Your Finance: Cut mortgage rate by prepaying loan

Wouldn't it be great if you could simply refinance your own high-interest mortgage without going through a bank or paying closing costs?

In a way, you can, says Keith Gumbinger of HSH.com, a Riverdale, N.J., mortgage research firm. His theory is that you can lower your effective interest rate by prepaying the loan.

That strategy might be useful for homeowners who can't refinance or who have a low balance left on their loans and can't find a refi deal that's worth its closing costs.

Gumbinger has devised a couple of new calculators that can help homeowners figure out what to do: The PreFi Calculator at hsh.com calculates the effective interest rate that results from paying a fixed extra amount every month; while The LowerRate at the website figures the amount of extra principal to prepay monthly if you want to hit a particular interest rate.

Prepaying your mortgage doesn't really lower your interest rate, but it reduces the amount you pay in interest over the life of the loan, so you end up paying the same amount in interest that you would if you had a lower interest rate.

Here's an example: Say you have 12 years left to pay off a 30-year fixed-rate mortgage that started out at $250,000 and carries a 6 percent interest rate. You've already paid off $227,355 and only have $62,241 left to pay.

With such a small amount left, you'd have a hard time finding a lender willing to write you a refi loan. You'd also have trouble saving enough interest on the refinance to justify the closing costs.

But if you paid an extra $200 a month, you'd burn the mortgage two years early and save $10,925 in interest. The total amount of interest you would pay -- $51,318 -- would be equivalent to the interest you would pay if your rate for the remaining 12 years was 5.36 percent.

So you're not technically lowering the interest rate, but you are reaping similar savings. The question is: Do you want to do that? Here are some considerations:

The strategy fits a narrow category of homeowner. Picture someone who can't refinance an older mortgage, has a high interest rate and wants to get out from under the loan to free up cash for college or retirement.

If you can make more money investing than you can save by paying down the mortgage, you're probably better off not paying off the mortgage early. Even a 6 percent mortgage costs only 4.5 percent a year if you're in the 25 percent tax bracket and deduct the interest, says Greg McBride, senior financial analyst at Bankrate.com. The final cost of the loan would be even less after the deduction reduced state income taxes, too.

You will lose some financial flexibility. "When you take liquid cash or sell other investments to pay off a mortgage, that money's gone," McBride warns.

Ultimately, that's what Gumbinger decided to do with his own home loan -- after running all the numbers, of course.