Q: I’m confused about annual percentage rates (APRs). I’m 3 years in on a 30-year mortgage. The APR on the loan 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 principal 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 point, 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