If you haven’t noticed, loan rates are low right now… I mean REALLY low. Like the lowest they’ve been in recent memory. So if you have debt, especially a mortgage, you’ve probably wondered, “should I refinance my loan right now?”
My wife and I recently had this same question. Our home loan was a 30-year fixed, locked in a 4.125%, and we were only 2 years into the loan.
I had honestly considered refinancing ~12 months ago, when I likely could have lowered our interest rate to ~3.75%, but at the time we didn’t do that, and I’m really happy we didn’t, because we just locked in a 15-year fixed at 2.75%! I’ll take a 1.375% reduction any day of the week!
So this raises the question, why not refinance EVERY time you can get a lower rate?
Well, to answer this we need to look at how mortgage amortization works. For some of you, this may be a relatively unfamiliar topic, but don’t worry, by the end of this article, you should have a much better grasp.
To start out, here’s a visual to give you the broad idea:
I have included a screenshot for both a 30-year and 15-year fixed mortgage, since I would say those are the most common terms… at least in my experience, but I primarily want to focus on the 30 year fixed.
In those graphs, the green and blue bar bars add together to form your overall payment. What do you notice about the early years of 30-year fixed? You may have known this already but the vast majority of your payment, at least in the early years, goes to interest… right back to the bank.
But what about making the smart decision and “building equity in your biggest investment?” At least in the early years, that’s essentially a fallacy. While you are paying off some principal, you also inherit a lot more expenses with home ownership (i.e. broken A/C Units, dishwashers, and refrigerators)
What does this mean to you? Well if you plan to stay in your home for the full term of you mortgage, then paying a lot of interest upfront doesn’t mean anything.
However, if you, like most people, only stay in a house for 13.3 years on average (which is frankly a lot long longer than I would have guessed), then by 13 years in (43% of a 30 year mortgage term) you’ve already paid 60% of the total interest you will pay!
Let that sink in for a second…
Banks are smart (that’s one way to say it) and they structure mortgages so they get their money up front.
So let’s say that you’ve been in your house for 15 years, and you have the opportunity to refinance your mortgage and get a lower payment (because yes, you have paid down the principal, even if it is slow going early on) for a mortgage that is a whole 1% lower… do you do it?
You might hear from the company looking to refinance you that this is a good idea. Think of all the cash flow you can free up… for other things to buy??? You WERE paying $1,500 per month, just think, now you can pay $1,000 per month AND you get a lower rate.
Don’t do it. Refinancing would be great for THEM, horrible for YOU.
I will add a qualifier and say most people who I have discussed a refinance with seem to be pretty honest, and they’re typically upfront if refinancing makes sense for you in your situation. But it’s always good to remember that they are incentivized to help you refinance to make some moolah.
So how do you know if you SHOULD refinance?
The good news is, if you’re like most people (myself included) then you’re not a math wiz. All you need to do is search for “mortgage refinance payoff calculator” to at least get pointed in the right direction.
Hopefully this article has helped you to understand that it’s not all about the interest rate. The earlier you are in your loan, the more viable a refinance would be, but if you’re into your loan 10+ years, then it might make more sense to just power through and knock that puppy out.