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When it comes to your mortgage the first thing people ask is “what is your interest rate?” Many people have the old rule of them embedded in their thought processes that it does not make sense to refinance unless you are lowering your interest rate at least 1%. This may be true in some cases however using this as a strict rule may cost you thousands. If you have the opportunity to lower your interest rate and you chose to pass it up, you may be making a financially painful mistake.
Of course we will take a look at how much you will save on your mortgage by refinancing to a lower interest rate. Everyone wants to save money however another way to analyze your mortgage decision is to examine the cost to not refinance. If you do not take advantage of a lower rate that is made available to you then the amount you would have been saving is what you are paying extra. For example, a homeowner with a $200,000 mortgage at 6.25% will pay $1231.43 per month in principle and interest. If they are able to lower their rate to 5.375% and keep their mortgage at the same amount, their payment will be $1119.94 for a monthly savings of $111.49. Over one year they will have saved $1337.88 and conversely if you do not refinance then you are costing yourself this much each year.
Obviously the monthly savings are nice but for those number crunchers out there, let’s also take a look at the big picture. The savings over the life of your loan is also important. Assume you have had your current mortgage for a full year or 12 payments. On a 30 year mortgage you would have 348 payments remaining. The biggest reason I hear from my clients on why they do not want to refinance is because it will restart their mortgage term over which will cost them money. This is absolutely true however with this example 348 payments at the higher current interest rate will be a total of $428,537.64 paid over the remaining life of the loan ($1231.43 x 348 months) whereas 360 payments at the lower interest rate is a total of $403,178.40 (1119.94 x 360 months). This means that even though you have 12 additional payments, you end up paying $25359.24 extra by not refinancing!
The other reason for not refinancing is because people say they do not want to take longer to pay off their home. That is also an excellent point, however most mortgages these days do not have prepayment penalties so you can pay extra each month and cut down your mortgage term. For this example if you were to refinance to the lower interest rate and continue paying the same payment therefore putting the savings towards the principle each month, you would pay your home off in 289.4 months or just over 24 years compared to the 29 you have remaining. By paying your mortgage off 5 years early you will save $73885.80 in interest! By not refinancing you are choosing to pay $73885.80 extra which makes no financial sense.