Refi-filter: Lowering my monthly payments, but paying more in the long run. Is it worth it?

October 26, 2009 7:45 AM

I'm eight years into a 30 year mortgage, having paid off about 10% of the total amount of the original loan. Does it make sense to refinance now if I can get a rate that is about 5/8 of a point lower than my current rate? This would shave about $250 off of my monthly payments. But then I'll still be paying for this loan for eight additional years after the original one would have been paid off, right? How do I calculate how much additional $$ I'll owe overall, and how do I decide whether paying more later is worth saving money now?
posted by ericbop to work & money (16 comments total)

On that basis is $250 x months left > $250 x 8 * 12 ?
posted by zeoslap at 7:53 AM on October 26

There are a bunch of refinance calculators out there that will tell you what you will save, but I think that the best way to do it is to refinance (assuming you will be there 5 more years or so) and keep making those higher payments. What about a 15 year mortgage?
posted by getawaysticks at 7:55 AM on October 26

Can't help you on the second question, but for the first, the term you want to google is "amortization calculator." If you include "refinance" in the search, you'll end up with something like this (never used, can't vouch for it), which should give you all the numbers you need to make your decision.
posted by Partial Law at 7:56 AM on October 26

I like this calculator.
posted by bonobothegreat at 7:58 AM on October 26

Yes, if you get another thirty year mortgage, the clock "resets", as it were, and you'll have to pay it off for thirty years from when you close on that loan.

If you're looking to refinance to save money short-term, this could be an option. If you're looking to save money in the long run, you could try refinancing for a shorter term mortgage (say, a 20 year). Quite often, the interest rate will be lower, so more of your monthly payment will go towards your principal.*

Probably the easiest way to figure it out is to find an amortization schedule (I use this one - http://www.bretwhissel.net/amortization/amortize.html) and plug in the dollar amounts.

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*We did this, but our 30 year mortgage interest rate was so high, and we refinanced so low (I believe we dropped about three percentage points) that our monthly payment went *down* when we went from a 30 year mortgage to a 20.
posted by Lucinda at 7:59 AM on October 26

You'll get an even better rate if you switch to a 15 year mortgage. You have 22 years left on the current mortgage. If you can better the rate by 5/8 pt for 30 years, you might save 1+ percent by reducing the term to 15 years. Living mortgage-free is sweet.
posted by theora55 at 8:00 AM on October 26

What's your goal? Would you rather have a paid off house in 22 years, or $250 in your pocket each month for the next 30?
posted by iamkimiam at 8:05 AM on October 26

Are you aware that you can pay more than the calculated minimum monthly mortgage payment every month? You can, and you can save a whole lot of money, over time, that way -- and have your house paid off in much less than thirty years.

Interest is only added on the remaining balance of your loan. If you pay more on the balance, there's less balance remaining, so less interest. If this goes on every month, or even most months, over 20-30 years, the savings are substantial.

An extra $250 paid the first month of your mortgage means a little less interest added for every subsequent month of the mortgage - and if you're paying less interest in a given month, that much more money goes to the principal balance, which leads to less interest in the following months, and so on.
posted by amtho at 8:27 AM on October 26

Important point: there's nothing that's stopping you from paying down a 30-year mortgage faster. If you have extra money, you can pay the principal down quicker.

IMO, the only important thing to understand in a refi is two things: how much does the refi cost and how much will it save me per month. Those two items will tell you how long it will take you to "payoff" the refinancing. Every month after the payoff period you remain in the house makes the decision to refinance a smarter one in hindsight.

Again, you can payoff your new 30-year in 22 years if you want. You could pay it off tomorrow if you had the cash and you'd be done. The clock does reset, but it's not really applicable to the refinancing question. The new mortgage has a lower interest rate, and that means you will end up paying less if you pay the refi mortgage off in the same period as your current one.

