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Mortgage refinance savings calculator

Cost of ownershipI just received a mailer from one of the big mortgage companies offering to refinance my mortgage at a rate of 3.875%. It goes on to say “THIS LOWER RATE COULD REDUCE YOUR MONTHLY PAYMENT TO $971.63!” Is this a good deal? Let’s take a look.

My current mortgage rate is 4.25% and the principle and interest payment is $1,107.12. On the surface it looks like I’d save a little over $135 a month. Not life changing, but it’s something. On the other hand, it’s worth taking a closer look to see what’s really going on.

First of all refinancing isn’t free. At the very least you’ll have charges for an appraisal, title insurance, and filing and legal fees. In some cases you may also pay loan origination and/or discount fees. Based on the quoted Annual Percentage Rate (APR) in my offer the estimate closing costs are about $4,100. This sounds pretty high to me, so I did a a quick check of my title company’s rates. Estimated costs assuming no points or fees from the bank are $2,532.

Assuming the lower number, it would take about 18 months for the monthly savings to offset the cost of the loan which shows up as an increase in the loan amount. The higher estimate would take almost three years. Of course if your main concern is cash flow this may not be important to you.

So why is the payment lower? The flyer implies that it’s due to your lower interest rate, but let’s take a closer look. The monthly payment for the re-fi loan is $971.63, but the same 30 year loan at my current rate of 4.25% would be $1,016.47. This is only a difference of only $44.84, not the $135 we calculated earlier. So where did the extra savings come from?

The difference is that I’ve been paying down the principle on my existing loan for about five years. My original loan was for $225,050 and I only have 25 years of payments left. The re-fi loan is for my current balance or $206,625 and the term is back to 30 years, so the principle amount of the new loan is lower and the term is longer. This accounts for the majority of the monthly cost savings.

Once again, if you’re just trying to lower your monthly cash expenses this may be acceptable, but the claim that the lower payment is due to the lower interest rate is misleading.

So what is the actual savings over time of this lower monthly payment? In either case I have to pay off the balance of $206,625. If I stay with my current loan my total remaining interest expense is about $130,000. With the re-fi it’s $142,000, so my $135 monthly cash savings turn into a $12,000 expense over time. So you’re paying less on a monthly basis but a higher total cost.

So does that mean that this offer is a bad deal? It depends on your personal situation. For instance, if you have a lot of credit card or student loan debt at much higher rates you may want to take the refi and apply the savings to paying it down. This could be a financial win. Ditto if you have investments that can reliably earn more than the mortgage rate. On the other hand some people are just uncomfortable with a mortgage and prefer to pay it off sooner rather than later. For them a 15 year re-fi at an even lower rate may be a good choice. Enter a 15 year term and 2.8% rate and your payment goes up to about $1400 but your total mortgage expense is reduced to just over $70,000.

Of course these numbers can change significantly based on the situation. For a rough idea of how a re-fi would work for you just enter your numbers into the green cells on the mortgage refinance savings spreadsheet, but keep in mind that these are only rough estimates. The best way to evaluate whether a re-fi is meets your needs is to contact your lender. Check our service providers page for recommendations if you don’t have one. And don’t be afraid to shop around.

Finally, whenever you or someone you know has questions about real estate give us a call. We’re never too busy to help.

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