Front-load additional mortgage payments?

Don TaylorQuestionDear Dr. Don,
I owe $47,000 on my mortgage. I believe I have 12 years left at 5.375 percent interest. Should I refinance to a 10-year fixed-rate mortgage, refi to a 5/1 ARM, or make extra monthly or yearly principal payments? I want my home to be paid off in five years while saving money on interest.
-- Cathy Credit

AnswerDear Cathy,
If you have the cash flow each month to pay off the loan in five years, regardless of whether you stay in your existing mortgage or refinance, you'll save a lot on interest expense versus paying off the loan in 12 years as shown in the table below.

Loan options
ExistingExisting + additional
New 5/1 ARMDifference between
extra payments and refi
Loan amount:$47,000$47,000$47,000-
Loan term (months):1446060-
Interest rate:5.375 percent5.375 percent3.21 percent-
Monthly payment:$443.59$895.05$848.92$46.13
Total interest expense:$16,877$6,703$3,935$2,768

The numbers in the table represent pretax estimates. Reduce your interest expense, and you may reduce the mortgage interest deduction on your federal income taxes. The tax deduction shouldn't be the tail wagging the dog in making the decision to pay down your mortgage. You just need to recognize it can reduce the realized after-tax savings.

If you decide to refinance, you must consider the closing costs associated with the new loan. Bankrate's 2011 Closing Costs Survey shows a national average of $4,070.

If your estimated closing costs were that expensive, you'd be better off just making additional principal payments on your existing loan versus refinancing into a 5/1 ARM or other type of mortgage. Front-loading the additional principal payments will reduce interest expense versus making monthly additional principal payments, but not by much.

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