Somebody smack me down hard if this is bad advice, but I don't think it is...
posted by mcstayinskool at 8:35 AM on October 26

on preview: what amtho said :)
posted by mcstayinskool at 8:35 AM on October 26

Two things to remember in your analysis, and not in any calculator I've seen:
(1) Tax consequences. With tax-deductible interest, the true savings of a lower interest rate can be less than they appear.
(2) Refinance costs. You should expect keep the place long enough after the refinance to recover these costs.
posted by exogenous at 8:58 AM on October 26

I strongly agree with amtho, mcstayinskook and exogenous. The right answer for you depends upon your personal financial goals. However, what has worked best for me is refinancing my home whenever it the interest rates dip enough to make it worthwhile. Then, I get the lowest monthly rate I can. All that extra money then goes to pay off other debts I might have (i.e., car payment), or else into some type of savings. With the tax credit and the low mortgage interest my savings rates are pretty darn close to the mortgage rate. In other words, whether I saved the money or sent it in to lower my principal on the mortgage ends up being close to a wash either way. So, in that case, I feel more comfortable saving the money. That way I have an emergency fund in case something happens. I could also use that money at any time to pay down the principal owed on my home. Conversely, if I had put the money to the principal on the home, that money is essentially gone until the home is payed off many years later.
So, even if I may lose a percent or two a year, I prefer to have the flexibility of having the cash on hand rather than gaining that extra percent or two when my house is fully paid off.
YMMV
posted by forforf at 9:20 AM on October 26

Most banks advertise mortgage terms of 15 or 30 years to make comparison shopping easier, but most can make the term whatever you want it to be. You could ask the bank if you can get a 22 year mortgage. The rate will probably be the same as the 30 year, or maybe a little lower. Your payment will still be less. Then you can compare the savings directly to the cost of refinancing and will be paid off at the same time.
posted by Yorrick at 9:39 AM on October 26

A possible additional benefit to paying ahead on your mortgage: On two ARMs I had, the policy was to recalculate the payments at each mortgage anniversary based on the then-outstanding balance at the then-applicable rate. That meant that my required payments typically went down each year that I'd been able to pay ahead by a significant amount, even in years that the rate increased. If, when your payments go down, you continue paying the same amount as last year, you'll be paying ahead even faster, yet you can always pay only the required amount if you need to. You'll want to double-check the policy on your mortgage, but it's written as mine were, you can buy yourself considerable flexibility.
posted by TruncatedTiller at 10:00 AM on October 26

Oh, to answer your primary question, I'll use made up numbers and I'm ignoring closing costs to give you the basic idea (but make sure you don't ignore the closing costs).

Original Loan: $360,000
Mortgage Rate: 5 5/8%
Monthly Payment: $1688
Payoff Date: 1/1/2032
Total Payments over life of loan 2002-2032: $607,680
Total Payments from 2002-2010 (approx): $162,048 (mo pay x 12 x 8) [sunk cost, already paid]
Total Payments from 2010-2032 (approx): $445,632 (mo pay x 12 x 22)
Payments from 2032-2040: $0

New Loan: $350,000
Mortgage Rate: 5%
Monthly Payment: $1458
Payoff Date: 1/1/2040
Total payments over life of loan 2010-2040: $524,880
Total Payments from 2010-2032 : $384,912
Total Payments from 2032-2040: $139,968

Difference in Mo Payment: $230
Savings 2010-2032: $60,720 (original loan payments - new loan payments)
2010-2032 Savings Saved at 4%: $97,108
Expense 2032-2040: $139,968

COST OF NEW LOAN = Expense - Savings = $42,860

So breaking this down a bit. You saved $60,720 the first 22 years of the new loan. However, the last eight years you ended up paying $139,968 that you otherwise wouldn't have if you stayed with the original loan. However, if you were smart and saved that money from the first 22 years at 4% interest, then it would appreciate to $97,108. So, in the end. if you got the new loan, you end up paying somewhere around $40,000 more.

The results here are heavily dependent upon what you do with the saved money. As another example:
Let's say rather than saving the extra money, you pay off debt that averaged a rate 6.75%. In that case, the additional cost of the loan is made up by the reduction in credit payments you would have otherwise made. Or to say it a different way, if you had saved cash left over from the monthly payments at 6.75%, you'd break even.

Hope this helps.
Note: I think this is accurate, but I'm not a realtor, financial adviser, tax adviser or anything else. The math may be inaccurate, there may be a significant mistake, or I could just be plain wrong. But this type of calculation is what I use,and it seems to have worked for me so far (20+ years).
posted by forforf at 10:16 AM on October 26 [1 favorite has favorites]

In a nutshell: yes, lower interest rate is better. Just pay off whatever amount per month you want to (over the minimum).

But: There are usually fees associated with refinancing. Make sure you'd save at least this much in reduced interest payments.
posted by amtho at 11:20 AM on October 26