Q: I’m confused about annual percentage rates (APRs). I’m 3 years in on a 30-year mortgageA Mortgage is a document granting a lien on a home in exchange for financing granted by a lender. The mortgage is the means by which the lender secures the loan and has the ability to foreclose on the home.. The APR on the loanA Loan is an amount of money that is lent to a borrower, who agrees to repay it plus interestInterest is money charged for the use of borrowed funds. Usually expressed as an interest rate, it is the percentage of the total loan charged annually for the use of the funds.. is 5.875 percent. My bank is now offering 5.45 percent APR.
I am wondering if it is worth the effort to refinance my loan. I already pay an additional $300 per month toward the principalPrincipal is the amount of money you borrow if you're getting a home loan. If you're buying a bond, the principal is the amount you're lending. Typically, you'll buy bonds with a face value of ,000. If you buy a ,000 bond, your principal is ,000. balance. Will I save money by refinancing?
A: Probably not at the interest rate you’ve quoted in your email. If you can’t even lower the interest rate on your loan by a half percentage pointA Point is one percent of a loan amount., it will probably take you several years to pay off the refinance closing costs. For example, if you save $50 per month but it costs you $3,000 to refinance, it would take you five years to pay off the closing costs with the savings. While that sounds good, it really isn’t.
The only way this would work is if the interest rate drops lower (as I was writing this, the 30-year mortgage rate fell again to just about 5 percent), and you can shave a full point or more off of your interest rate. Or, if you can refinance your current balance to a 15-year mortgage with an interest rate of 4.5 percent or lower, you’ll shave years off of your loan term and pay a lower interest rate.
But by paying $300 per month extra, or $3,600 per year, you’ve already effectively cut the term of the loan by a significant amount. For example, if you make once extra payment a year, you’ll shave 8 years off of your loan term, and pay off the loan in about 22 years. If you make two extra payments per year, you’ll pay off the loan in 18 years. If you’re making three extra payments per year, you’ll save even more in interest because you’ll get the loan paid off that much faster.
So, spending $2,000 or $3,000 to refinance when you’re already on a great path doesn’t make much sense unless you’re cutting your loan term to 10 or 15 years in length. Then, refinancing might make some sense.
March 20, 2009