With the recent drop in mortgage rates, there is a rush to refinance home mortgages. According to the Mortgage Bankers Association (MBA), the average rate for a 30-year fixed mortgage rate dropped to 5.08%, over a point lower than last month. The MBA reports this drop caused mortgage applications to increase 48% over the prior week and 80% of that were refinancing to lower their house payments.

With rates going down, shouldn’t everyone refinance? Because of the mortgage crisis, there are a couple of reasons refinancing is not an option for everyone. Banks have tightened up their lending guidelines and the best rates are reserved for borrowers with the best credit scores. If credit is not an issue, the borrower will need to have sufficient equity, 20% or greater, in their homes to avoid the requirement of private mortgage insurance. The insurance could add a point or two the monthly payment thus eliminating any interest savings. Given the decline in the real estate market, it could be very possible that the much of the borrower’s equity has vanished.

Let’s take a fictional couple called Chad and Betty Jacobson. The Jacobsons took a $200,000 mortgage 10 years ago at 6.5%. Their monthly payment is $1,264.14. After 10 years of making monthly payments, the Jacobsons have paid down their $200,000 mortgage to $169,522. What? The Jacobsons have paid consistently on their mortgage for 10 years; shouldn’t their balance be a lot lower? Heck, they have paid a total of $151,696 ($1,264.14 x 120 months). What the Jacobsons did realize is that on a 30 year mortgage, in the first few years the majority of their payment has gone to pay interest (If they follow the 30 year repayment plan, the Jacobsons will pay a total of $455,088 on a $200,000 mortgage). Well, they are a little ticked, so they are very receptive to the idea of refinancing at a lower interest rate.

So the Jacobsons go shopping for a new mortgage and find a lender that will give them a 5% rate. They heard not to refinance unless they can drop at least a point, so they think they are doing pretty good by dropping a point and half. They refinance of total of $172,000 ($169,522 + closing costs) at 5% giving them monthly payments of $923.33. Chad and Betty are really excited about the extra $340.81 per month in their pocket and brag to all their friends. What they did not tell their friends is that it’s going to take them an extra 10 years to payoff their house and cost them about $29,000 more in interest by refinancing. Why? Because they already had their mortgage for 10 years and by adding another 30 years, they really turned it in to a 40 year mortgage.

Now let’s do some life math: How old are the Jacobsons? What if they were 25 when they took out their first mortgage? Originally, they would have paid off their home mortgage at 55. Now it will be paid off 65.What if they refinanced before at age 35 and this is there second refinance? How excited do you think they will be when they realize their house won’t be paid off until they are 75? How do you think being in debt until 75 might affect their retirement plans?