Consider Repayment Schedule When Refinancing a Mortgage
Looking to save money on your mortgage by refinancing? While the interest rate is the main thing people focus on, the mortgage term - how long it takes to pay off the loan - is an often-overlooked factor that can provide major savings over either the short- or long-term when refinancing a mortgage.
Understanding how reworking your payment schedule affects your monthly payments can enable you to dramatically lower your monthly mortgage payment even beyond what you originally estimated, or realize big savings in interest while paying off your mortgage years ahead of schedule with relatively little financial pain.
Let's say you have a 30-year mortgage you've been paying on for seven years and you're thinking about refinancing. Let's also assume you borrowed $250,000 at 7 percent interest, but are confident you can qualify to refinance at a 5 percent rate.
A common mistake
For many people, their first instinct is to compare the difference between a 7 percent rate and a 5 percent rate on a $250,000 30-year mortgage. Doing that, you find that would refinancing would reduce your monthly payment from $1,663 to $1,342 - a savings of more than $320 a month. Sounds pretty good, right?
Only that's not how it works. What people tend to forget - and what many mortgage refinancing guides overlook - is that you're not refinancing a $250,000 loan! After seven years of payments, your mortgage balance would be about $227,500 - and you would have only 23 years remaining, not 30.
But refinancing a $227,500 loan over 23 years (assuming you want to stay with the same payoff date) won't give you payments of $1,342 a month. Because of the difference in amortization schedules between a 5 percent and a 7 percent loan, plus the approximately $4,500 in closing fees required to refinance (based on 2 percent of the loan balance) your new mortgage payment would actually be about $1,416 a month - not quite as attractive as before, but still a savings of about $245 a month.
A 30-year refinance can dramatically reduce payments
However, suppose you're in a position where you need to lower your monthly mortgage payment dramatically. In that case, you could refinance your $227,500 mortgage ($232,000 with refinance closing fees included) as a new 30-year mortgage and reduce your monthly payment to $1,245! That's a reduction of about 25 percent, more than $415 less per month than you were paying before.
Of course, if you take this option, you end up paying for it in significantly greater interest costs over time and an additional seven years of mortgage payments. But if you're in a financially tight spot, perhaps due to you or your spouse losing a job, taking a cut in pay or incurring unexpected medical bills or other expenses, it's an option worth checking into.
A 15-year refinance may be more affordable than you think
On the flip side, suppose you're refinancing the same mortgage but you're in good financial shape and can adequately handle your monthly mortgage payment. In that case, you might consider accelerating your payoff by refinancing your $227,500 loan balance into a 15-year mortgage.
Because a 15-year fixed rate loan currently runs about half a percent less than an equivalent 30-year loan, the savings on interest can be significant. Refinancing $232,000 into a 4.5 percent 15-year fixed rate loan would give you a monthly payment of about $1,775 - only $112 more per month than you're paying now and you'd eliminate eight years of mortgage payments in the process. That's a huge savings over the long haul if you can afford a slightly higher monthly payment.
It's a good time to refinance right now, because even though mortgage interest rates have fallen back down to near-record levels, the refinancing frenzy that followed the first cycle of low rates last spring and summer has pretty much abated, meaning lenders are more eager for your business. Credit requirements have also begun to loosen somewhat, so that makes it a bit easier to obtain a refinance as well. But these conditions won't last forever, so you want to act soon to take advantage of them.