refinance

Mortgage refinance payoff may be small

Don TaylorQuestionDear Dr. Don,
We currently have 7½ years and $76,000 left on a 15-year mortgage. Our rate is great -- 4.75 percent fixed. Could I do a seven-year adjustable-rate mortgage refinance at 3.2 percent to pay off the remainder of our loan?
-- John Juncture

AnswerDear John,
You're halfway home to paying off an existing mortgage with a mortgage rate below 5 percent. The decision to refinance will come down to how expensive the closing costs are on the new mortgage and whether you can take full advantage of the mortgage interest deduction on your taxes.

I put together the table below using your numbers and Bankrate's mortgage calculator.

Closing costs vs. lost deduction
Existing mortgageRefi with a 7-year ARM w/ additional principal paymentsRefi with a
7-year ARM
Loan amount:$76,000.00$76,000.00$76,000.00
Interest rate:4.75 percent3.2 percent3.2 percent
Loan term (months):9085360
Mortgage payment:$1,005.43$328.67$328.67
Additional principal payment:$ -$676.75$ -
Total monthly payment:$1,005.43$1,005.43$328.67
Total payments:$90,488.00$84,988.00$118,323.00
Total interest:$14,488.00$8,988.00$42,323.00

Difference in total interest:$5,500.00
Estimated loss of mortgage interest deduction: (28 percent) x $5,500 =$(1,540.00)
Estimated closing costs on new mortgage:$(3,741.00)
$219.00

The closing costs used in the table are the national average from Bankrate's 2010 Closing Costs Survey. The survey assumes a home being purchased, not refinanced, and a $200,000 mortgage. Your closing costs may be lower.

The estimated loss on the mortgage interest deduction assumes a 28 percent marginal federal income tax rate, and that you can fully use the mortgage interest deduction on your taxes. That means that the mortgage interest deduction isn't just replacing the standard deduction on your taxes. The estimate doesn't consider how that loss of a deduction is spread over the mortgage term, so it's slightly overstated.

If my closing cost estimates and mortgage interest deduction assumptions are close to what you can expect, you're jumping through a lot of hoops but won't save much money.

Get an estimate of the closing costs on the new loan and review your tax situation, bringing in your tax professional if necessary. This should show you if the savings could add up to thousands instead of hundreds. Make sure that there wouldn't be a prepayment penalty on the new loan if you decide to refinance and aggressively pay down the new mortgage.

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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.

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