Are you thinking about refinancing your mortgage? If so, you are probably wondering how much you might be able to save on interest. For many people, refinancing is the best way to reduce the total amount of interest they'll pay over the term of the mortgage, cut down on the number of years remaining on the loan and make owning a home more affordable in the long run.
At Addition Financial, we get a lot of questions about mortgage refinancing. We work with our members to ensure they understand their options. Using a mortgage refinance calculator can help you understand how much you can save.
In this post, we’ll review the ways you may save by refinancing your mortgage. We’ll also give you some tools to help you calculate your potential savings.
How Does Refinancing a Mortgage Help Homeowners Save Money?
We want to start by helping you understand the benefits of refinancing your mortgage. People refinance for different reasons. One of the most common reasons is refinancing can save them money by lowering the interest rate.
Perhaps you bought your home at a time when your income was significantly lower than it is now. And, over the years, your credit score may have increased with your income. You may qualify for a better interest rate now. The rule of thumb is, if you can reduce your interest rate by 1%, refinancing will save you money over time.
When you first got your mortgage, most of each month payment was applied toward interest, not the principal amount you borrowed. For the first few years, the amount you owe doesn't seem to budge with each payment. It takes several years before you begin to see the principal balance shrink. Refinancing won’t reduce the principal of your mortgage, but it can reduce the amount of interest, which means you'll pay less each month – and you’ll also pay less over the term of your mortgage.
How Much Can You Save by Refinancing Your Mortgage?
Determining how much you can save depends on several factors. Since we don’t know the specifics of your current mortgage, let’s look at some examples of how much you might be able to save. We’ll also link to a refinancing calculator, so you can crunch the numbers.
As of 2019, the average interest rate for a 30-year mortgage was about 4%. If you recently bought a home and your rate is lower than that, there may not be a point in refinancing right now. But, if your rate is higher than 4%, you might reduce your monthly payments and your total payment by refinancing.
Let’s look at a quick example. Imagine you have a $200,000 mortgage at an interest rate of 4.5%. Your current mortgage payment is $1,013.37.
If you were to refinance your mortgage at a lower rate of 3.75% with a 30-year term, your payment would be reduced to $926.23 per month. That’s a savings of $87.14 per month.
If your interest rate is higher than 4.5%, then your savings would be greater. However, it is important to think about the up-front costs associated with refinancing your home as part of the equation.
The closing costs to refinance can be substantial. Using the above example, let’s say your closing costs were $2,000. It would take you nearly four years to recoup your expenses. (That’s $2,000 divided by $87.14, which comes out to 23 months.)
Depending on the term of your new mortgage, the refinance option might be worth it. If you refinance for 30 years, for example, you would spend 23 months recouping your closing costs, and the remainder of the 30 years paying less than you would have otherwise paid.
Another reason for refinancing is to reduce the term of the mortgage. Perhaps you have 23 years left on your mortgage, but your income has increased so that you can afford a bigger payment. If you're planning to retire, and you'd like to have your home paid off when you do, you might refinance for 10 or 15 years. Your payment will probably increase, but you will achieve your goal of retiring without mortgage debt.
The Addition Financial website has a handy refinancing calculator that you can use to determine how much you can save by refinancing. You can find it here.
To use the refinancing calculator, you’ll need several pieces of information. They include:
- Your original mortgage amount
- Your original interest rate
- The date of your original mortgage
- The term of your original mortgage (example: 30 years)
- The interest rate of your new mortgage
- The term of your new mortgage (in our example, the loan term was 30 years)
Other Factors to Consider
As you prepare to refinance, there are some other factors you will need to keep in mind. For example, the amount you can save on interest will depend on:
- Your payment history
- The amount of debt you have
- Your FICO score
- The value of your home
- The closing costs for the refinancing
You’ll want to take everything into consideration as you compare rates and calculate your potential savings. It’s important to talk to your lender and make sure you understand all the financial ramifications of refinancing.
If average interest rates now are substantially lower than they were when you qualified for your mortgage, or if your credit score and financial situation are strong and have improved, then it is probable that you can save money by refinancing your home.
To learn about Addition Financial’s flexible mortgage and refinancing options, please click here.
Posted on Jun 13, 2018
Topics:
