When you refinance a home don’t you, in effect, start all over and lose all the interest you’ve already paid? I know you’ve lived there all that time, but that’s not what I’m asking.
Peace,
mangeorge
You “lose” the closing costs in the sense that you have to pay them again. You may have to pay points (pre-paid interest), so I guess you “lose” that, too. You lose nothing else that I can think of.
These numbers are wild guesses;
You buy a house for 100k. and finance it for 30 years.
After 10 yeqrs you’ve paid 90k in interest and 10k on the house. Actually I don’t think you will have paid nearly that much against the principal, but I’m favoring simplicity.
So you refi the 90k for 30 years. In other words, you start all over.
How have you not lost that 90k in interest you paid for your original mortgage?
Most people at work don’t seem to know, and are 10-15 years at most into their mortgage and don’t want to talk about it. Especially if they’ve refinanced.
You lose the interest no matter what you do. It’s the price you pay for borrowing the money. The more you borrow, the more interest you pay. You keep whatever principal you paid on the original loan because you only have to refinance the remaining balance.
How do you not “lose” that money regardless? It’s interest on a loan, not money you’re putting into savings. The money you’re “paying yourself” when you buy a house is the principal, which accrues in the form of equity.
The benefit you get in paying interest on a mortgage is that that money is tax-deductible, so you’ve gotten 90k worth of tax deductions over that time.
The point of refinancing is usually to take advantage of lower interest rates or cash out some equity.
It might be worthwhile if you can drop your interest rate quite a bit. I played around at bankrate.com a bit; they have a great calculator that lets you plug in all the variables so you can see how long it will take to recoup your costs of refi, as well as how much money you’d save.
Seems to be that I once read you should only refi if you can drop your interest rate by 1% (or maybe it was 1/2%, I can’t remember.)
I love bankrate’s calculators!
Thanks, I’ll have a look at that.
I’m not going to refinance, I’m just curious.
Besides, I’m 63. I doubt I’d qualify for a 30 year loan. Unless that’s a plus.
Also, the reason your interest payment is initially so much larger is that your outstanding balance is larger when you start out. Your monthly interest payment is just your monthly interest rate times your outstanding balance.
If you had a 30-year, $100k loan and had paid off $10k of it after 10 years and then refinanced the remaining $90k at the same interest rate, your first interest payment on the new loan would be about the same as the last interest payment you made on the first loan. If you could manage to pay off the second mortgage in 20 years, your total payments would be exactly the same.
(Obviously you would not actually do this, because the closing costs on the refinance would not get you any savings.)
I believe the OP is considering the interest paid over the lifetime of the loan, and observing that by starting the clock over, you will “lose” interest in the sense that you will pay it again over the new lifetime if it’s the same length as the original loan, losing somewhat less if the interest rate is lower. What needs to be remembered is that paying a dollar today is not the same as paying a dollar 10 years from now. Money has time value - if I have to pay you $1000 in 2018, I can invest a much smaller amount in something with a guaranteed return and have the $1000 for you in 2018. In terms of the refi’ed mortgage, you might ask whether the reduced payments now are enough to make up for the interest payed on the longer schedule out into the future.
[I hope the following doesn’t confuse you]
Let’s alter the scenario a bit: Let’s say that you’re refinancing because you can get an interest rate that’s 1-2% less than what you were paying before. Because of this, and because you’re only financing $90k instead of $100k, your monthly mortgage payments (on a 30 year loan) are a couple hundred dollars less.
After playing around with a mortgage calculator, you realize that if you pay a couple hundred dollars more per month (roughly what you were paying originally), you can get the loan paid off in 15 years, so you get a 15 year mortgage.
Now you’re where you were before, except 5 years ahead.
Yes, you start all over, because a refinance means you pay off your current mortgage with a new mortgage. You get no credit for previous payments made, because you now have an entirely brand new mortgage. It may be wise to do this for 2 reasons:
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Interest rates are lower now then when you got the first loan. So, it makes sense to get a new loan, payable over 30 years at 6% interest, then to keep your old loan, which charged 10% interest over 30 years, even though you’ve already paid down the first 10 years of that first loan, and have only 20 years of payments left.
(I’m not crunching numbers, but am merely pullling numbers out of my ass. Interest rates and amortization (i.e. payment schedule) may vary. But, assuming the numbers work, this is one reason a person would refinance). -
You want to cash out the equity on the property. Equity is the difference between what is owed on the house and what the house is worth. So, lets say you borrowed $200K on a house that is worth $250K. You have $50K in equity, and could elect to do a “cash out refi”, whereby you take out a new loan for $250K. The first $200K pays off the initial mortgage, and the remaining $50K is cash in your pocket.
