refinance

When is mortgage refinancing a good move?

Don TaylorQuestionDear Dr. Don,
My mortgage lender is offering to refinance my loan at a lower rate due to my excellent payment history. Here's my current situation: I have seven years left on my mortgage. I owe $81,500 at a fixed interest rate of 5.5 percent.

The lender is offering me a loan at 4.13 percent with no closing costs or any expense other than interest. I pay my taxes separately. I do not see the advantage, other than lowering my monthly payment and saving interest on the remaining years. I need to be able to calculate the interest savings and how much my payment will be lowered to determine if this is a good offer. Can you help me with these calculations?
-- James

AnswerDear James,
There are two key things to consider before taking advantage of this offer. First, is the new interest rate a fixed rate? Second, is the loan term the same as your existing loan?

Extending the loan term can increase the interest expense, even if it's at a lower interest rate.

Bankrate's mortgage payment calculator will calculate the monthly payment and will provide an amortization schedule that shows the total interest expense for the new loan. You can also enter the particulars for your existing mortgage loan and determine its total interest expense.

In addition, you can use Bankrate's refinancing calculator to determine how much you'll save by refinancing. I ran the numbers, too, and my results are shown below:

Refinancing option
Existing loanRefinancingDifference
Loan balance:$81,500.00$81,500.00
Remaining loan term (months):8484
Remaining loan term (years):77
Interest rate:5.5 percent4.13 percent
Loan payment:$1,171.16$1,118.89$52.27
Total payments:$98,377.31$93,986.87$4,390.44
Total interest:$16,877.31$12,486.87$4,390.44

You also should recognize that the interest savings may be less on an after-tax basis if you can fully utilize the mortgage interest deduction on your income taxes. In that case, you can estimate your effective savings as the difference in interest expense, times one minus your marginal federal income tax rate. If you're in the 25 percent bracket, then your effective savings after tax would be $4,390 x (1 - 0.25), or around $3,293.

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