When is it worth it to refinance?

Don TaylorQuestionDear Dr. Don,
Is it worth refinancing if that means going from a 30-year fixed loan with 25 years left at 6.1 percent to a new 30-year fixed rate loan at 5.25 percent with $4,000 in closing costs? My original mortgage was for $350,000 and my new one will be $331,500. The new mortgage will also have to include a $100 per month fee for PMI for the first four years.

-- John Juxtaposition

AnswerDear John,
As with all refinancing decisions, it depends in part on how long you plan to be in the house. Bankrate's refinancing calculators provide breakeven and total interest expense scenarios to help you decide whether refinancing is worth it given the costs associated with refinancing and the planned time in residence.

You're capturing a lower interest rate, but you're extending the loan term back out to 30 years. As you can see in the table below, that means you actually wind up paying more in total interest expense when you refinance.

Total interest expense for 30-year refinance
Existing mortgage
Refinance 30-year fixed
Refinance 30-year fixed with additional principal payments
Refinance 20-year fixed
Loan balance:$ 331,500$ 331,500$ 331,500$ 331,500
Interest rate:6.10%5.250%5.250%4.625%
Loan term (months):300360279240
Monthly payment:$ 2,156.17$ 1,830.56$ 2,056.17$ 2,119.67
Total interest expense (pretax):$ 315,350.66$ 327,499.90$ 244,053.71$ 177,219.91
Estimated after-tax expense (25%):$ 236,512.99$ 245,624.92$ 183,040.28$ 132,914.93
After-tax savings(loss) estimate versus existing mortgage:$ (9,111.93)$ 53,472.71$ 103,598.06

Some of my assumptions in the table may not mirror your exact situation. You can use Bankrate's mortgage calculator and amortization schedule to construct a table that exactly mirrors your situation. Look at what happens if you make additional principal payments on the 30-year refinancing. I assume an additional principal payment of $225.61 for a monthly payment of $2,056.17, $100 less than my estimate of your current monthly payment to leave room for the $100 monthly PMI, or private mortgage insurance, payment. Once the PMI policy is canceled, you can add that money to the monthly additional principal payment.

Bankrate doesn't report 20-year mortgage rates, so I estimated a 20-year rate from Bankrate's 15- and 30-year national averages. Even with a $100 PMI payment added on, you're about at the same monthly payment I estimate for your current mortgage. Shortening the loan generates the biggest bang for the buck, if it fits in your monthly budget. When in doubt, go with the longer term and make additional principal payments as circumstances allow versus getting tied to a high contractual monthly payment that is a stretch in your monthly finances.

With all the current talk of the federal government eliminating the mortgage interest deduction, you'll have to decide whether you want to hang your hat on the pretax or after-tax numbers, although there's no conflict in ranking between the two methods.

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