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Is it time to refinance a mortgage?

Don Taylor, Ph.D., CFA, CFP
Don Taylor
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Dear Dr. Don,
I have a $390,000 mortgage at a 5½ percent fixed interest rate for 30 years. I have 27 years left in the current term. Is it a good idea to refinance the loan for 30 years fixed at a 4.37 percent interest rate? Closing costs will be $1,800.
-- Valentina VacillatesDear Valentina,
If you plan to stay in the house for a while, and you qualify to refinance, this is an opportune time to bring down your mortgage interest rate with relatively inexpensive closing costs. The Bankrate feature, "6 questions to ask before a refinance," can help you decide.With the Fed's decision to start a second round of quantitative easing, homeowners should continue to see downward pressure on mortgage interest rates. That said, you shouldn't try to wring the last 0.01 percent out of your refinance rate. One way to keep your finger on the pulse of the mortgage market it to read Bankrate's weekly Mortgage Rate Trend Index, and Holden Lewis' weekly mortgage column. I have both features sent to me as an e-mail alert every Thursday.I used your numbers, assuming that the $390,000 was the initial mortgage balance. Three years into the mortgage, the loan balance should be about $373,333. From there, I looked at some refinancing options and using Bankrate's mortgage calculator arrived at the table presented below:

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Refinancing options

Existing mortgage Refinance 30-year fixed Refinance 30-year fixed
with additional
principal payments
Refinance 20-year fixed
Loan balance: $373,333.00 $373,333.00 $373,333.00 $373,333.00
Interest rate: 5.5% 4.375% 4.375% 4.15%
Loan term (months): 324 360 262 240
Monthly payment: $2,214.38 $1,864.00 $2,214.38 $2,291.94
Total interest expense (pretax): $344,124.89 $297,706.03 $206,945.05 $176,733.10
Estimated after-tax expense (25%): $258,093.67 $223,279.52 $155,208.79 $132,549.82
Difference after-tax from existing mortgage: - $34,814.15 $102,884.88 $125,543.85

The after-tax numbers assume a 25 percent marginal federal income tax bracket, and that you can fully utilize the mortgage interest deduction on your taxes. Simply put, that means that the mortgage interest deduction isn't just replacing the standard deduction on your taxes. Since Bankrate doesn't report a 20-year rate, I estimated a rate for that mortgage.Although I don't show it in the table, extending the refinancing back out to 30 years adds an additional $34,000 in interest expense. A better strategy would be to make additional principal payments, so your monthly payment on the refinance remains the same as your current mortgage. By doing that move, you shave more than eight years off the 30-year mortgage term, and tens of thousands of dollars off the interest expense.You can put a finer point on your refinance decision by using one of Bankrate's refinance mortgage calculators.

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