November 8, 2012 in Refinancing

Dear Dr. Don,

I have five years and eight months remaining on my 15-year mortgage loan at 4.875 percent, and the monthly payment is \$1,403. My current banker has offered a so-called mortgage rate reduction with a new 10-year rate of 2.75 percent and a payment of \$801 per month. Do you think that I should take this offer? What are my advantages? Will I save more or less with this refinance offer?

Your prompt response to my inquiry is greatly appreciated.

Thank you!

— Steve Speedy

Dear Steve,

With the refinance, you’d be extending the current term of your mortgage from 68 months to 120 months, or 10 years. Even though there’s a substantial drop in the interest rate, you won’t save on interest expense because of the loan extension. The numbers below tell the tale.

### ‘Mortgage rate reduction’ math

Existing mortgage Refinance Difference
Loan amount \$83,214 \$83,953 + \$739
Interest rate 4.875% 2.75% – 2.13 points
Loan term (months) 68 120 + 52
Loan payment \$1,403 \$801 – \$602
Total interest expense \$12,190 \$12,168 \$22

The difference between the two loan amounts comes from estimating them based on the loan terms, interest rates and payment amounts you provided.

The question becomes: What are you going to do with the extra \$602 per month that the mortgage rate reduction provides in your monthly budget? If you use it to make additional principal payments on the new mortgage, assuming there’s no prepayment penalty, then you can capture additional interest savings. You’d save about \$5,700 and have the new 10-year loan paid off in five years and five months, or three months faster than your existing mortgage.

I haven’t considered the impact that the reduced interest expense could have on the mortgage interest deduction on your taxes. Even with the potential loss of that deduction, it’s still a winning strategy to take advantage of the lower mortgage rate and use the savings to pay down your loan balance.