Decoding the Upfront Costs of Refinancing

Q: I'm retired, living in a condo. I have a first mortgage that is a 30-year at 5.875 percent. I pay $657 per month. My second mortgage is paid off. I've been offered a refinance at 4.5 percent, which would cost me $572 per month, but it would cost me $3,919 to close on the loan.

Should I do it?

A: I've spent a lot of time recently talking about how you have to pay more attention to the total cash in the deal than to the interest rate on the loan. You've been offered a deal that will cost about $4,000 and will save you $85 per month. At the end of year one, you'll have saved $1,020. At that rate, it will take you nearly four years to pay off the costs involved with the mortgage and to start saving real money.

But there are other important questions you'll have to answer: Where will you be in four years? Is this the last mortgage you're ever going to have? How far into your current mortgage are you? If you're 15 years in and are resetting the bar to 30 years, you're going to pay another 15 years' worth of interest on top of $4,000 in closing costs. Then you wouldn't be saving money -- you'd be spending real money.

The only way to know whether the plan works is if you refinance your current loan balance and reduce the term of your loan to match the end date on your current loan, and you pay less money overall. And you have to plan to be in the house for at least five to seven years to make the effort somewhat worthwhile.

You also need to understand what costs are included in the almost $4,000 you're going to pay. If part of that amount is for real estate tax and insurance escrows that will go toward paying your expenses down the line, you should probably exclude those expenses from the calculation. And if part of the $4,000 is prepaid interest on the loan -- whereby the loan broker assumed you were closing on a day other than the first day of a month -- you need to exclude that amount, also.

If after you exclude prepaid interest and escrow charges, you're left with closing costs closer to $2,000, it will still take you a little more than two years to break even on the costs. You have to then decide how long you plan to stay in this house and keep the loan.

One last piece of advice: You should ask your loan broker to compute the amount you would pay per month if your new loan actually had to be paid off in full on the same date as your existing loan. When you refinance an existing loan that has only 25 years to go with a new loan that has 30 years to go, most of the initial monthly payments will go to paying the interest owed on the loan. But as you are further into the loan, even five years down the line, more of your monthly payment is a repayment of the principal rather than mortgage interest.

When you have both numbers computed to the same end date, you'll be able to compare the actual amount you'll pay monthly on an apples-to-apples basis. You may find that the monthly savings that result from extending the term of your loan are actually less than the $85 you expect. If the savings are quite a bit less than $85 per month, the time it will take you to break even on the costs of refinancing is even longer, making a refinance even less worthwhile.

Please reassess your situation based on your answers to the above questions, and I'm sure you'll figure out which direction you need to go.

Ilyce R. Glink is an author and nationally syndicated columnist. Her latest book is "100 Questions Every First-Time Home Buyer Should Ask." Samuel J. Tamkin is a real estate lawyer in Chicago. If you have questions for them, write to Real Estate Matters Syndicate, P.O. Box 366, Glencoe, Ill. 60022, or contact them through Glink's Web sites, http://www.thinkglink.com and http://www.expertrealestatetips.net.