by Mark Martinho
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x Mark Martinho ~ August 6, 2010

How to Really Save Big when you Refinance

OK, this is not a Redwood City story, but it is topical to many out there. The other day I was with a friend and I mentioned that I was refinancing my house to take advantage of the lower rates and he replied that despite rates being lower for him too, he did not want to refinance and start the clock again of paying his mortgage for 30 years. Wow, common perception, but he could not have been more wrong!

Of course, it all depends what you do with the new loan! Don’t just get a lower rate on your mortgage and make the minimum payment, because then you’re likely worse off! Instead refinance for a lower interest rate, but keep making the same old payment you have today.

Here is a typical scenario as to why you really want to do this.

  • Original Loan: Let’s assume that you started off with a $400,000 mortgage at an annual percentage rate (APR) of 5.5%. With a 30 year fixed, fully amortized loan, your monthly payment would be $2,271.

  • Your loan Today: Assume that you are eight years into paying this mortgage off and still have 22 more years to go. At this point your loan has been reduced to $347,500 and if you continue paying it, you will pay the bank a total of $600,000 over the next 22 years.

  • Refinancing: Now let’s assume you refinance the remaining debt of $347,500 with a 30-year fixed loan with an APR of 4.5%. Your payment would be $1,760 but you would now pay the bank at total of $633,600 over 30 years. The lower rate is actually costing you $33,600 more over the life of the loan because you’re paying the loan off over 30 years again. You have the bank’s money longer and it’s not free.

  • Keep making old Payments: If I refinance, but keep making the same old $2,271 then there’s BIG SAVINGS! By making the same old payment, I actually payoff my loan in 19 years, I just cut three years off my original loan. But there’s more!!! My total payments to the bank now only total $517,800. This is $82,200 less then I would have paid had I kept my original loan and nearly $116,000  less then if I refinance and only make new lower payment of $1,760.

By refinancing and making the old payment, we can pay off the loan three years earlier and save over $82,000. Now that’s worth doing!!!

Things to consider when refinancing:

  • Verify that the lender does not charge pre-payment penalties.
  • Verify that if you make a larger payment, that it actually goes to payoff the principle and not into an impound account – it does you no good there!

Good luck and save some green!