing, because you'll still be charged 6.75% on the remaining balance. But it's better than doing nothing. If you paid $500 more every month, you'd retire the mortgage in another 15 years or so instead of 25 years. That would save you about $129,000 in interest, compared with the $160,800 saved by refinancing.

By reducing your loan balance, the prepayments also would reduce the loan size relative to the property's value -- the loan-to-value ratio. Even if you started out underwater, meaning owing more than the home was worth, the process, coupled with normal home-price appreciation would eventually get you above water. At that point it would be easier to refinance, assuming rates were still low enough to make that worthwhile.

Prepayments, by the way, can also be done in a lump sum. And if you start a monthly prepayment program you can stop or interrupt it whenever money is tight.

The downside? With a monthly prepay of $500, you'd pay $2,446 a month instead of the $1,946 under the current loan (or the $1,410 with the refinance loan). The extra $500 put into the mortgage would be hard to get back out. You'd need to sell the home or get a new mortgage or home-equity loan. So do it only with money you can afford to keep tied up.

Prepayments are clearly not as good as refinancing. But if the refinancing door has been slammed in your face, a prepay program can be a good middle ground. Use the Mortgage Loan Calculator to run your own numbers.

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