Dear Dr. Don,
We have lived in our home for eight years and plan to stay at least 12 (years) to 20 years more. We are currently three years into a refinanced 30-year mortgage at 5.88 percent. We did some work to our home and took about $17,000 out of our previously paid-off home equity line of credit, which is at the prime rate plus 0.5 percent.
We are looking at doing a cash-out refinancing of our primary mortgage to pay off the HELOC and consolidate the payments. We have been quoted a 30-year, fixed-rate mortgage at 4.8 percent with about $4,500 in closing costs. We have the option to buy down the rate to as low as 4.3 percent for $7,000 in total closing costs.
I have been reading yours and many other articles for advice, but I haven’t seen any on buying down a loan for a long-term stay in the house. What do you suggest?
— Erik Evaluates
Points come in two flavors: discount and origination. Origination points are just one way of paying closing costs. They cover the lender’s cost of originating the mortgage. Discount points, on the other hand, are prepaid interest. You are, as you described, buying down the interest rate used to calculate the mortgage payment by paying these discount points.
The longer you plan to remain in the house without refinancing your loan, the more sense it makes to pay discount points. With a horizon of 12 years to 20 years and historically low mortgage rates, it can make perfect sense to prepay interest. Check out Bankrate’s “Mortgage Points Adviser.”
The annual percentage rate, or APR, presented by your lender will allow you to compare loans with different points because it incorporates the points into the equation. Wheatworks allows you to download a free “Mortgage APR calculator” that will allow you to input your closing costs and calculate the APR. Lenders aren’t required to input the actual closing costs into the APR they calculate for you.
The last piece in the puzzle is to determine if refinancing saves you total interest expense. Bankrate’s “Savings from refinancing” calculator will spell it out for the first mortgage, but won’t let you input the particulars on the HELOC. Run the numbers for the refinancing without considering the HELOC to see the break-even point and compare total interest expense.
Keep in mind that the prime rate plus 0.5 percent is currently only 3.75 percent, so you’re actually increasing the interest rate on $17,000 in mortgage balances — at least over the near term. It should be such a small part of the refinancing that it should not really drive the refinancing decision.
If you decide to refinance and can qualify for the cash-out to pay off the HELOC, go ahead and do it.
Read more Dr. Don columns for additional personal finance advice.