Sudden savings alert! Mortgage rates are dropping again. How much could you save if you refinanced at a lower rate?

At the moment, a 30-year fixed rate loan is about 4.75%; a 15-year fixed is about 4.02%, according to Bankrate.com.

Pay less, save more
A refi only makes sense if the numbers work. For example, if you wanted to refinance your current 30-year fixed mortgage of $175,000, which is at 5.75%, down to 4.75%, you could save $162.00 per month now—and about $22,600 in interest over the life of the loan.

But, there are costs associated with a refi, as we describe here. In our current example, assuming the refinance costs are about $2,000, it would take about a year to recoup those fees.

Use this calculator to run your own numbers. (MP and Amanda are considering refis right now. MP wants to swap her 30-year for a 15-year. She'd pay about $120 more per month, but save $121,000 in interest!)

It ain't saving until you save it
But wait. There's one more key step. Whenever you kill a bill, cancel a sub or drop a charge—it ain't savings until it's in the bank.

So save your savings, as we describe in our recent post for Ramit Sethi's "I Will Teach You to Be Rich" blog.

Your move: Tell us some other ways you've saved money on a loan.

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Q: How do I decide whether it makes sense to refinance my mortgage at a lower interest rate?

In this example, imagine that you're refinancing a $160,000, 30-year fixed mortgage that is currently at 6.5%, into a 30-year fixed at 5.5%. Your current payment is $1,011 and you have 25 years left on your mortgage.

A: Start by doing a cost-benefit analysis. A step-by-step guide:

1. Ask your lender to give you a detailed breakdown of closing costs, which are usually 2% to 4% of the total loan, and typically include an application fee, appraisal and inspection fees, credit check, and attorneys' fees.

In this example the approximate closing cost would be: $3,630


2. By refinancing, you will lower your payment. Ask your lender what that lower amount is.

By refinancing, your monthly payment would drop by $103 to $908.


3. Divide the refinancing cost by the monthly savings--$3630 divided by $103 = 35.17. That's the number of months that you would need to remain in your house to break even.

You would have to live in the house for about 35 months—or three years—to break even on what you spent refinancing.

If you plan to in your house for less than three years, it doesn’t make sense to refinance your mortgage. Use this calculator to do your own ballpark estimate.

Other considerations:

• By refinancing, you start from scratch; thus you pay mostly interest and little principal on your loan for several years.


• Still, you would about $23,557 in interest over the full term of the loan (i.e. 30 years).


• If you're not going to stay in the house long enough to pass the break-even point AND reap some of the interest gains (say, 10-15 years), then a refi would only serve to lower your monthly payments.

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Just what is a balloon mortgage, and should you be wary of this type of loan?

Remember, oh, about a year ago, when the credit markets went haywire and we learned that millions of Americans had taken out home loans they suddenly couldn't afford? A number of factors played into that perfect storm; one was the popularity of balloon mortgages.

Balloon loans are deceptive. They usually carry a term of five or seven years, but the payments are based on, say, a 30-year repayment schedule. At first payments are modest — as if you had 30 years to repay the loan! But you don't. After five or seven years, you owe the entire balance of the loan.

Let's do the math: If you borrow $100,000 balloon loan for a period of seven years, at 6.0% interest, your monthly payments are about $599. After seven years you would have paid only about $49,700, with $90,225 now due.

Given that most people don't have that kind of cash, they usually plan to refinance before the loan ends — or sell their home. If the value of the home drops (see economic crisis, above), they may not be able to cover the balloon payment before it pops.

Why we like balloons, sort of: They're often a much lower interest rate than a fixed loan. They're also convenient, if you need a short-term loan and you have ESP and know that you can refinance or sell before you owe that ginormous payment.

Why we think they're scary: Scads of research on financial behavior has shown that people tend to fall for the promise of a short-term gain ("Only $600 a month, honey!") and ignore the price they'll pay down the line.

As with any big financial decision, do your homework, consult online calculators, reckon not only your present comfort level, but your long-term peace of mind. Then go with a fixed rate loan, OK?

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