Refinancing a mortgage at a reduced principal amount can save you hundreds per month and thousands over the life of the loan. A $200,000 mortgage priced at 5.0 percent carries a payment of $1,073.64 per month with total interest of $186,513.24 to be paid over 30 years. Reduce that mortgage to $150,000 and refinance at 4.75 percent and you will pay $782.47 per month with total interest of $131,689.77 paid over the life of the loan. That’s a savings of close to $300 per month and almost $55,000 over 30 years.
Contact your bank and ask if your mortgage carries a prepayment penalty. If so, you will pay a penalty based on a set percentage of principal. For example, with a prepayment penalty of 2.0 percent, you will pay $1,000 to reduce the principal by $50,000.
Submit principal reductions to the bank via certified check, wire or electronic transfer. Banks are suspicious of large transactions involving cash. You can also do this at settlement.
Complete a mortgage application with the lender of your choice. Enter the final principal amount you intend to refinance. If you owe $200,000 but intend to refinance at $150,000, indicate the latter figure on the application.
Provide the bank with supporting documentation. Banks typically require two years of Forms W-2 and federal tax returns, one month’s worth of pay stubs and three months’ worth of bank statements. The bank statements should indicate that you have the money available for the principal reduction at closing.
Sign a commitment letter. Upon approval, the bank will send the letter to you outlining the terms and conditions of closing.
Call the bank to schedule a closing. Coordinate with any third parties involved such as attorneys or title companies.
Request a payoff figure in writing through the date of settlement from your original bank. If you are refinancing with the same lender, it will already have this on hand.
Attend settlement and sign the loan documents. Make arrangements to pay down the principal as part of settlement if you have not already done so. The new loan at the reduced amount will take effect after three business days.