refinance

15-year refinance looks like sweet deal

Don TaylorQuestionDear Dr. Don,
I am trying to decide how to refinance my current mortgage. I currently owe $146,000 at 5.875 percent with 24 years left on my original 30-year mortgage. I am looking at refinancing for 15 years at 4.25 percent with a promotional closing cost of $500.

To keep the payment the same as I'm paying now, I would need to put down a $16,000 down payment. Do you think this is a smart way to go? Or should I just look at a 20-year mortgage at 4.875 percent for the current balance of $146,000? This would also keep my payment around the same and I would not need the down payment.
-- Darren Down-Payment

AnswerDear Darren,
A cash-in refinancing is being used a lot by homeowners who want to capture low mortgage rates today but don't have enough equity in their homes to qualify for refinancing. The Bankrate feature "'Cash-in' refinance activity skyrockets" discusses this trend in greater depth.

You don't appear to be in that situation, however -- you're just considering the cash-in refinancing in order to be able to afford a much shorter mortgage term than your existing mortgage. The table below shows how each financing option plays out:

Financing options
Existing mortgageRefi with a
20-year mortgage
Refi with a
15-year mortgage
Loan amount:$146,000$146,000$130,000
Interest rate:5.875 percent4.875 percent4.25 percent
Loan term (months):288240180
Mortgage payment:$946.72$953.48$977.96
Total payments:$272,657$228,836$192,0331
Total interest:$126,657$82,836$46,033
1) Total payments include $16,000 of additional equity.

You benefit by getting a lower interest rate and a shorter loan term. The trade-off for the 15-year mortgage is the impact the $16,000 would have in your investment portfolio or an emergency fund, and the impact of the reduced mortgage interest deduction on your income taxes.

My rule of thumb is that it makes sense to prepay your mortgage if the effective rate of interest on your mortgage is higher than the after-tax returns on your investments. You can estimate the effective rate on a mortgage by using Bankrate's mortgage tax deduction calculator.

If it makes sense for you to do a cash-in refinancing to afford a 15-year loan, then it makes sense to do the same with your existing mortgage or the 20-year refinancing. The table below shows how total interest expense changes for those two mortgages.

Changing interest amounts
Existing mortgageRefi with a
20-year mortgage
Refi with a
15-year mortgage
Loan amount:$130,000$130,000$130,000
Interest rate:5.875 percent4.875 percent4.25 percent
Loan term (months):288240180
Mortgage payment:$842.97$848.99$977.96
Total payments:$242,777$219,758$192,033
Total interest1:$112,777$73,758$46,033
Effective interest expense:$75,560$49,418$30,842
1) Total payments include $16,000 of additional equity.

Closing costs at the promotional amount of $500 aren't a key variable in the analysis. What's key is your ability to free up $16,000 in liquidity without putting too much strain on your emergency fund or other financial goals.

To approximate total interest on an after-tax basis, multiply the total interest number by one minus your marginal tax rate (1 - marginal tax rate). I used 33 percent in the example above. A 15-year cash-in refinancing looks like a pretty sweet deal to me.

Get more news, money-saving tips, and expert advice about mortgages and real estate by signing up for a free Bankrate newsletter.

Ask the adviser

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.
 

Bankrate's content, including the guidance of its advice-and-expert columns and this Web site, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this Web site is governed by Bankrate's Terms of Use.

News alert Create a news alert for "refinance"

advertisement

Show Bankrate's community sharing policy
          Connect with us
advertisement
MORTGAGE & REAL ESTATE NEWSLETTER

Timely market news and advice for consumers ready to buy, sell or invest in real estate. Delivered weekly.

advertisement
Partner Center
advertisement

Connect with us