refinance

Refinance or pay extra on mortgage?

Don TaylorQuestionDear Dr. Don,
I have a 30-year, $266,000 mortgage at 4.875 percent with 335 payments left. From the first payment, I paid an additional $330 per month, aiming to pay off the loan in 20 years. Now, the same local bank is offering a 15-year mortgage at 3.875 percent.

Should I refinance to a 15-year loan to cut down further on interest expenses? Since I am already making additional principal payments of $330 per month, the higher monthly payment for the new, shorter term mortgage -- assuming I refinance $250,000 -- shouldn't have much of an impact on my monthly budget. I am not sure if it is worth the move to pay the closing costs or if I should just increase the extra principal payment each month. I would appreciate your advice.
-- Grace Gains

AnswerDear Grace,
The key in any refinance is how long you expect to remain in the house. From a break-even perspective, you want to be in the home long enough to at least recoup the closing costs of the new mortgage.

The advantage of refinancing is in capturing the lower interest rate. Making additional principal payments will shrink your total interest expense and shorten the term of your mortgage, but you're still paying the higher interest rate on the loan balance.

Your existing approach of making an additional principal payment each month of $330 shortens the 30-year loan by 10 years and saves almost $90,000 in interest expense (pretax). When you refinance to a 15-year fixed-rate loan, it shaves another five years off the loan term and saves you an additional $45,000 in interest expense (pretax). I ran your numbers using Bankrate's mortgage calculator and amortization schedule and got the results below:

New loan vs. old loan by the numbers
New loanOriginal loan
Loan amount:$250,000.00$266,000.00
Interest rate:3.875%4.875%
Loan term (months):180240
Monthly mortgage payment:$1,833.60$1,407.69
Additional principal payment:$0.00$330.00
Total monthly payment:$1,833.60$1,737.69
Total interest expense:$80,047.78$150,832.79
Interest paid to date:-$26,189.31

Bankrate has several refinance calculators that allow you to input the information on the new mortgage and the old mortgage for you to see whether you can expect to benefit from refinancing over the time you plan to be in the house.

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