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"When Should I refinance Part 1"
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Article: "When Should I refinance Part 1"
By Andre Plessis
I am often asked "When should I refinance?" The most common reasons for refinancing are the following:
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Lower your interest rate, thus your monthly payments. |
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Obtain a shorter-term loan to build equity more quickly. |
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Take cash out of your property. |
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Opportunity to convert your loan from an adjustable rate to a fixed-rate installment loan or vice versa. |
By obtaining a lower interest rate that causes one's monthly mortgage payment to be reduced. But you may want to ask yourself how long will it take to cover the cost of doing the loan.
By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total of the payments made during the life of the loan can be reduced significantly. Again you need to find out if it is worth refinancing your home by analyzing the cost of doing the loan.
A 3rd reason why homeowners refinance is to consolidate debts and replace high-interest loans with a low-rate mortgage. The loans being consolidated may include second mortgages, car loans, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumers loans are not tax deductible, while a mortgage loan is tax deductible. But you seriously need to analyze that option of refinancing as you are going to tap into your equity, which is not the best way to become financially free. Building your equity as fast as possible should be a primary goal for every homeowner in America. Also if you have accumulated debt it's because you have mismanaged your personal finance. What make you certain that this won't happen again in the future. If you have not carefully analyzed your financial situation you are most likely to repeat your mistake. You cannot refinance over and over again because you do not know how to manage your personal finance. You need to assess your financial situation so you do not repeat the same mistake. If you keep on over spending you will have to refinance again and at some point you may not have anymore equity to remedy your problem.
People also refinance to convert their adjustable loan to a fixed loan. The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments. Again you need to put in perspective how much it will cost you to refinance and if it is a true benefit in the long run.
The answer to the question "When Should I refinance?" is a complex one. One way to find out if refinancing is a good option would be to divide the cost of doing the loan divided by the monthly saving. that would tell you how long it would take you to recuperate your money.
Example: If it cost you $3000 to refinance and you save $100 per month it would take you 30 month to recuperate your cost of doing the loan. You would then save money after the 30th month (2.5 years). If you plan to live in the house for longer than this period of time, it could make sense to refinance.
Sometimes, you do not have a choice and you are forced to refinance. This happens when you have a loan with a balloon provision, but with no conversion option. In this case it is best to refinance a few months before the balloon comes due.
I will take this topic one step further by showing you exactly what happen when you refinance and the numbers bellow will show you when it may make sense to refinance. If you have never looked at an Amortization Table then you need to do so immediately because it is going to show you how you pay off a loan and with the example bellow you will understand even better when it is truly the best time to refinance. To view a 30-year Amortization Table CLICK HERE. If you scroll down the page you will see that I have highlighted in yellow year number 20. Year 20 is the year when half of your monthly mortgage payment goes towards your principal. You can see during all the previous year that most of your payment has been going towards interest payments. NOT VERY FUN!! Beyond year 20 more money will go towards principal than towards interest payments paid to your wealthy lender.
You can see as well that if you have a $100,000 loan @ 7% and you choose a 30-year term you will end up paying $139,508.90 interests over the life of the loan. There is a second table with a $200,000 loan.
That leads us to the 2 Amortization Tables bellow. Those 2 tables are very important as they will show you if it is in your best interest to refinance or not. On the left table I highlighted in red so you can see how much interests you pay. You can see that after 10 years into the loan you would be paying almost 50% ($65,648.68) of the entire interests on this 30-year loan ($139,508.90). After 20 years you would be paying ($116,972.68) so about 85% of all the interests. The remaining 10 years you will be basically paying 50% towards principal, YES just the last decade of your loan. So what that tells us is that the most you are far in the loan, the better off you are not to refinance.
If you refinance to a 1% lower rate (from 7% to 6%) after 10 years you would have paid $65,648.68 in interests. At that time you still owe $85,812.38. So you only have around $15,000 in equity unless the property value went up. But in any case you still owe over $85,000. So if you refinance again and take no cash out and your rate is not 1% less so 6% (previous 7%), then you will have to pay $99,403.51 in interests.
