Better to Pay Down Mortgage or Refinance?

Dear Dr. Don,

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. 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?

Thank you,

-- Kendi Curtail

Dear Kendi, 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.

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.

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.

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