Even though it’s only been a year since we bought our house, we had been hearing so much about how low interest rates are right now that we decided to look into the possibility of refinancing. We spoke with a close family friend who works at a bank in the mortgage department. Our current rate is 4.625, and she told us that she could get us down to 3.75%. She said we could roll the closing costs into the loan and still end up with payments that would be about $200/month lower than what we pay now. Sounds great, right?
We decided to sit down and crunch some numbers to see if this would really be a good idea. We loved the thought of a 3.75% interest rate, but would refinancing really save us money in the long run?
You’ve probably seen personal finance websites that caution against looking just at the monthly payments when financing a car. Instead, they advise that you look at the total purchase price plus total interest and consider the total cost of the vehicle rather than whether you can afford the monthly payments. We do the same thing with our house.
The total cost of the house (principle amount plus total interest over the life of the loan) is more important to us than the monthly payment amount. We plan to stay here forever (I know, we said that before… but this time we mean it!) or at least for a very long time, and paying off the loan is one of our top priorities.
We used a mortgage calculator from Bankrate, which I like because it allows you to enter odd numbers for the total length of the loan. Here’s the nitty gritty: We currently owe about $152,000 on our house. Our interest rate is 4.625%, and we have about 12.5 years left on our 15 year loan (we’ve been in the house a year but we’ve been making extra payments ever since we moved in).
We can refinance at 3.75%, but it would start our loan over again at 15 years, and it would add about $4500 to the outstanding balance (refinancing would cost between 2 and 3 percent, and I’m going with the higher end to err on the conservative side). So we would then owe about $156,500 on the new loan.
We pay extra on our loan every month, but there’s no way to be sure that we’ll always be able to do that. So I wanted to look at both an early payoff scenario as well as the total interest we’d pay if we kept our mortgage for its full term.
In our current loan, if we stop paying extra and take the full 12.5 years to pay it off, we’ll pay about $48,400 in interest between now and the time we pay it off. If we have the loan paid off five years from now (our goal), we’ll only pay $18,600 in interest between now and the time we pay off the house.
If we refinance and don’t make extra payments, we’ll have a payment about $200/month lower than what we have now, but it will be for 15 years rather than 12.5 years. And over the course of that time, we’ll pay $48,400 in interest. Yep – the same amount (I rounded my numbers, but the actual values were within $70 of each other). If we refinance and then add the same amount of additional payment that would allow us to pay off our current loan in five years, it would take 5.5 years to pay off the new loan (because of the extra $4500 tacked on for closing costs). And the total amount of interest paid would be about $16,900. That is less than we’ll pay over the next five years with our current loan, but only by about $1700. That is far less than the closing cost of the refinance, even if we were able to get a new loan with a 2% closing cost.
So basically, even though the monthly payment would be $200 lower, we’d still be paying the same amount of interest if we kept our loan for the full term, and we’d be paying for the closing costs of the loan too. If we continue to pay extra each month in order to pay off the house quickly, we’d save about $1700 in interest with the new loan, but that doesn’t make up for the closing costs that would be tacked onto our loan in order to refinance.
So… we aren’t going to refinance. Sure, it would give us a lower monthly payment, but that payment would be set for the next 15 years rather than the 12.5 years on our current loan. And refinancing won’t really save us any money in the long run.
I know that it’s a great time to refinance if you’ve got a higher interest rate, but since our rate is already pretty low, the math just doesn’t work out. Are any of you considering a refinance right now? What’s more important to you – the monthly payment, or the total cost of the house?