talking about the historically low
are ready to decide if it 'pays' to refinance home loans. The 'rule of thumb' supplied
by banks is that if you can reduce your interest rate by 1% it is usually
But there is more to it than that. Like how long are you planning on staying
in the house? If there were no fees or costs involved that wouldn't be a
But in the real world, the first thing you need to determine is what rates
do you qualify for and what are the other factors like property value and
When you refinance home loans is common to roll the additional costs and fees back
into the mortgage so there are no "out of pocket" costs. But this allows the
Bank or other mortgage holder to charge you interest on these fees. At the
current low interest rates and if you choose a short time period for your
mortgage the additional interest will be relatively small.
But even at these low rates, if you have a 30 year mortgage, interest will
end up doubling the amount of fees over the 30 year life of the loan.
Let's assume you took a 30 year, $115,000 First mortgage on an apartment 5
years ago. The interest rate at the time was 7.5% and your principal and
interest payment was $765.10 per month.
(If $765.10 sounds low to you, remember your "actual payment" to your loan
may only $116, the balance are go to bank's pocket as interest charged)
After paying $765.10 per month or $9181.20 per year for 5 years you have
spent a total of $45,906. Plus, you still owe about $108,000 on your
$115,000 mortgage and you still have 25 more years to go!
Obviously, not much of your payment goes toward principal the first few
years of a 30 year mortgage! So the sooner you can get out from under the
Now that interest rates have fallen to around 5% you are considering
refinancing. Let's assume legal fee and additional fees and expenses will be
about $3,000. This means you will have to "borrow" $111,000. to pay off your
$108,000. loan (or come up with the $3,000.) from savings.
If you decide to refinance the additional costs for another 30 years... your
loan amount would be $111,000. and you would be almost back to where you
started 5 years ago... but your payment would drop to $595.87 for a monthly
savings of $169.23
Now although it would be nice to have an additional $169.23 to spend each
month, the question is what will you do with the money? Go out to eat more,
buy more gadgets? Invest it in your retirement fund? Or just "spend it"?
If you just "spend it"... it isn't really helping you get ahead and you are
now in debt to the bank for an additional 5 years. Not a good prospect...!
So what if we set the mortgage term to 25 years so at least we aren't moving
backwards. In that case, your payment would be $648.89 saving you $116.21
per month. So for an additional $53.02 per month you knocked 5 years off
Personally, This is a slightly better solution. At least you aren't pushing
your retirement out an additional 5 years while you continue paying your
Remember, the original question was... Is it worth it to refinance and pay
the additional $3000. or just keep paying on the existing mortgage?
Keep in mind, as soon as you sign the papers the equity you have in your
house drops by $3000! Assuming you chose the 25 year mortgage (with the
$116.21/mo savings) it will take you 25.8 months to break even
($3000/$116.21) because at that point you will have saved the $3000. it cost
you to refinance. Any time in the house after that is gravy.
So if you intend to stay in your house 3 or more years it would pay for you
But wait what if you took it one step further? What if you kept your payment
the same as you are paying now and reduced the term of your mortgage as far
as possible? A $111,000 mortgage at 5% with a payment of about $765 would
require a term of 223 months or about 18.5 years.
Assuming you could get an 18.5 year mortgage and you intended to stay in
your house that long, this would be an excellent move! You have drastically
reduced the amount of money you will pay the bank over the life of the
mortgage and you are free and clear 6.5 years earlier!
Even if you have to move sooner, your equity will be building faster so you
will be able to take more money with you when you sell.
Unfortunately, lenders do not usually let you choose an odd term length like
18.5 years , so you would have to choose either a 20 year term with a
payment of $732.55 which would still save you about $30/month but also knock
5 years off your loan (and build equity somewhat faster).
Or you could choose a 15 year term with a payment of $877.78 which would
actually cost you about $110/month more than what you are currently paying
but would knock a full 10 years off your mortgage. If your income has risen
since you got your initial mortgage and you could swing it... it would be
money well spent.
For those with higher incomes who have difficulty saving, this is a great
idea because it actually forces you to save a little bit more each month and
once you get used to it, you won't even miss the money.
Another idea is to see if you can remove the mortgage insurance off your
mortgage. On this loan, the mortgage insurance might add an additional
$100/month to the loan (for the first 10 years), so you would still have to
pay it for 5 more years.
if you have made improvements or renovation to the house... or property
values have increased dramatically in your neighborhood... you might be able
to get the new loan without the mortgage insurance. If you can, you will
save an additional $100/month! With that savings you can move to the 15 year
mortgage without mortgage insurance for the same amount that you are
currently paying for a 30 year mortgage with mortgage insurance. Not bad eh?
Whack 15 years off your mortgage just like that!
Another way to reduce the monthly payment is to...reduce the amount you
borrow. If you could come up with the additional $3000 in closing costs from
savings, your monthly payment on a 15 year mortgage would drop from $877.78
to $854.06 ... or only about $89. per month more than what you are currently
Is it worth $89/month to knock another 5 years off your mortgage?
That depends on your personal circumstances! If your budget is already
stretched to the limit, or it will put you at risk if you lose your job, NO.
But if you can find a way to come up with $3.00 per day (perhaps by giving
up cigarettes, or skipping a trip to the vending machine or to McDonalds) it
will save you thousands over the life of your mortgage!
* Most of the banks does offer
zero moving cost (bank will bear the legal processing fees) for refinance
if your loan is above $100,000. Do check around in
Loans page for more information.