Refinance Calculator: How Does Refinancing Work
Refinancing simply replaces your current home loan with a new mortgage that has different terms. Refinancing usually requires that you have a certain amount of equity in your home. Generally, you need at least 20% equity but this varies depending on the loan program.
Should I Refinance My Mortgage?
A good question to ask before even getting started with refinancing is how long you plan to stay in your current home. It may not make good sense to spend thousands of dollars in closing costs only to obtain a lower rate.
On the other hand, if you’re looking to stay in your home for the lifetime of the loan, extending the term of your loan could mean paying less each month, although you will be paying more in total interest in the long run.
The benefits of refinancing your home will take time to accrue so you need to make sure you are staying there long enough to break-even on the cost of refinancing. Determining how long it will take to break even will come in handy, especially if you don’t plan on staying in your house for that long. For example, if the break-even point on your refinance is 5 years, and you only plan to live there for another 4 years, then it’s not beneficial to refinance because you will not be recouping your costs prior to selling the home.
When you’re deciding whether you should refinance, you have to consider your financial goals. There are several potential benefits to refinancing, which include:
When Should I Refinance My Home?
How Much Will Refinancing My Student Loans Save Me
According to a recent analysis of self-reported data provided by borrowers who refinanced their student loans through Credible, Credible users who refinanced into a shorter term loan saved an average of $17,344 over the life of your new loan.1
But keep in mind the amount you save will be dependent on your specific situation.
1 to see how this savings was calculated.
Drawbacks Of Refinancing Into A 15
Having all your money tied up in your home can be risky. Many financial experts recommend having at least three to six months of emergency savings set aside in case you lose your job or cannot work for extended periods.
You may not want to refinance if it will negatively impact your monthly cash flow. Thats especially true in the uncertain financial climate were currently in. You have to make sure you can continue to make payments or you could risk losing your house, cautions William Stack, a financial advisor with Stack Financial Services LLC in Salem, Missouri.
Instead of refinancing a mortgage, you could contribute more money toward a 401 plan or an IRA account or beef up your emergency savings fund. The latter approach helps you avoid revolving credit card balances from month to month and incurring more debt at a higher interest rate.
I believe that if youre not maxing out any available employer match to your retirement plan, its a mistake to accelerate your mortgage payments by shifting to a 15-year mortgage, says Allison Bishop, CPA, a financial coach in Portland, Maine. Youre giving up a 100-percent return on your investment in favor of something more like a 3 to 4 percent return. Its also smarter to put that extra money toward paying down higher-interest credit card debt if you have it.
Recommended Reading: How Exactly Does A Reverse Mortgage Work
When Is Refinancing A Bad Idea
On the other hand, there are definitely times when refinancing your mortgage would not be a good idea. Well give you some examples.
It wouldnt be wise to refinance because you want to use the money to:
- Get a new car
- Pay off credit card bills
- Roll up other debt into a refinanced mortgage
Wiping out your home equity to buy new stuff you dont need puts your home at riskespecially if you lose your job or have other money issues.
Also, the reason you dont want to roll up other debt into one gigantic refinanced mortgage is because you want to pay off your smaller debts first .
Lumping your student loan debt into your mortgage means its going to take a lot more time to pay off those loans and your mortgage too. It puts you even further away from completing either of those goals. No thanks.
Make More Frequent Payments
It could be one extra mortgage payment a year, two extra mortgage payments a year, or an extra payment every few months. Whatever the frequency, your future self will thank you. Maintain these additional payments over an extended period of time and you’ll likely eliminate several years from your term.
A quick note here: there is no best day of the month to pay your mortgage. Both the principal and interest amounts decrease over time, whether you make payments on the 1st, 15th, or a date in between.
Don’t Miss: How Do Mortgage Lenders Make Money
How Could Refinancing Lower My Payment
- Lower interest rate If you lock in a lower interest rate, you could lower your monthly payment because you’re paying less to finance your home.
- Eliminate private mortgage insurance If you put less than 20% down on your home, you’re probably paying PMI. If you’ve built at least 20% equity in your home, you could stop paying your PMI, which would lower your monthly payment.
- Extend your loan term If you refinance to a longer loan term, it would decrease your monthly payment.
One option you may benefit from is switching from an adjustable-rate mortgage to a fixed-rate mortgage. With an adjustable rate, you will receive an initial period of a set interest rate which will at some point reset to a rate that can change, for the rest of the life of the loan.
Most homeowners choose an ARM if they believe they’ll be in that home only a few years, since they can save money with the lower initial interest rate an ARM offers.
If you plan to stay in your home for a while, however, converting to a fixed-rate mortgage will help you be better able to budget over the long term since your interest rate will remain unchanged.