So if we add the interests you already paid $65,648.68 plus what you will owe on the next loan $99,403.51 then total interests you will be paying will be $165,052.19. So you will be paying an additional $25,543.29 in interests because you refinance after 10 years into the loan. NOT A GREAT IDEA TO REFINANCE AFTER 10 YEARS! The example shows that you refinance to get a lower rate (from 7% to 6%). So you may be saving money every month because your payment is lower but in the end that new loan cost you money because you pay an additional $25,543.29 in interests, plus the closing costs. So it basically costs you around $30,000 to refinance and get a lower rate. Not a very good idea.
If you scroll down the page there are 2 other tables that show the example if you refinance after 5 years. It is still not a good idea to refinance after 5 years because you will be paying a total of $34,074.49 + $109,040.33 so a total of $143,114.82 in interests. An additional $3605.92 in interests plus all closing costs.
That shows us that refinancing after 5 years to to get a lower rate (1% lower) is not a good idea because over the life of the loan you would have spend about $6,000 to $9,000 extra to get a lower rate.
If you scroll down the page and go to page 2 we will discuss about an example when you refinance and lower your interest rate from 7% to 5%.
Calculation Results
Loan Amount: $100,000.00 ~ Term of the Loan: 30 years ~ Interest Rate: 7.000%
Monthly mortgage payments: $665.30 ~ Total interest paid over the life of the loan: $139,508.90
Calculation Results
Loan Amount: $85,812.38 ~ Term of the Loan: 30 years ~ Interest Rate: 6.000%
Monthly mortgage payments: $514.49 ~ Total interest paid over the life of the loan: $99,403.51
Amortization Table
Year Loan Balance Yearly Interest Paid Yearly Principal Paid Total Interest 2007 98,984.19 6,967.82 1,015.81 6,967.82 2008 97,894.95 6,894.39 1,089.24 13,862.21 2009 96,726.96 6,815.65 1,167.98 20,677.85 2010 95,474.55 6,731.21 1,252.42 27,409.07 2011 94,131.59 6,640.67 1,342.96 34,049.74 2012 92,691.55 6,543.59 1,440.04 40,593.33 2013 91,147.41 6,439.49 1,544.14 47,032.82 2014 89,491.65 6,327.87 1,655.76 53,360.69 2015 87,716.19 6,208.17 1,775.46 59,568.86 2016 85,812.38 6,079.82 1,903.81 65,648.68 2017 83,770.95 5,942.20 2,041.43 71,590.88 2018 81,581.94 5,794.62 2,189.01 77,385.50 2019 79,234.69 5,636.38 2,347.25 83,021.88 2020 76,717.75 5,466.69 2,516.94 88,488.57 2021 74,018.87 5,284.74 2,698.89 93,773.32 2022 71,124.88 5,089.64 2,893.99 98,862.96 2023 68,021.68 4,880.44 3,103.19 103,743.39 2024 64,694.16 4,656.11 3,327.52 108,399.50 2025 61,126.09 4,415.56 3,568.07 112,815.06 2026 57,300.08 4,157.62 3,826.01 116,972.68 2027 53,197.49 3,881.04 4,102.59 120,853.72 2028 48,798.32 3,584.46 4,399.17 124,438.18 2029 44,081.14 3,266.45 4,717.18 127,704.63 2030 39,022.95 2,925.44 5,058.19 130,630.07 2031 33,599.10 2,559.78 5,423.85 133,189.85 2032 27,783.17 2,167.69 5,815.94 135,357.55 2033 21,546.80 1,747.26 6,236.37 137,104.80 2034 14,859.60 1,296.43 6,687.20 138,401.24 2035 7,688.98 813.01 7,170.62 139,214.25 2036 0.00 294.65 7,688.98 139,508.90 Year Loan Balance Yearly Interest Paid Yearly Principal Paid Total Interest
