mortgage

Use savings to pay off house, or refinance?

Don TaylorDear Dr. Don,
My husband lost his job. We owe $60,000 on our mortgage and have $50,000 in savings. With the mortgage payment, we can barely manage on my salary. Should we supplement my income from savings, using about $500 per month until the mortgage is paid off in five years, and not save any more money? Or, should we refinance our current 5.25 percent mortgage for a longer term so I can make the payments without a problem and still be able to save a small amount of money? I am in my 50s and was looking forward to being mortgage-free! Thanks,
--Melodie Mortgage

Dear Melodie,
Being mortgage-free in retirement is a sound financial goal. You're on track to do it in the next five years. That's great. Is your husband looking for a new job? Is it possible that your one-income situation is temporary? Your plan to raid the savings account for $500 per month to balance your household budget while your husband is out of work makes sense.

Your idea of refinancing to reduce your loan payment so you can continue to put money aside, however, doesn't make sense. The yield you will earn on the savings is going to be lower, probably much lower, than what you would pay in interest expense on the mortgage.

Whether you should refinance depends on: your ability to qualify for a loan as a one-income family; the interest rate; and, especially, the closing costs.

You're so close to paying off your current mortgage that paying several thousand dollars in closing costs to get a new loan doesn't make sense, as shown in the table below. Bankrate's 2011 Closing Cost Survey reported a national average for closing costs of $4,070, although that was for a new purchase mortgage of $200,000. A loan that has low or no closing costs -- because those costs are priced into a slightly higher refinance interest rate -- can get you around this issue.

Refi with closing costs options

 Existing mortgageRefi w/15-yr. fixed-rate mortgageRefi w/30-yr. fixed-rate mortgageRefi with a 5/1 adjustable-rate mortgage*
Loan amount$60,000$60,000$60,000$60,000
Interest rate5.25%3.17%3.91%3%
Loan term (months)60180360360
Loan payment$1,139.16$419.27$283.34$252.96
Total interest expense$8,439.54$15,469.01$42,004.12$31,066.47
Interest expense + $4,070 in refinancing closing costs $19,539.01$46,074.12$35,136.47
*Assuming the rate never adjusts.

A refinance to extend your loan term, assuming your income is sufficient to qualify for the refinancing, will reduce the interest rate on your loan and reduce your monthly payments. To achieve those savings, however, you'll increase your total interest expense, unless you make additional principal payments to shorten the effective loan term.

Featured Rates

The following table shows a "no-cost" refinancing, assuming that option raises your interest rates by 0.375 percent and has you making additional principal payments to pay off the loan in five years (thus assuming the ARM rate never adjusts). You do save on interest expense, and you lower your monthly payment. You can decide to skip additional principal payments if you're in a cash crunch in any given month.

'No-cost' refi options

No closing cost optionExisting mortgageRefi w/15-yr. fixed-rate mortgageRefi w/30-yr. fixed-rate mortgageRefi with a 5/1 adjustable-rate mortgage*
Loan amount$60,000$60,000$60,000$60,000
Interest rate5.250%3.545%4.285%3.375%
Loan term (months)60606060
Loan payment + additional principal payment$1,139.16$1,092.71$1,112.72$1,088.15
Total interest expense$8,439.54$5,562.86$6,763.49$5,288.95

Talk to your lenders about "no-cost" financing to see if this refinance option can work for you.

Get more news, money-saving tips and expert advice 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 website, 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 website is governed by Bankrate's Terms of Use.

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