Refinance mortgage with home equity loan?


At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

Dear Dr. Don,
My credit union has recommended that I take out a home equity loan at a fixed rate of 3.8 percent. That would be lower than the rate of 4.75 percent on my current mortgage, which still has 27 years to go and $249,000 left to pay.

With a refinance, I was told I could lower it to a 20-year fixed-rate equity loan and it would only cost me $50 more per month. It sounds great to get seven years taken off my mortgage, but I worry that this is too good to be true. I’m told there are no closing costs. What do you think? Should I move forward on this?

— Michael Mortgage

Dear Michael,
At first, it reads like a slam-dunk. But keep in mind that there’s really no such thing as a zero closing cost mortgage. Instead, mortgages charge closing fees in other ways, such as a higher interest rate on the mortgage.

The good news is you’d be capturing interest savings in two ways: in the lower interest rate on your mortgage and on the shorter loan term. The table below shows how you can save $86,463.84 in pretax interest expense over the next 20 years by refinancing with the 20-year fixed-rate home equity loan.

Save on pretax interest expense

Current loan 20-year home equity loan Difference from current loan
Loan amount: $249,000 $249,000 N/A
Interest rate: 4.75% 3.8% 0.95%
Loan term (months): 324 240 84
Payment: $1,365.22 $1,482.78 $(117.56)
Total payments: $442,330.87 $355,867.03 $86,463.84
Total interest: $193,330.87 $106,867.03 $86,463.84

I show you paying an extra $117.56 a month instead of the $50 you mention in your letter, but that could be because you don’t have exactly 27 years remaining on your existing mortgage. If you can afford the additional expense, you’ll gain a lot of interest savings.

Ask yourself if you can get a lower rate from a different lender, even if that means paying closing costs on the mortgage. A 0.25 percent lower interest rate on $249,000 represents a pretax interest savings of $7,745.72 over the 20-year life of the new loan. That assumes you hold the loan for the full 20 years. You might be better off paying the closing costs upfront to capture a lower interest rate.

If you really want to see some savings, look at refinancing into a 15-year mortgage at 2.97 percent, which is Bankrate’s national average at the time of this writing. It’s an extra $350.74/month versus your existing mortgage, but it reduces the pretax interest expense by $133,000 versus your existing mortgage.

Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.

Ask the adviser

To ask a question of Dr. Don, go to the “Ask the Experts” page and select one of these topics: “Financing a home,” “Saving & Investing” or “Money.” Read more Dr. Don columns for additional personal finance advice.

Bankrate’s content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate’s Terms of Use.

More On Mortgages And Refinancing: