Sue’s Mortgage Puzzle

Last time Sue refinanced her mortgage was six years ago. She received a 15-year fixed loan with 5.5% interest. Her monthly payment is $880, and Sue currently owes $38,000.

Sue is considering refinancing. She has been offered a 5-year fixed loan with 4.25% interest. You can check an online mortgage calculator and see that on a loan of $38,000, her monthly payments will be $700. The closing costs are $1,400. Should Sue refinance?

Seems like a no-brainer. The closing costs will be recovered in less than a year, and then the new mortgage payments will be pleasantly smaller than the old ones. In addition, the new mortgage will last five years instead of the nine years left on the old mortgage.

What is wrong with this solution? What fact about Sue’s old mortgage did I wickedly neglect to mention? You need to figure that out before you decide whether Sue should really refinance.

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3 Comments

  1. Leo:

    Is there any pre-payment penalty?

  2. konyo:

    Closing rates are also important to know if it’s worth refinancing

  3. Tomasz Wegrzanowski:

    With payments like that she’ll pay off her original mortgage in 4 years, not 9.
    It will cost $240 more than the second mortgage, or $1160 less if you consider closing costs.

    The question is – is paying $1160 worth delaying repayment by one year?

    Also, she could decrease her payment of the original mortgage to around $720 to get to 5 year schedule. That would cost her $1200 more than the second mortgage, or $200 less after considering closing costs.

    So, not really.

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