Refinancing your home loan can save you a lot of money, but it is not always the right choice. There are costs involved in completing a refinance, so you need to make sure that the potential savings outweigh the costs involved. Another concern when refinancing is losing the progress you have made in the amortization of your loan. When you refinance your mortgage you are paying off the current loan and replacing it with a brand new loan… which also means you start over for a new full term of 15 or 30 years.
The way mortgage loans are amortized the vast majority of interest is paid at the very beginning of the loan. Let’s look at a common example…
Most people start out with a 30 year fixed mortgage. If the initial loan amount is $200,000 and the interest rate is 6.00%, the monthly payment would be $1,199.10. The first year of the loan 83% of the payment goes towards interest and only 17% goes towards paying off the loan. By year 15 of the same loan 61% of the monthly payment goes towards interest and 39% of the payment goes towards the principal.
Why is this so important? It’s because how long you have paid towards a loan affects how much you benefit by refinancing and lowering your rate! After a certain point in the life of a mortgage it no longer makes sense to refinance without a drastic drop in rate.
I have worked with clients that could lower their rate 3% and it didn’t make sense because they were close to paying their loan off. I have also had clients that would only reduce the rate 1%, and the refinance saved them money and was definitely worthwhile.
The KEY is working through all the numbers and having your loan officer perform an analysis of all costs vs savings to ensure the refinance will save you money.