Is lower interest rate worth it when refinancing if you pay more over lifetime of loan

Question

I have owned a house for 2 years and have a 30 year fixed rate mortgage at 3.75% interest. I am considering refinancing into another 30 year fixed rate mortgage at 3.49% interest. Refinancing would certainly lower my monthly bill and I will have broke even on closing costs after 2.5 years from the savings.

All of those details sound worth it to me. However, I am calculating out the difference that paying 2 extra years on this lower rate will cost me and noticing that in the entire lifetime of the loan, I will have paid more overall if I refinance, even though I save every month. I am uncertain if this data point really matters when it comes to the decision to refinance?

Here is what my monthly payments are for principal/interest only. Current loan: 1168 Refinanced loan: 1117

I have 28 years (336 months) left to pay on my current loan. That means over the remaining lifetime of my current loan I will pay $392, 448. However, if I take 30 years (360 months) times the refinanced amount, I arrive at a lifetime total payment of 402,120. This means I will have paid $9,762 more overall if I refinance. Of course, my PMI will be reduced with the refinanced loan and I have calculated that will be about $4,000 less overall. That being said, I am still paying more over the lifetime of the loan, despite having lower monthly payments and reduced PMI.

Does the overall lifetime payment amount have any realistic impact? While I doubt I will live here a full 30 years, I intend to live here at least another decade.

Answer 1

The chance that you'll either refinance again or sell the house in 28 years probably negates any negative impact of extending the loan another two years.

However, I'm still not sure this refinance is worth it. You didn't say what the closing costs are, but the general rule is that you need to lower your interest rate by about 1% to make the new loan worth the expense of refinancing. Even if your closing costs were $2,000 (which would be fairly low), saving $50 a month is going to take you 40 months to make up for the closing costs. Plus, not all of that $50 a month is interest savings, so the payback will be even longer. Usually you want to be able to pay back your closing costs in about 2 years.

You might get more bang for your buck (if you can afford it) by reducing the term to 15 years. You'll have a higher monthly payment, but you typically get a lower rate with a shorter loan, so you'll pay back the closing costs more quickly. The interest per month will also drop faster than with a 30-year loan.

If you can't afford a shorter loan length, I don't think saving $50 a month is worth it. You may also be better off paying a little extra to get down to 80% Loan-to-Value and getting rid of PMI all together.