A miniature refinance boom is developing in the mortgage industry at this time.
It’s small in stature for a couple of reasons. Number one, most of the folks with sufficient equity in their homes have refinanced at the last rate dips. Number two, the emphasis today is a shorter-term loan.
Of course, going from a 30-year amortization to a 25- or 20-year term is likely to increase the monthly house payment.
However, rates are lower for shorter-term loans and the total payment savings can be very substantial.
For example, if you borrowed $250,000 on a 30-year loan in 2009, and your interest rate was 5.25 percent, you had a monthly payment of $1,380.51.
If the first payment on that loan was due in September of 2009, the loan would have 332 remaining payments after December of 2011.
How much is this loan going to cost over its remaining lifetime? The math is easy — $1,380.51 multiplied by 332 is $458,329.
This calculation is an important exercise when considering a refinance, and there are others that should be done. For the moment, let’s compare this loan with a refinance to a 20-year term.
The $250,000 loan from the fall of 2009 would have a principal balance of $241,478 in December of 2011. Refinancing that to a 20-year loan at a rate of 3.875 percent would create a new monthly payment of $1,468.56 — but there is more to the story. The $1,468.56 payment multiplied by 240 payments is $352,454.40. This is $105,875 less than the total for the existing loan. It is true that you must increase the house payment from $1380.51 to $1,468.56, but is this not a worthwhile investment? I say yes.
If you refinanced, you are paying $88.05 more per month. You would make that higher payment for 240 months and the total increase over that time is $88.05 multiplied by 240 for a total of $21,132. Is it wise to spend $21,132 to save $105,875? I think you know the answer.
How nice to have your loan paid off 7.5 years earlier than previously scheduled. If you are a geezer like me, that is strong inducement.
Still, there is some further analysis we should do. There are expenses involved in taking out a loan, whether charged as up-front fees, or converted to a higher interest rate on the loan.
In this model, I refinanced the $241,478 loan to a new 20-year mortgage of $245,000. (The consumer would have to increase their loan by $3,500, so we need to look at that.)
The existing loan would decline to $237,994 in one year. The 20-year loan, with payments starting in February, would have a balance of $237,426 at year’s end. This is an important point and the calculation should always be done.
Here, it will only take 12 months for the consumer to pay off the closing costs and end up with a lower loan balance. In many cases it can be two to four years before that happens. If you sell or refinance before that time, you actually lost money on the deal.
One last comparison — after five years, the current loan would have a balance of $219,300. The refinance loan would only be $201,049. If you were selling the house at that time, you would pocket an additional $18,251. In this era of short sales — which take forever — owing less on your mortgage could be the difference between “Deal, or No Deal”.
David Ryland is the acknowledged dean of loan originators at Big Valley Mortgage in Roseville. He has 30 years of experience as a loan officer, manager, trainer and mentor. He can be reached at dryland@apmortgage.com.
