How do you know when it’s time to refinance?

Easy—when it saves you money!

Sounds simple, but the obvious answer usually is the wrong one.

Example:

Michael has an existing 30-year fixed he’s had for 5 years with a 6.5% interest rate and a monthly payment of $3,160 per month. He’s now offered a new 30-year fixed loan with a 5.5% interest and a lower monthly payment of $2,838—a monthly reducƟon of $322. Most folks would jump on that right away, and almost all loan officers would be happy to provide him with the refinance—but is it a wise financial maneuver? Well, no…

You see, Michael’s remaining interest expense on the original loan is currently $480,047 over the next 25 years. By taking out a new 30 year fixed with a full 1% reduction to the interest rate, his total interest expense for the new loan will be $522,017—costing him an additional $41,970 for making this blunder. Resetting the loan term to the original length is always a mistake.

Solution:

Yes, take the lower interest rate, but use an off-term home loan to match what you currently have left. In this case, 25 years. The monthly payment will drop to $3,070 (only about $90 per month) but the total interest expense for the new loan will drop to $421,130—a total savings of $58,917.

Not everything is as it seems with a refinance. A rate reduction is important, but not at the expense of adding additional time to the loan. You’ve worked hard to pay it down, why reset it?

Not many loan officers will do this sort of analysis for a client. I would actually insist that a client be aware of choices that are available. Home loans can be written with any term from 10 to 30 years (a 40 year is available as well). If you want a 17 year for instance, that’s easy.

Refinancing isn’t exactly in vogue currently, but they will be in the near to intermediate future and I thought it prudent to get this information out before folks start making dreadful financial mistakes—again…

Reset it and regret it…

Scott Lawson