Amortization Table
Year Loan Balance Yearly Interest Paid Yearly Principal Paid Total Interest 2017 84,758.60 5,120.08 1,053.79 5,120.08 2018 83,639.82 5,055.08 1,118.78 10,175.16 2019 82,452.03 4,986.08 1,187.79 15,161.24 2020 81,190.98 4,912.82 1,261.05 20,074.05 2021 79,852.16 4,835.04 1,338.82 24,909.09 2022 78,430.76 4,752.46 1,421.40 29,661.56 2023 76,921.69 4,664.79 1,509.07 34,326.35 2024 75,319.55 4,571.72 1,602.14 38,898.07 2025 73,618.59 4,472.90 1,700.96 43,370.97 2026 71,812.71 4,367.99 1,805.87 47,738.96 2027 69,895.46 4,256.61 1,917.26 51,995.57 2028 67,859.95 4,138.36 2,035.51 56,133.93 2029 65,698.90 4,012.81 2,161.05 60,146.74 2030 63,404.56 3,879.52 2,294.34 64,026.26 2031 60,968.71 3,738.01 2,435.85 67,764.27 2032 58,382.62 3,587.77 2,586.09 71,352.04 2033 55,637.02 3,428.27 2,745.59 74,780.31 2034 52,722.09 3,258.93 2,914.94 78,039.24 2035 49,627.36 3,079.14 3,094.72 81,118.38 2036 46,341.76 2,888.26 3,285.60 84,006.64 2037 42,853.52 2,685.62 3,488.25 86,692.26 2038 39,150.12 2,470.47 3,703.39 89,162.72 2039 35,218.31 2,242.05 3,931.81 91,404.78 2040 31,043.99 1,999.55 4,174.32 93,404.32 2041 26,612.21 1,742.08 4,431.78 95,146.40 2042 21,907.09 1,468.74 4,705.12 96,615.14 2043 16,911.76 1,178.54 4,995.32 97,793.68 2044 11,608.34 870.44 5,303.43 98,664.12 2045 5,977.81 543.33 5,630.53 99,207.45 2046 0.00 196.06 5,977.81 99,403.51 Year Loan Balance Yearly Interest Paid Yearly Principal Paid Total Interest
Calculation Results
Loan Amount: $100,000.00 ~ Term of the Loan: 30 years ~ Interest Rate: 7.000%
Monthly mortgage payments: $665.30 ~ Total interest paid over the life of the loan: $139,508.90
Calculation Results
Loan Amount: $94,131.59 ~ Term of the Loan: 30 years ~ Interest Rate: 6.000%
Monthly mortgage payments: $564.37 ~ Total interest paid over the life of the loan: $109,040.33
Amortization Table
Year Loan Balance Yearly Interest Paid Yearly Principal Paid Total Interest 2007 98,984.19 6,967.82 1,015.81 6,967.82 2008 97,894.95 6,894.39 1,089.24 13,862.21 2009 96,726.96 6,815.65 1,167.98 20,677.85 2010 95,474.55 6,731.21 1,252.42 27,409.07 2011 94,131.59 6,640.67 1,342.96 34,049.74 2012 92,691.55 6,543.59 1,440.04 40,593.33 2013 91,147.41 6,439.49 1,544.14 47,032.82 2014 89,491.65 6,327.87 1,655.76 53,360.69 2015 87,716.19 6,208.17 1,775.46 59,568.86 2016 85,812.38 6,079.82 1,903.81 65,648.68 2017 83,770.95 5,942.20 2,041.43 71,590.88 2018 81,581.94 5,794.62 2,189.01 77,385.50 2019 79,234.69 5,636.38 2,347.25 83,021.88 2020 76,717.75 5,466.69 2,516.94 88,488.57 2021 74,018.87 5,284.74 2,698.89 93,773.32 2022 71,124.88 5,089.64 2,893.99 98,862.96 2023 68,021.68 4,880.44 3,103.19 103,743.39 2024 64,694.16 4,656.11 3,327.52 108,399.50 2025 61,126.09 4,415.56 3,568.07 112,815.06 2026 57,300.08 4,157.62 3,826.01 116,972.68 2027 53,197.49 3,881.04 4,102.59 120,853.72 2028 48,798.32 3,584.46 4,399.17 124,438.18 2029 44,081.14 3,266.45 4,717.18 127,704.63 2030 39,022.95 2,925.44 5,058.19 130,630.07 2031 33,599.10 2,559.78 5,423.85 133,189.85