Should I Refinance My Mortgage

The question about refinancing your mortgage comes down to one simple question.  Will I save money?

My hypothetical couple, Mr. & Mrs. Smith own their home which is worth $350,000 and their current mortgage balance is   $191,991.  They are two years into their five year term with an interest rate of 5.45% and their projected amortization is currently 23 years.

The couple has run up some debt in the last couple of years and feel that they may be paying too much interest.  Their debt is as follows:

The balance for the loan on their 5^th wheel trailer is $22,500 with an interest rate of 7.6% and payments of $300 per month.

The balance on their personal line of credit is $15,000 with an interest rate of 6.25% and payments of $450 per month.

The balance of their credit card is $18,000 with an interest rate of 13% and payments of $540 per month.

Mrs. Smith has called her current bank and asked for the penalty for breaking the mortgage contract.  The penalty amount of $6220 is provided and although Mrs. Smith is concerned that the amount may be too high to save money she wants to pursue refinancing their home, if it is in their best interest.

Mr. & Mrs. Smith want to know if they will save money by refinancing and consolidating all of their debt into a new 5 year mortgage.

Where to start?

The couple doesn’t know who will figure this out for them and they call their friendly mortgage broker and bank rep.  Upon meeting with both, they are told that they can bring their monthly payments down by $981 by extending their amortization to 30 years.  This appeals to Mr. Smith, but Mrs. Smith knows they will pay more interest overall and does not want to extend the amortization.  Mr. & Mrs. Smith agree that they want to stay on track to having their mortgage paid in 23 years.

Mrs. Smith is referred to a Mortgage Professional who was quite helpful in refinancing her friend’s home.  Mr. MP advised Mrs. Smith that he will fully evaluate their current situation and needs.  Mr. MP explains to them that they can refinance at a five year rate of 4.55% and the only variable in the calculations is the rate that they would be renewing at in 3 years when their mortgage term is up.  All agree that 5% is a reasonable assumption.  The new lender has offered to pay the legal fees for the refinance.

Mr. MP provides the following options to Mr. & Mrs Smith based on the next five year term:

1.  Consolidate all their current debt into their mortgage dropping the total monthly payment from $2265 to $1475 and saving them $790 a month, while being on track for paying off their mortgage in 23 years.  Mr. Smith is excited about the new possible monthly cash flow, but Mrs. Smith does not like the idea.  Mr. MP cautions that this will mean that their debt after 5 years would be $32,270 more than currently projected.

2.  Consolidate all their current debt into their mortgage and keeping their amount of debt at the end of the five year term the same as it would be if they did not refinance.  Mr. & Mrs. Smith wonder what the point of this is until Mr. MP explains that their total monthly payment would drop from $2265 to $1956 a month saving them $309 per month.

3. Consolidate all their current debt into their mortgage and not changing their monthly payments.  Mr. MP explains that although their monthly payments stay the same the lower rate reduces interest costs and the couple is ahead $22,061 over the five year current projection.

Mr. & Mrs Smith think that it will be tight but they can keep the payments the same and are leaning towards saving the $22k over five years.  Mr. MP agrees that is a good way to go, but cautions if things get tight and they end up carrying a balance on their credit cards it could reduce the savings from refinancing substantially.  Mr. MP advises that it may be better for them to reduce their payments by $309 per month so they do not have to rely on their credit cards.  Mr. MP also advises that lump sum payments can be made anytime of the year. Mr. & Mrs. Smith agree that they would be better off with the cash flow and the ability to make prepayments.

After some discussion Mr. & Mrs. Smith decide that they are going to reduce their monthly payments by $309 and make a concentrated effort not to take on anymore debt.  Mr. & Mrs. Smith agree that this will give them more control over their debt and they should not have to rely on their credit cards.

Questions, comments?

Disclaimer:  For the purpose of this illustration all numbers are rounded off and all interest rates are compounded semi-annually.  Everyone’s situation is unique and should always consult a Mortgage Professional who will work with you and present all of your options.