Dear Dr. Don,
We currently own a home that we originally purchased for $390,000. The current value of our home would be around $460,000. We are five years in on a 10/1 adjustable-rate-mortgage. It is a first mortgage at 5.25 percent with an outstanding balance of $302,000. Our second mortgage is a 15-year fixed rate loan at 8.25 percent with a loan balance $64,000. My total monthly payments are $3,557.80.
I was wondering if now was a good time to refinance the two mortgages and combine them. My lender gave me a quote of a 30-year fixed at 5.35 percent with about $7,500 in closing costs. He said my payment would be reduced by $500 a month! Is it worth it? If not, what do the rates have to be for me to refinance?
-- Frank Financing
Dear Frank,
I'd want to know why the closing costs are so high. Bankrate does an annual "Closing costs overview." In 2008, the national average for closing costs in the Bankrate survey was $3,118. Granted, the survey results were for a $200,000 mortgage, but many of the costs don't increase just because the mortgage is bigger.
If part of the $7,500 is discount points paid to lower your interest rate, you'll want to consider what that does to the loan's annual percentage rate. The Mortgage Shopping Worksheet available from the Federal Trade Commission can be used to compare loans on an apples-to-apples basis.
You can also use The Mortgage Professor's "APR on Fixed Rate Mortgages" calculator to find out how points change the loan's APR.
The decision to refinance isn't based just on closing costs and interest rates. How long do you plan to be in the house? The longer you plan to stay in the house, the easier it is to justify refinancing to a lower interest rate.
Using your numbers, saving $500 a month on your mortgage payment but paying $7,500 in closing costs means it will take you 15 months for the lower payment to recoup your closing costs. The Bankrate calculator "Will you save by refinancing your mortgage?" will help you do the math. Also, take a look at the Debt Consolidation Calculator on The Mortgage Professor's Web site for a more detailed approach to your refinancing decision.
Speaking of doing the math, there must be some part of the equation you're leaving out, because I can't come close to matching your combined monthly payment of $3,557.80. It's likely that the total includes an escrow payment for your property taxes and homeowner's insurance. You can use Bankrate's "Mortgage payment calculator" to check your payments.
If you plan on being in the house for a while, it makes perfect sense to get out from under that 8.25 percent rate on the second mortgage while also locking in on a rate on the first mortgage that is only 0.15 percent higher than the current rate on your 10/1 ARM. (Make sure you know whether there is a prepayment penalty on the mortgage.)
You've got the equity in your home to do an 80 percent loan-to-value first mortgage (assuming your appraisal numbers are right), so there's no private mortgage insurance issue.
Does a refinance make sense for you? Try Bankrate's refinance calculator to find out how much you might save.