Why You Should Refinance

A big mistake that I often see, is people that are not taking advantage of the opportunity to refinance there homes.  I decided to work out some numbers for fixed rate mortgages that could prove how much interest can be saved over the life of the loan (technically you should present value the future interest to get a better gauge but we won't worry about it at this point).  Remember this only applies to fixed rate mortgages (not I/O interest only teaser loans, Option-ARMS adjustable rate mortgage or Reverse-ams which actually grow principal over time).

Most people realize the notion that when you get a 30-year fixed mortgage (the Cadillac of mortgages) you will be paying a lot of interest over the course of the loan - but how much interest?  Below is an image to show on a yearly basis roughly how much of your payments are interest over each year of a 10-year fixed mortgage (with an interest rate of around 8%), a thirty year would be even worse in interest!

Email me for a spreadsheet that can work out different rates and maturities!

You can see from the image above that during your first year of payments you are almost paying entirely interest and barely any principal on your loan.  Most people know not to run up credit card debt inter-monthly because you end up paying dear in interest but look what your house is costing you if you pay the minimum mortgage payment.  This should be a red light to pay off your house as fast as possible (after you have settled any debt with higher interest rates).  Below I've worked through some numbers that compare the interest paid over the life of a loan of different maturities over a couple different interest rates.

Suppose you got a $200,000 thirty year fixed mortgage with a 7.5% monthly interest rate.  Your monthly payments would be $1,400 and over the course of the loan you would pay a whopping $300,000 in interest,  what a waste!  Lowering that to a 20 year increases payments to $1,600 but lowers lifetime interest to $184,000.  A ten year increases payments to $2,400 but reduces lifetime interest to $83,000.  Remember, extra interest doesn't get you anything extra.

I had talked about refinancing so lets take a look at the benefits of refinancing to a 5% loan at each of these maturities from that 7.5% interest loan.  Remember, mortgage refinancing requires paperwork and does cost money, usually $3,000-$5,000 which is worth some attention.  Many people are refinancing right now, if you go to bloomberg.com, bankrate.com or any real-estate website you could probably see 30-year averages below 5% (historically this is extremely low).  In the future I will discuss what changes this rate (entities such as Fannie Mae, Freddie Mac and United States Federal Reserve), but at this point assume you get that $200,000 30yr-fixed mortgage at 5% as opposed to 7.5%.

This new loan results in $1,100 payments per month (a savings of $300 per month) and lifetime interest of $184,000 (a savings of $116,000 over the life of a loan).  If you had started with a 20 year 7.5% loan on that $200,000 and converted to a 5% loan you would pay$1,300 a month (a savings of $300 again) and lifetime interest of $115,000 (a savings of $69,000 in lifetime interest).  If you had the ten year your monthly payments would be $2,100 and over the life of the loan you would save $30,000 and only pay $53,000 total.

This should show you that if you can afford the payments, your best bet is to go for a shorter term loan.  If you can refinance, work through some numbers and taking to cost into consideration figure out if the lower payments and interest savings are worth it to you, feel free to email me if you want a spreadsheet to compare different rates a loan terms.  Don't forget to keep that credit rate up, you still have to get approved at your lower rate!  Feel free to email me with any questions - unmaskingfinance@yahoo.com