I’ve been getting this question a lot lately, and mostly because of how low the interest rates have been.
The general rule of thumb most of us have heard is to reduce your interest rate by 1% or more. Well, this isn’t always the case, because what’s more important is how much interest you will be saving and how long you will have the mortgage.
Here is an example of a person reducing their mortgage interest rate by 1%:
Current Loan Details:
- $200,000 loan balance
- 6% interest rate
- 30 year fixed rate
- $1199.10 monthly payment (principal & interest)
- $231,677.04 is the total amount of interest that will be paid over the 30 years.
New Loan Details:
- $200,000 loan balance
- 5% interest rate
- 30 year fixed rate
- $1073.64 monthly payment (principal & interest)
- $186,513.24 is the total amount of interest that will be paid over the 30 years.
These are the two major benefits for doing this refinance:
- The monthly payment is reduced by $125.46
- The total amount of interest saved over the 30 years is $45,163.80. Wow!
Now, this example is best followed if you plan on having your current mortgage for all 30 years. The reality is that most of use will either move and buy a new home or refinance again sometime in the future. So, an important thing to ask yourself is: “How long do I plan on keeping this mortgage?”
Let’s say you and your family plan on buying a new home in about 1 year, but are looking into refinancing into a lower rate because the rates are so low. Using the example above, you are saving $125.46 every month, so the total amount of monthly savings over the next year is $1505.52. If the closing costs for the refinance is $2000, most people would think it’s not worth it. Why should you pay $2000 to save $1505.52 for that year? Well, at first it may seem like that, but don’t forget about how much you are saving on the interest as well.
Using the same example above, the amount of interest you pay over the first year of your current loan is $11,933.19. The amount of interest you pay over the first year of you new loan is $9,933.00. That is an interest savings of $2000.19 over that one year.
Most people tend to forget how much interest they save when they lower their mortgage interest with a refinance. Yes, it’s nice to recoupe the closing costs with the amount of savings every month, but the total amount you have to pay back to the lender in interest is just, if not more, important when looking to refinance.
Don’t forget to check own credit report before looking at refinancing. If you already know what kind of credit you are working with, this gives you a bit more leverage when trying to negotiate the best interest rate available. Checking your credit report before hand is also good for those that dont’ have the best credit, because then you can focus on working on fixing the credit report.
Your goal is to do whatever you can to pay the least amount of interest on the largest loan you will probably have your entire life.
