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We have been in our current house for about 2.5 years and have a 30 year mortgage at 3.875%. We could refinance to a 30 year at 3.375%. Our mortgage amount is about 500k. Refinancing adds about 12k to the mortgage but even with that, the monthly payment reduces about $210 a month. Is there a downside to doing the refinance?

This is probably way too simplified, but I have been paying the current mortgage for about 30 months (330 more to go). So doing a new 30 year mortgage would add 30 months to our payment schedule (back to 360). If I multiply the $210 savings by 330 months--I save $69,300 for those months. But then when I multiply the mortgage I would be paying by the extra 30 months I would be adding on, it would be about $75,000. So would I actually lose out in the end (assuming I don't ever add payments to the principal)? I know this doesn't factor in what I would have been doing with the money saved each month and if I invest it or use it to pay down the principal.

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    Why does refinancing add $12k to the balance? Are you borrowing additional money, or just rolling the closing costs into the new loan (in which case 12k seems like a lot)? – yoozer8 Feb 28 at 16:30
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    There's a reasonable chance that rates will continue to go down depending on how hard this whole Coronavirus hits the markets. Might be worth waiting to see if you could get an even lower rate. This obviously is speculation and has its risk but I wouldn't get too excited over a 0.5% reduction in my rate. – user1723699 Feb 28 at 18:34
  • Is the new mortgage with the same company as the old mortgage. Sometimes when switching companies the new mortgage seems to have a higher fee because they need you to fund the escrow account, they don't count on getting the balance from the old account. – mhoran_psprep Feb 28 at 23:44
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It depends on what your objective is.

If your objective is to eventually own your home with no mortgage then what you are doing makes no sense:

  • You are adding $12,000 to your debt, presumably because there are “points” (fees paid to get a lower interest rate) on the loan and you are adding these fees to the amount being borrowed.

  • You had 27.5 years left to pay, and with this refinance you are adding 2.5 years to your payoff date, and inexplicably not considering the possibility that you can pay extra principal on the new 30 year mortgage to cause the new mortgage to be paid off in 27.5 years.

If your objective is to increase your cash flow then what you are doing is fine. It isn’t what I would do. When I stop working and retire I don’t want a mortgage payment so that I have the flexibility to live rent free.

Whenever I have done refinances I have these rules:

  • Never pay points or fees. That includes the cost of the appraisal. If a bank insists on fees, keep shopping. My rationale is that this likely won’t be the last refinance. In the 1990s rates dropped rapidly for a time relative to the 1980s, and I was a serial refinancer. Paying thousands of dollars in fees each time would have made no sense because that would be money down the drain after I refinanced again later. What matters is the lower interest rate.

  • Never increase the debt

  • Always compared mortgage payment of the refinance with my current by amortizing the new loan over the number of months between today and my deadline for paying it off. My deadline was set from 30 years from when I bought my original house. If I stick to the first two rules then the mortgage payment will always be lower even with the extra principal paid each month.

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You asked,

Is there a downside to doing the refinance?

Ultimately that can't be answered by us, because different people will have different criteria for what counts as a "downside." Or, another way to look at this, people will have different motivations for deciding about the specific scenario you've presented:

  • If you have cash flow problems and are after a way to reduce your fixed monthly expenses, even at the cost of a "worse" long term situation, the refi makes sense, because it drops your payment by $210 a month.
  • If you want free cash every month in order to invest in a specific investment you feel strongly about for some reason, same as above.
  • If you're right on the brink of crossing some income tax related threshold, having the slight difference in interest paid on a mortgage (which can be tax deductible) might be important.
  • If your ultimate goal is to get out of your house in the near future, the refi probably doesn't make sense, because (it sounds like) you're rolling some closing costs into the principal, so your DTI will get worse in the near term (you'll have less cash out of the house for a given sale price)

Ultimately, many people don't refinance just because of a specific difference in the long term cost of the mortgage (you won't "see" the difference you're talking about for many years). Few people stay in their house for 30+ years. Many people, thus, make refinancing decisions based on monthly cost, or a desired difference in equity after a certain point in time (because they're planning on selling). Or, they refinance because it's an opportunity to get some equity out of the house as cash, so they can do a home improvement project. All of those factors may (or may not) influence what counts as a "downside" for you, personally.

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  • Thanks for the comment. I do plan on staying in the house a very long time--even the full 30 years unless something unforeseen happens. I don't need the cash flow. The current payment isn't difficult for us. I guess I was wondering if it is dumb not to do the refinance or if there are negatives to doing it. Talking to a loan officer, they try to make it sound like I would obviously want to do it, but I am trying to see if there are downsides they don't want to talk about. – David Feb 28 at 16:46
  • Well, especially if you're planning on staying in the house for a long time, the obvious downside is that the refi costs you more in total. If you're not sensitive to cash flow and have no plans for that extra $210 a month, it doesn't make sense to me (personally.) Especially since it sounds like you'd need to roll $12k into the loan to close it. If you could get a half point decrease in rate without that $12k hit, it would probably make sense. – dwizum Feb 28 at 16:49
  • Also, it may be worth looking at your current loan just to check that there aren't any prepayment penalties. They're not very common (any more) but if you're thinking about a refi, you don't want to be surprised. – dwizum Feb 28 at 16:50
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    Thanks again for your help. One of the things the person said, was that since I am fine paying the current monthly payment, I could refi to the new 30 year, but just add the $210 to the principle each month. I don't think they told me how much earlier it would be paid off (although I can figure that out in excel). So it doesn't sound like there would be any prepayment penalties. But I will probably try to do the math to see if that makes my overall costs better. I will also try to call around to other places to see if there is less of a fee for doing the refi. – David Feb 28 at 16:58
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    This is just a minor point in your answer, but I can't think of any scenario where it makes sense to purposely pay more interest just so you can cross the tax threshold of being able to itemize. – TTT Mar 1 at 15:02
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This becomes a business decision and the way I figure it out is the break even point on the cost savings on the rate, and the cost to refinance. In this case, you are reducing your rate by .5% on a 500K house, so the savings on the finance charge is about $208/month. You are saying that it will cost you about 12K to refi. So the break even point is around 58 months.

Because of that, I would tend to recommend a pass on that deal. Either the interest rate needs to be lower, or the cost of the loan less, 12K does sound like a lot for a refi. The rate is very good, but I suspect that you are paying points to buy down the rate.

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The homeowner is already wrapped-up in a long-term mortgage so they might as well take the re-finance offer that adds 30 months but that increases their cash-flow.

Then if the mortgage is non-recourse the additional cash-flow can go into investments. Otherwise the additional cash-flow should go into mortgage prepayments.

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