Are you Making a Mistake by Refinancing?

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.