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Fixed Rate Refi

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Posted On: 12/12/2012

Question:

I've been prepaying varied amounts on my fixed rate 5.125 percent, 15-year mortgage. I'm thinking that as of today, my effective rate is a lot lower than 5.125 percent, and this makes refinancing less attractive. Is there a formula I can use to find my real interest rate on the remaining balance, whether or not it includes the amounts I've already prepaid?

Answer:

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A fixed-rate mortgage is a thing of financial beauty. You pay interest on the outstanding loan amount, so if you make prepayments, the length of the loan is cut. With less money outstanding, the interest cost is lowered – but the rate is unchanged.

Imagine that you owe $100,000 at 5.25 percent over 15 years. The monthly cost for principal and interest is $804 over 180 months. The potential interest cost over the life of the loan is $44,698.

If you pay an additional $100 per month, the interest rate remains the same but the loan term is reduced from 180 months to 152 months. The estimated lifetime interest cost is $37,119.

Today, interest rates for fixed-rate 30-year mortgages are below 3.5 percent for well-qualified borrowers – and under 3 percent for fixed-rate 15-year loans.

Let's say the cost of refinancing is $2,500 – a sum added to your loan balance with a “no-cost” refinance (meaning you bring no cash to closing, not that there really is no expense to refinance). Is this worthwhile in your situation? How long will it take to recapture your refinancing costs in the form of lower monthly payments?

If you have little time remaining on your present loan or a small balance, then the closing costs for replacement financing may be better spent paying off the current debt. Sometimes this is a financing-and-numbers issue, but sometimes it's also a question of personal preferences, the option that makes you most comfortable.

For specifics, speak with lenders and run the numbers with an amortization calculator.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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