Mortgage Q&A: Goals dictate best refi option

Q. My wife and I have been in our current home almost 15 years. We have a 5.75 percent 30-year fixed-rate loan with a balance of about $224,000. We have another 15 years to go before it’s paid off.

We are thinking of taking advantage of today’s low rates and refinancing. I want to refinance the balance to a 15-year fixed-rate loan so we don’t add another 15 years to our loan term. My wife thinks we should refinance to a new 30-year loan and take out about $20,000 in cash to pay off a car and some credit-card debt.

I would hate to waste our hard-earned equity by paying off consumer debt. With whom do you agree?

A. There’s not a right or wrong answer to your dilemma. The path you take regarding your mortgage financing should depend upon your personal objectives. I’ll demonstrate what I mean, but let’s backtrack first.

My calculator tells me the loan you took out 15 years ago was for $320,000 and your monthly principal and interest (P&I) payment is about $1,900. This would make your balance about $224,000 today at a rate of 5.75 percent. Now, let’s examine your options.

• Refinancing your existing balance to a 15-year loan would result in an interest rate of about 4.25 percent with little or no cost. Your P&I payment would drop to about $1,700, and your term would remain at 15 years. Clearly, this is a smart move. You drop your rate from 5.75 to 4.25 percent, your payment is reduced by about $200 a month, and you don’t extend the term of your loan.

If you can’t decide what to do, this would be your course of action because it’s an “apples-to-apples” lateral move - drop the rate, take no cash out, keep the remaining term and pay zero or little in fees.

• Refinancing the existing balance to a new 30-year loan would result in an interest rate of about 4.75 percent with little or no cost. You would have a P&I payment of about $1,200, freeing up about $700 in monthly cash flow. While this savings is significant, you ultimately will pay more interest over the life of the loan because you are extending the term another 30 years.

Is this a bad thing? Not necessarily. Mortgage interest is tax deductible, so if you have a significant taxable income, the after-tax rate on 4.75 percent could be close to 3.50 percent.

Also, it depends on what you might do with the $700 not spent on the mortgage. Perhaps you need it for a college fund. Are you maxing out your retirement contributions? You must ask yourself these kinds of questions to make the right decision.

• Refinancing to a 15-year fixed-rate loan and taking out $20,000 cash to pay off consumer debt is another option. At 4.25 percent, your payment would be close to $1,850 - $50 less than your current payment. Ultimately, your monthly cash outlay would drop significantly because you also would eliminate the payments on the credit cards and automobile. But do you want to pay interest on that debt for the next 15 years?
• Finally, you can refinance to a 30-year fixed-rate loan and take out $20,000. The payment would be close to $1,300, and you would eliminate the payments on the consumer loans. This course of action likely would result in the biggest boost to your monthly cash flow, but you also would pay more interest over the life of the loan. Still, there’s no crime in carrying a mortgage with a fixed rate that’s equivalent to 3.50 percent after the tax deduction.

So there’s no right or wrong answer. Ask yourselves what’s most important - cash-flow relief or becoming debt free? The only thing I would caution against is paying off consumer debt by rolling it into your mortgage loan and then turning around and buying another car on credit and jacking up your credit-card balances again.

Send e-mail to henrysavage@pmcmortgage.com.

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