Dear Dr. Don,
I currently have a remaining balance of $145,000 on a 30-year fixed mortgage on a house that will probably appraise for approximately $185,000. We purchased it for $200,000, but we were responsible and put down a hefty down payment.

The problem I have is the current mortgage is 3.5 years old with a 6.375 percent rate. I currently qualify for a 5 percent rate, but there’s a prepayment penalty for 60 months (1.5 years left) that will cost me $4,500 (on top of the typical closing costs) if I refinance.

I’m not planning on moving or selling anytime soon, but I could certainly use the additional $200 a month in mortgage savings. Would you take it? (And I do have the closing costs; I’m looking to use equity to cover the prepayment penalty.)
— Chris Conundrum

Dear Chris,
Would I refinance given what you’ve told me? Probably not, even though I don’t think mortgage rates will still be this low when your prepayment penalty is up 18 months from now.

You can make your best decision by using The Mortgage Professor’s “Refinancing One FRM Into Another FRM” calculator.

Just include the prepayment penalty as an additional cost in closing on the mortgage. I did it with your estimates and only came up with a savings of $129 a month and a break-even of about six and one-third years. It also assumes that you can fully use the mortgage interest deduction on your income taxes. Your results will vary based on your income tax bracket and some other input variables.

My assumption was that you had total closing costs of about $7,200, which includes the $4,500 prepayment penalty. The 2009 Bankrate Closing Cost Survey showed a national average of about $2,700.

The calculator makes you choose between financing all of the closing costs or none of them. That doesn’t match your decision to use equity to cover the prepayment penalty but to pay cash for the normal closing costs. However, it is close enough to make a decision on the refinancing.

Read more about refinance.

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