Should You Refinance Your Mortgage?

We have five years and about $65,000 to go on a 15-year mortgage at a rate of 5.25%. Is it worth it to refinance to another 15-year loan at a rate of about 3%, assuming no closing costs? We would accelerate our payments because we would still like to pay off the mortgage in five years, about the time we’re eligible to retire.

That sounds like a good plan. “Any time you have the opportunity to significantly reduce your home-loan interest rate -- from 5.25% to 3% in your situation -- you should grab it,” says Mari Adam, a certified financial planner in Boca Raton, Fla. “If you are lucky enough to do this with no closing costs, don’t think twice about the idea.”

Adam ran the numbers to show how much you could benefit from the lower rate. If your mortgage amount was, say, $155,000, your current monthly payment is probably about $1,250. If you refinance the remaining $65,000 at 3%, your monthly payment would shrink to about $450 -- saving you $800 on your monthly mortgage payments.

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The downside to refinancing is that you’re taking out a new 15-year loan, which means you could be making monthly payments long after you plan to retire. To avoid that situation, Adam recommends taking the amount you save every month and applying it to your mortgage as an extra principal payment. That would enable you to retire the new mortgage in less than five years -- a little faster than your current pay-down schedule -- and save thousands in interest.

Adam points out another advantage of refinancing: flexibility. “While you may intend to pay the extra principal monthly, you are not required to do so,” she says. “You can adjust your plans if you encounter unforeseen financial difficulties over the next few years.”

At current interest rates, refinancing is generally worthwhile for anyone whose current interest rate is 5% or higher, says Adam. If closing costs are involved, divide the closing costs by the monthly savings to see how many months it will take you to start saving money. Be careful before refinancing to a shorter-term mortgage at a slightly lower interest rate and a higher monthly amount. You could be locking yourself into too-ambitious a payment schedule if money gets tight.