How Extra Mortgage Payments Work
Sometimes, it makes more sense to pay down the principal balance on your existing loan instead of getting a new loan.
Also known as accelerated payments, this strategy involves paying a lump sum toward your mortgage principal balance.
There are a few ways you can pay extra on your mortgage. Popular strategies include:
- Making one extra payment each year. If you can make 13 payments instead of 12 every year, you could shave a few years off your loan term. You could turn your tax return or holiday bonus into a mortgage payment
- Paying your mortgage bi-weekly. This allows you to make an extra payment each year without making a full payment all at once. Essentially, youd pay half your monthly loan payment every other week rather than making the full payment once a month, which results in 13 total payments each year
- Making larger payments. You could add $100 or $200 a month to your monthly payment. The key is to do this regularly so youll see long-term savings, and youll also need to make sure the extra money goes toward your principal
These are good ways to save on interest and repay your loan sooner. But these strategies wont lower your monthly payment the way a refinance can.
Don’t Miss: Should I Have A Mortgage
More On How To Maximize Total Wealth
The decision of whether to refinance your mortgage is multidimensional, especially if you account for maximizing total wealth. We believe it can be an oversimplification to focus on only one factor of savings . This approach doesnt take into account other variables in your financial picture that affect your total wealth over the course of the loan. Here are 6 other variables to account for when calculating total wealth:
1) Tax deduction of your closing costs and mortgage interestIn the tool, were assuming a current and future marginal tax rate of 28%. This is used to estimate the amount by which you can reduce your taxable income over the loan term.
2) Opportunity cost of investing your moneyIf you lower your monthly mortgage payment, you might choose to invest the difference in bonds or stocks. This can add up to a lot of money in the long run! We assume a post-tax investment yield of 3.5%. If you keep most of your savings in a bank account, decrease this to 0%. If you invest most of your savings in the stock market, increase it to 6%.
3) Cash flowIn the tool, we factor in one-time, out-of-pocket closing costs as well as the adjustment to your current monthly payment. Both of these affect your cash flow. If it will be difficult to absorb these adjustments, it may not make sense to refinance your mortgage even though it might save you money in the long run.
Pay Off The Loan Faster
In most cases, shortening your loan term allows you topay off your principal faster. A shorter term often means you’ll have a higher monthly payment but fewer overall payments, reducing interest over the life of your loan. Additionally, shorter-term loans typically have lower interest rates than those with longer terms .
You can also speed up your loan repayment to a bi-weekly cadence, which many lenders allow. Bi-weekly payments equate to one extra payment each year and 51 fewer months on a 30-year loan. This ultimately reduces the amount of interest you pay. Before signing, confirm a bi-weekly payment option with your lender.
Read Also: What Mortgage Can You Afford Based On Salary
What’s The Difference Between Being Prequalified And Preapproved
A quick conversation with your lender about your income, assets and down payment is all it takes to get prequalified. But if you want to get preapproved, your lender will need to verify your financial information and submit your loan for preliminary underwriting. A preapproval takes a little more time and documentation, but it also carries a lot more weight when youre ready to make an offer on a home.
Consider The Term Of Your New Loan
Before you decide to refinance, calculate your break-even point and how the overall costs including total interest of your current mortgage and your new loan would compare.
Take note that refinancing usually makes more sense earlier into your mortgage term.
In the early years of your mortgage term, your payments are primarily going toward paying off interest. In the later years, you begin to pay off more principal than interest, meaning you start to build up equity the amount of your home that you actually own.
Once you refinance, its like youre starting over. Say youve been paying off your old mortgage for 10 years, and you have 20 years to go. If you refinance into a new 30-year mortgage, youre now starting at 30 years again.
Also Check: How Do Mortgage Loan Officers Make Money
Diy Extra Payment To Prepay Mortgage
Lets say you want to budget an extra amount each month to prepay your principal. One tactic is to make one extra mortgage principal and interest payment per year. You could simply make a double payment during the month of your choosing or add one-twelfth of a principal and interest payment to each months payment. A year later, you will have made 13 payments.
Make sure you earmark any additional principal payments to go specifically toward your mortgage principal. Lenders typically have this option online or have a process for earmarking checks for principal payments only. Ask your lender for instructions. If you dont specify that the extra payments should go toward the mortgage principal, the extra money will go toward your next monthly mortgage payment, which wont help you achieve your goal of prepaying your mortgage.
Once you have built sufficient equity in your home , ask your lender to remove private mortgage insurance, or PMI. Paying down your mortgage principal at a faster rate helps eliminate PMI payments more quickly, which also saves you money in the long run. You can also refinance your mortgage to eliminate PMI altogether.
