What Could Refinancing Do for Me?
Everyone knows that a home loan’s interest rate is the most important factor in its overall cost. However, lower interest rates can save you very different amounts depending on how you pay your home loan.
Case Study: benefits of refinancing
The following comparisons are of a $300,000 home loan over 30 years at 6.4% compared to a loan that’s 1% cheaper.
By refinancing at a lower rate, you could:
1) Save money every month
By reducing the interest rate by 1%, repayments go down by $192 per month. If you choose to pay these new lower repayments, you save $69,120 ($192 x 360 months) over the life of the loan.
2) Cut years off your loan
However, if you maintain the repayments at the same amount as when you had the original, more expensive loan, because you have a lower interest rate, you are now paying off more of the principal every month ($192 more to be exact). This would have your mortgage paid off 6 years earlier, allowing you to avoid paying $111,948.31 in interest.
3) A big lump sum right away
If you prefer not to wait to get the benefit of the new, lower rate, if you want extra money right now but don’t want to increase your repayments or the amount you had to pay back, you could borrow an additional $34,195 on the same loan when refinancing today and pay back the exact same amount you would have when the loan was at the 1% higher rate.
CAUTION: I do not advocate borrowing that extra money unless you are going to financially benefit from doing so in the long run. In general I recommend Option 2—paying your new, cheaper loan at the old, higher repayments.
It is worth understanding that $300,000 at 6.4% over 30 years is the same as borrowing $334,195 at 5.4% ($300,000 + the $34,195 you save by lowering your interest rate). You pay back the same amount on each loan, which is the real cost of the loan to you.
In this scenario, $34,195 is what you are giving away to the bank that you could have to spend today.
That’s right, by choosing a lower interest rate, you could borrow $34,195 more right now and keep your repayments exactly as they are. This extra $34,195 is what you would have paid in interest to the more expensive lender. The total you pay back will be exactly the same, but you would have an extra $34,195 right now to do whatever you want with!
It’s not my suggested course of action with a cheaper loan, but the money is better in your pocket than the banks.
People often see refinancing as a hassle and are happy to plod along. Instead, be wise about just how much you could benefit from refinancing to a lower rate.