Use Savings for My Mortgage? Or Vice Versa?

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Published July 16, 2012

| Bankrate.com

Dear Dr. Don,
My husband lost his job. We owe $60,000 on our mortgage and have $50,000 in savings. With the mortgage payment, we can barely manage on my salary. Should we supplement my income from savings, using about $500 per month until the mortgage is paid off in five years, and not save any more money? Or, should we refinance our current 5.25% mortgage for a longer term so I can make the payments without a problem and still be able to save a small amount of money? I am in my 50s and was looking forward to being mortgage-free! Thanks,
--Melodie Mortgage

Dear Melodie,
Being mortgage-free in retirement is a sound financial goal. You're on track to do it in the next five years. That's great. Is your husband looking for a new job? Is it possible that your one-income situation is temporary? Your plan to raid the savings account for $500 per month to balance your household budget while your husband is out of work makes sense.

Your idea of refinancing to reduce your loan payment so you can continue to put money aside, however, doesn't make sense. The yield you will earn on the savings is going to be lower, probably much lower, than what you would pay in interest expense on the mortgage.

Whether you should refinance depends on: your ability to qualify for a loan as a one-income family; the interest rate; and, especially, the closing costs.

You're so close to paying off your current mortgage that paying several thousand dollars in closing costs to get a new loan doesn't make sense, as shown in the table below. Bankrate's 2011 Closing Cost Survey reported a national average for closing costs of $4,070, although that was for a new purchase mortgage of $200,000. A loan that has low or no closing costs -- because those costs are priced into a slightly higher refinance interest rate -- can get you around this issue.

Refi With Closing Costs Options

  Existing mortgage Refi w/15-yr. fixed-rate mortgage Refi w/30-yr. fixed-rate mortgage Refi with a 5/1 adjustable-rate mortgage*
Loan amount $60,000 $60,000 $60,000 $60,000
Interest rate 5.25% 3.17% 3.91% 3%
Loan term (months) 60 180 360 360
Loan payment $1,139.16 $419.27 $283.34 $252.96
Total interest expense $8,439.54 $15,469.01 $42,004.12 $31,066.47
Interest expense + $4,070 in refinancing closing costs   $19,539.01 $46,074.12 $35,136.47
*Assuming the rate never adjusts.

A refinance to extend your loan term, assuming your income is sufficient to qualify for the refinancing, will reduce the interest rate on your loan and reduce your monthly payments. To achieve those savings, however, you'll increase your total interest expense, unless you make additional principal payments to shorten the effective loan term.

The following table shows a "no-cost" refinancing, assuming that option raises your interest rates by 0.375% and has you making additional principal payments to pay off the loan in five years (thus assuming the ARM rate never adjusts). You do save on interest expense, and you lower your monthly payment. You can decide to skip additional principal payments if you're in a cash crunch in any given month.

'No-Cost' Refi Options

No closing cost option Existing mortgage Refi w/15-yr. fixed-rate mortgage Refi w/30-yr. fixed-rate mortgage Refi with a 5/1 adjustable-rate mortgage*
Loan amount $60,000 $60,000 $60,000 $60,000
Interest rate 5.250% 3.545% 4.285% 3.375%
Loan term (months) 60 60 60 60
Loan payment + additional principal payment $1,139.16 $1,092.71 $1,112.72 $1,088.15
Total interest expense $8,439.54 $5,562.86 $6,763.49 $5,288.95

Talk to your lenders about "no-cost" financing to see if this refinance option can work for you.

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