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Should I refinance into a 'no-cost mortgage'?

Dr. Don Taylor, Ph.D., CFA, CFP, CASL
Don Taylor

Dear Dr. Don,
My current mortgage loan balance is $263,000. I financed the home with a 10-year fixed-rate loan at 3.25 percent. I have nine years and four months to go. My question to you is: Is it worth it to refinance with a 10-year no-cost mortgage at 2.75 percent?

-- Rony Redo

Dear Rony,
Sure, but recognize there's really no such thing as a "no-cost mortgage." The closing costs are baked into the interest rate. Still, you're saving one-half of 1 percentage point in interest on more than a quarter of a million dollars. Go for it. The table below shows the interest savings.

Refinance and save

Existing mortgage Refinancing Difference
Loan amount 263,000 263,000
Interest rate 3.25% 2.75% 0.5%
Loan term (months) 112 120 8
Loan payment 2,725.49 2,509.31 216.18
Total interest expense (rounded) 42,255 38,117 4,138

I recommend taking the difference in the two monthly mortgage payments and using it to make additional principal payments each month. That reduces your total interest expense to about $7,682 instead of $4,138 and shortens the loan term of the refinancing to nine years and two months, or about what's left on your existing loan.

Your after-tax savings will be less than these dollar amounts with any reduction in the mortgage interest deduction on your income tax return. Still, it's worthwhile to go ahead with the refinancing into this so-called no-cost mortgage.

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