What The Early Mortgage Payoff Calculator Does
Do you want to pay off your mortgage early? Maybe you have 27 years remaining on your home loan but you would rather pay it off in 18 years instead. The early payoff calculator demonstrates how to reach your goal.
The mortgage payoff calculator shows you:
How much more principal you would have to pay every month so you can pay off the loan in a certain number of years.
How much interest you would save by paying off the loan early.
There are many reasons you might want to accelerate the mortgage’s payoff, but the motivation usually boils down to either or both of these:
You want to own your home free and clear by a milestone in life, such as your retirement or the beginning or end of your kids’ college years.
You want to reduce the total interest you pay over the life of the loan.
To steadily pay off the mortgage early, you need to know how much more to pay toward the principal balance every month to accomplish that goal. This calculator lets you do that.
When paying down the principal on a mortgage faster, keep in mind that each servicer has its own procedures for assuring that your extra payments go toward the principal balance instead of toward future payments. Contact your servicer for instructions.
Recommended Reading: Which Bank Is Best To Get A Mortgage
Today’s Best Mortgage Rates
Our rate table lists the best current local mortgage rates available from our lender network. Set your search criteria by entering your loan data and selecting the relevant products from the dropdown, click search and we’ll help you compare the market by showing you the most relevant offers for homeowners.
Why Do People Refinance Their Home Mortgage Loan
Refinancing your home mortgage allows you to pay off your original mortgage with a new loan. Typically, people refinance their original mortgage loan for one or more reasons:
- to earn a better interest rate,
- to convert a variable rate to a fixed rate ,
- to reduce monthly payments by extending the repayment term of the loan , or
- to reduce interest charges paid over the life of the loan by reducing the repayment term of the loan.
Read Also: How To Get Rid Of Escrow On Mortgage
How Much Are Prepayment Penalties
When you agree to a particular mortgage term, your are signing a contract for that amount of time, generally between 1 and 10 years. If you break your mortgage before that term is over, you’ll be charged a prepayment penalty, as a way to compensate the mortgage provider. How much this can cost varies wildly based on the type of mortgage you have, the time remaining on your term, as well as your mortgage provider – each lender has a different way to calculate prepayment penalties.
The exact prepayment penalty calculation that applies to you will be laid out in your contract, but there are two methods used, outlined below.
How To Use The Early Mortgage Payoff Calculator
To fill in the calculator’s boxes accurately, consult a recent monthly statement or the first page of the Closing Disclosure that you received when you closed on your mortgage.
Under Loan term , enter the number of years for which your home is financed.
Under What was your mortgage amount?, fill in the loan amount. In the Closing Disclosure, you can find this on the first line of the Loan Terms section.
Under Interest rate, enter the percentage.
Under How many years are left on your mortgage?, you’ll need to enter a whole number, so round up or down.
Likewise, under In how many years do you want to pay off your mortgage?, you’ll have to enter a whole number, rounding up or down.
Under How much do you still owe ?, look for this figure in a recent monthly statement, or contact the mortgage servicer. Or you can use NerdWallet’s mortgage amortization calculator and drag the slider to find out how much you still owe.
Don’t Miss: What Is The Rate For A 15 Year Mortgage
When Should You Reconsider Refinancing Your Mortgage
There are a few situations when you might want to rethink refinancing your home.
- Prepayment penalty If your existing mortgage has a prepayment penalty, consider if youll save enough to make paying the penalty fee worth it. And ask your lender if its willing to waive the penalty if you refinance your mortgage with it.
- Moving soon Do you already have your eye on a new home? Calculate your break-even point to make sure you wont lose money once you factor in the costs of refinancing.
- Existing home equity loan If you have a home equity loan or line of credit , you may have to ask that lenders permission to refinance your loan. If it doesnt agree, you might have to pay this account off before you can refinance.
How To Calculate Your Refinance Savings
Okay, put on your math hat! Lets say you bought a $300,000 house with a 30-year mortgage at a fixed interest rate of 4% and had a 20% down payment .
After around 10 years of paying about $1,150 per month on your mortgage, your loan balance is now at $200,000. You want to save money, so you consider a refinance.
Using our mortgage calculator, you enter your remaining loan balance of $200,000. To test the refi option, you shorten the mortgage term from your remaining 20 years to 15 years and drop your interest rate down a percentagefrom 4% to 3%.
Youll notice that the shorter 15-year term will make your new monthly payment go up from $1,150 to about $1,400 per monthbut dont worry. Youve probably earned some raises over those 10 years to be able to afford that $250 increase each month. Plus, youll pay off your home five years sooner and save $53,000 in interest!
Just make sure your monthly mortgage is never more than 25% of your monthly take-home pay.
Read Also: How To Pay Mortgage Online Rbc