Refinance could reduce tax deduction

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Dear Dr. Don,
My current monthly mortgage is $1,692.80. I always apply an extra $308.99 to the principal. The loan was opened in June 2005 with a fixed interest rate of 5.88 percent. I plan to sell and retire within the next five years.

If I were to refinance $255,000 at 4.75 percent with a monthly payment of $1,386 and apply an extra $614 to the principal each month, would I be ahead in five years with this new loan? Or would I be further ahead by standing pat and skipping the refinance?
— Amy Amortizes

Dear Amy,
I’d love to do the math for you regarding this refinance, but there are too many unknowns for me to be exact.

For example, was the first mortgage payment in June 2005? Or is that when the loan closed? Did you make an additional mortgage principal payment every month? Or did you start sometime after the first payment?

You can use Bankrate’s “Mortgage payment calculator” with its corresponding amortization schedule to determine the total mortgage interest paid under the different scenarios. The goal should be to find a financing and additional payment approach that minimizes the total mortgage interest expense after considering the closing costs associated with the new loan.

I took a stab at it by inferring a couple of data points and didn’t come close to your numbers on the refinancing.

If you’re using the mortgage interest deduction, don’t forget to consider the impact of this deduction on your taxes. You’ll want to look at the total mortgage interest expense on an after-tax basis. It isn’t likely to change the decision, but it will reduce the gap between the two approaches. That’s because you’ve reduced the mortgage interest expense and by doing so, reduced the tax deduction.

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