Informed Refinancing: Know the Real Cost

If you have a $300,000 mortgage at 6.5%, and could refinance it at 5%, isn't that a no-brainer? Not necessarily. Understanding mortgage amortization can help you decide if refinancing a home loan is really such a great deal.

Mortgage Refinance: When You Think You're Saving Money, But Aren't

Most often, people refinance to get the lowest mortgage rates and/or lower monthly payments. Just understand that when loan officers compare your refinance mortgage payment to your current mortgage payment, the difference doesn't necessarily represent "savings." Here's why: every time you refinance from one mortgage to another home loan with the same term (usually 30 years), you restart the clock. If you are ten years into your mortgage when you refinance, it will take you a total of forty years to get rid of your house payment. And that means paying more interest over the life of your loan.

An Example of Phantom Savings

Here's an example of how a lender might claim to be saving you money when it obviously isn't.

• You have $374,444 left on a $400,000 mortgage that you have been paying for five years at 6.5%.
• Your payment is $2,528.
• A lender offers you a new loan at the same 6.5% interest rate.
• Your new payment is $2,367, $161 less each month. The lender calls this "savings."
• You pay an extra $93,627 over the life of the loan and it takes a total of 35 years to retire your mortgage.

How Do You Know if Refinancing Is a Good Idea?

Shoprate.com's refinance calculator can tell you. While it shows you a "savings" of $161 a month, it also indicates that your interest saved is negative $93,627. Supposing you could get 4.5% at a cost of $10,000? Over the life of your loan, you'd save $65,389.

Sometimes, Refinancing to a Longer Term Makes Sense

Paying more interest during the life of your mortgage isn't always bad--sometimes cash now is more important than cash later. For example, you could put the extra money towards higher interest like credit card accounts, invest in yourself or your children by paying for college, or generate additional income by putting the difference in payments into high-earning investments like stocks. As long as you are aware of the trade offs and your reasons for making them, refinancing can be sensible.

Refinancing: No Wrong Decisions, Only Uninformed Ones

Not everyone agrees that paying off the mortgage as quickly as possible is an appropriate financial goal--after all, you can't eat your house. In addition, a residence is not a diversified investment. If your home represents the bulk of your wealth, that could be risky--look what happened to all those retirees when the Florida housing market crashed. You might be better off taking on a mortgage and using the proceeds to top up retirement funds. Use a mortgage calculator, weigh the pros and cons, and make the best decision for your own circumstances.