Better to pay down mortgage or refinance?
Weigh the pros and cons and crunch numbers carefully before you decide.
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Question: We have a 30-year fixed-rate mortgage with a rate of 4.875%. We originally borrowed $165,000. We still have 25 years left until the loan is paid off. Just a year into the mortgage, we placed it on biweekly, or twice-monthly, payments. We also have been paying toward the principal as much as possible and now have the principal down to $124,000. (Bing: What are interest rates on 15-year mortgages right now?)
Our goal is to pay it off, if possible, in five years. Some people have told us the rate of interest is on the high side and urged us to refinance since we have good credit. I feel it would probably cost us about $5,000 to refinance. So, if we pay it off in five years, would it really be worth paying the extra fees? What is your advice? — Kendi Curtail
Answer: You would pay the closing costs and refinance at the lower rate if you plan on staying in the house. You expect that your total interest expense, including closing costs, will be lower if you refinance than if you don't. Personally, I'm not a fan of biweekly mortgage payments. You don't need that crutch if you're making the additional payments on your own. I'd urge you to avoid signing up for the biweekly plan if you do refinance.
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I don't know how realistic it is for you to expect to pay off $124,000 over the next five years. While impressive, you only paid down just $41,000 over the last four or five years. The very aggressive effort to pay off the mortgage may not be realistic unless your financial circumstances have changed.
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What might be better is to refinance into a 15-year fixed-rate loan. A recent national average for a 15-year fixed-rate loan is 2.97%. That would reduce your interest rate by 1.9%. While your loan balance decreases with each mortgage payment, that interest rate savings when applied to a constant $124,000 loan balance saves $2,362 in the first year alone.
I used Bankrate's biweekly mortgage calculator to estimate your monthly payments, total interest and payoff date, but I didn't include any additional principal payments. I then used Bankrate's mortgage calculator to calculate that information on a new 15-year fixed-rate loan. By my calculations, I found that you would save $42,000 over the life of the mortgage by refinancing into a 15-year loan with monthly payments. That assumes $5,000 in closing costs on a loan of 2.97%. It sounds like a good idea if you can really swing it.
I have another viewpoint that no one has mentioned. I am also trying to pay off my mortgage at an accelerated rate. Each year for the past 3 years I have managed to pay down my mortgage by about 20K and at the end of the year I have refinanced. My reasoning is this. After 29 years with my last company I was let go. It took me a year to find another job. If it happens again I want to be left with a mortgage payment I can live with and have met that goal now.
Also instead of paying down the mortgage each month we put the money in a bank account and then paid one payment with what we had accumulated throughout the year. Reason was we would need the income if I lost my job again. Yes we did pay additional interest but the peace of mind knowing that we would have needed funds offset the interest loss.
Now that we have the payment that we can live with we just put the money in the bank. If I can keep my job for two more years we will have the cash to pay off our home. If I lose my job we will have the cash survive.
Don’t wait on the re-finance as the rates are climbing. The most it has cost me in my last three refinances is about 2K. There are still no point no cost loans available but they are fewer now than last year.
Amazing !!! Although several responses refer to the shallowness of the article, it
is interesting that human behavior continues to drive the solution. "I feel good",
"it makes me happy", etc. while both article and responders ignore the more
critical factors impacting the gentleman's query. Nothing about adjusting for
taxes, the damaging result of inflation, the outright avoidance of what-is-more
efficient, the silence and void of "the magic of compounding" Behavioral financial
planning answers many questions that one needs to hear and consider, not what
the person wants to hear....little or no educating the counter-intuitive aspects of money.
I personally find that refinancing will in the end not save a lot of money. Since the y want to pay off the house in five years, the time is not very long. Interest is calculated based on the remaining principal, so as the principal reduces so does the interest. Rather than bi-weekly, I would recommend putting the entire extra payment additional principal. Most mortgage payment slips have a box for this. In the end, the interest rate will be reduced by almost half by paying a full payment as it will be applied directly on the principal. Why give a bank or financial institution to simply do all the work that is completed, and you will save the $5000. I have always paid down my mortgages that way. Now I have no mortgage, and it is a great feeling being in a house that I really own. Before I moved to this house, I had paid off the previous house, so it was great to get a check for the full amount so I could pay cash for this house and bank the rest since we had downsized.
I think your analysis should have been using their expected pay off period...five years...and without even running the numbers I would say you won't save any appreciable money by refinancing.
If they paid off 41 K in the last 4 years, I think they have demonstrated significant intent to pre pay mortage. so you running the exisitng loan, based on minimum payments, and comparing that to a 15 year payback doesn't reflect their reality. At least make it apples to apples and compare them based on the same payback timeframe (15 year...or even their desired 5 year)
the best answer might have been to suggest they run a amortization calculation themselves, to look at all the options.