A home loan refinance should save you money, but if done wrong it can cost you a bundle.
People refinance for one of two reasons;
- Reduce the cost of your loan via a loweer interest rate and/or costs
- Change the way your loan is set up for an upcoming or future purpose
In some cases it can be both.
This article covers the first reason; saving money on the cost of your loan and the mistake people make that costs them a bundle.
The #1 mistake is….. forgetting about the TERM of your new loan.
We get so focused on finding a lower rate and/or lower costs we overlook this critical part of the puzzle. The term of your new loan is as important as your interest rate in calculating the overall cost of your new loan.
Here’s an example so you can see where the figure of $44,515 above came from.
Mr & Mrs Homeowner bought their home five years ago and borrowed $400,000. They started with a thirty year loan and their current interest rate is 4.10% with payments of $1933/month.
After five years they have reduced the loan to $362,371.
They receive an offer to refinance their loan with a new rate of 3.70%. They decide to take up the offer and go ahead with the refinance. They’re told their new repayments will be $1668/month ‘saving’ them $265/month. Wow they think, how good is that, not only do we get a lower interest rate, but our repayments are lower. Perhaps we can afford that holiday after all.
The tiny but expensive detail they forgot to check or most likely didn’t think was important is the term of their new loan. Even though they are five years into their existing loan, their new lender decided to set their new loan at a thirty year term.
Let me show you why this matters.
- Their ‘old’ loan paying $1993/month over the remaining 25 years would cost $579,900. Including interest of $217,529 and the loan of $362,371.
- Their new loan of $362,371 with repayments of $1668/month over 30 years costs $600,480. This includes interest of $238,109.
- If their new lender had set their new loan over a 25 year term taking into account the five years they have had the loan, their payments would be $1853/month( still less than their existing loan) costing $555,965. This includes interest of $193,594.
You see that tiny little detail of overlooking(or ignoring) the new loan term(and lower repayment) making it 30 instead of 25 years will cost them a whopping $44,515 ( $238,109-193,594) interest they shouldn’t have paid. More importantly, they will pay $20,580 more interest than if they had done nothing and kept their existing loan!
Now I know the eagle eyed readers will have thought of some more ‘what ifs’. And, here they are;
- What if they kept their repayments at $1993/month and had a new 30 year loan? They would pay a total of $532,390 including interest of $170,019. Now we’re talking. They save $47,509 compared to their old loan and $68,090 compared to minimum payments of $1668/month and spending the $265/month they thought they had saved.
- What if they kept their repayments at $1993/month with their new 25 year loan? The result is exactly the same as above.
- Sometimes the purpose of a refinance is to reduce the monthly payments to free up income to pay other high cost debt. In this case starting the new loan with a 30 year term would be helpful in the short term. But, when the other high cost debt is paid off, the repayment should be increased on the new loan.
Refinance checklist-7 top tips
- Know why you’re refinancing and how you will benefit.
- If your loan is more than 80% of your property value, refinancing is a waste of time because of lenders mortgage insurance.
- Calculate your change over cost. It could easily be $1000.
- Calculate how long it will take to recover the costs of refinancing.
- Calculate your savings on the cost of interest, not on your repayments.
- Small home loans are not worth refinancing.
- Check the term of your new loan. Must be less than the time remaining on your current loan.
Refinancing is not a hit and miss affair. It needs to be done with careful thought so you benefit. Otherwise, don’t do it. Often simply increasing your current loan repayments, will have equal benefit.
To receive a professional assessment of your current loan(s) to see if refinancing will benefit you, please complete our online Client Information Form. If we can’t we will tell you.
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