Given the historic lows for interest rates, it’s a good time for homeowners to review their mortgage information. It’s easy to get excited by low rates, but everyone should evaluate a new loan based on their current financial situation as well as their long-term goals.
Do the math to make a better decision on refinancing
When you refinance, look at the length of time you will be paying, as well as the monthly payments.
If you refinance into another 30-year mortgage:
Don’t make the mistake that better monthly cash flow always costs less in the long term.
For example, let’s review a 30-year loan for $400,000 taken out by someone in 2012. They’re refinancing 8 years into the loan term. Their current payment is $1,796; they have 22 years left, and will pay a total of $474,000 over the remaining years. They owe $348,000 now and would be resetting the clock on the new loan.
At a rate of 2.75%, the payment drops to $1,421, a monthly savings of $375. Sounds great so far. But look at the total payments. The lifetime loan cost is over $511,000. The new loan is $37,000 more.
Monthly payment: -$375 Total cost, over 30 years: +$37,000
If you refinance into a new 20-year mortgage:
The best way to mitigate the long-term effects in the above example is to consider a shorter term mortgage or to make extra principal payments. A loan at 2.75% will cost $1,887 per month, a $91 increase for a 20-year term. That brings the total payments under $453,000.
Monthly payment: +91 Total cost, over 20 years: -$21,000
There is no one-size-fits-all solution for refinancing a loan.
Look at the options and carefully consider your goals.
- If you plan to move in the next few years, the benefits of refinancing may be substantially reduced.
- If monthly cash flow is a concern, a longer-term loan may be better.
- If you are focused on paying the loan down, or paying if off completely, a shorter term could be more appealing.