Dear Dr. Don,
How can I find out whether I would save money by either making additional principal payments each year or refinancing my mortgage? I owe $167,000 and have about 25 years left on a loan with an interest rate of slightly less than 5%. I could likely lock in at less than 3% on a 15-year fixed-rate mortgage. At the same time, I can make additional principal payments each year on my current 30-year loan. Can you help me decide?

Thanks,
-- Julie Jump-Start

Dear Julie,
The first step for you is to estimate how long you plan to remain in the house. If you think you could be moving in a few years, it isn't a good idea to pay thousands of dollars in closing costs just to lock in that lower interest rate.

Bankrate's refinancing calculators can tell us how long it takes to break even on refinancing. This estimate looks at how long it takes to recoup closing costs through lower monthly mortgage payments.

Making additional principal payments will reduce your total interest expense, but you will be stuck with the higher interest rate. If you do refinance, you would get a lower rate of interest, and you could make additional principal payments.

The chart below, while only estimating your situation, shows how you could make additional principal payments on your current loan equal to the difference in payments between the existing loan and a new 15-year loan at 2.95% interest, and you would still pay $48,533 in interest expenses versus a new 15-year refinancing. Another benefit is refinancing also shortens your loan term by 3 ½ years.

Additional payments vs. refi

  Current loan w/additional principal payments 15-year refinancing Difference
Loan amount $167,000 $167,000  
Interest rate 4.95% 2.95% 2%
Loan term (months) 222 180 42
Payment $971.41 $1,149.26 $(177.85)
Additional principal payment $177.85 $- $177.85
Total monthly payment $1,149.26 $1,149.26 $-
Total payments $255,400.16 $206,866.74 $48,533.42
Total interest expense $88,400.16 $39,866.74 $48,533.42

This analysis doesn't include closing costs from a refinancing or the potential reduction of the mortgage interest deduction on your income taxes. Even so, it's clear refinancing is a better option than making additional principal payments on your existing loan if you plan to be in your home for a long time.

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