In theory, this may make sense if you intend to use the cash to improve the worth of the house (i.e. build a pool or another room). Many people, though, use the extra money for other things (i.e. vacations, or paying credit card debts), and are dependent on the hope that they can recoup the housing investment due to appreciation of the property.
The risk in doing this, of course, is that the house isn’t really worth $250K, and that the value is inflated (which describes the recent housing bubble). So, you’re now paying $250K on a house that may only be worth $220K, which means you’re “upside down” on the house. You now don’t have the option of selling the house to satisfy the debt, so you’ll face foreclosure if you get behind in your payments.
To expand on this:
Let’s say you borrow $100k at 6% for 30 years.
When your first payment comes due, you have to pay 1/12 of 6% of the $100k. So, out of your first payment, $500 goes to interest, and about $10 (WAG for illustration purposes) towards the principal. (There’s also PMI and taxes and escrow, etc., that I’m leaving out for simplicity).
Now, the next month you owe $99,990 to the bank. You make the same payment, and $499.95 goes towards interest, and $10.05 goes to the principle.
Now you only owe the bank $99,979.95. So you’re slowly chipping away at the principle at first. *
After 29 years and 11 months, you will only owe the bank about $476. Of your last payment, $23.80 will go towards interest, and $476 will go towards principle.
There may be better mortgage calculators out there, but this is the one I’ve used for years. (acting kinda wonky right now, but that might have to do with my PC and Java.) Karl's Mortgage Calculator
- If, during those first few months, you were to pay an extra $1,000, that would all go toward the principle, and would knock about a year off of your mortgage (assumming there’s not prepayment penalty). I did that a few times when I had the money, and now, after 2 years, I only have about 24 years to pay off my mortgage. [Whether or not that’s a good idea (due to tax reasons) is another debate. But on my first house, I paid about $10k the first year in interest, and that only saved me about $500 on my taxes. So unless someone explains differently, I’m going to keep throwing extra money towards my mortgage.]
Right. I’m beginning to get it. I looked at those calculators, and the ones on my credit union’s website.
Right now my ARM is very close (a little lower) to what a fixed* would be. Always has been, in fact. If I were to refinance to a 15 yr. fixed mortgage, AND the ARM I no longer have any more were to go up a couple percent, I’d be ahead.
*My present ARM is close to the four fixed rates estimated on bankrate.com. And I have about 15 yrs. left on my mortgage.
So I’ll likely sit tight. I’m likely going to sell in a few years anyway, when I retire.
I think that if you play around with the numbers, you’ll be surprised at how little extra money it takes to turn a 30 mortgage into a 20 or 15 year mortgage. Unfortunately, not many people say “Hey, even though we qualify for a $150k loan, let’s get a $90k house and pay it off in 10 years, then upgrade.” They say “Let’s get the biggest house we can possibly afford.”
Play around with the numbers, is what I’m saying. (Sorry, I kinda veered off topic a bit.)
Banks are not legally allowed to take your age into acocunt when making a credit decision (except so far as you must be of legal age to enter into a contract).
It’s been my experience that they will not either. Almost all underwriting is mostly automated, and date of birth is not one of the fields that is used in those calculations.
I just bought a townhouse at age 55 and was offered my choice of either a thirty or fifteen year mortgage, so age is definitely not a factor. I opted for the fifteen because it had a slightly better interest rate, and I’m planning on making additional principle payments anyway to try to pay it off in ten years or so.
The mistake most people make when refinancing is to take out an even larger sum for the same term.
If you take out a smaller sum or shorten the term, you won’t end up constantly being 30 years out from the end of the loan and never paying it down.
Interest isn’t really “lost.” It’s simply a reflection of the opportunity cost of the money. If you can make more more money by your use of the bank’s money than the money costs you in interest, you are actually ahead taking out the loan.
If, for instance, your home appreciates faster than your net interest (actual interest less the savings from deducting it) costs you, you may do very well. Or perhaps you refi and use the money for a really really good stock that makes you a ton of money. In both cases, the opportunity cost for the money was well worth it.
Of course, sometimes house values crash and the market tanks. 
If it makes financial sense for you to pay off your home loan, you should still refinance if a lower interest rate offsets any closing costs, but you should take the money you saved each month from getting a lower interest rate and apply it to the principal. This will reduce the term of the loan such that the new loan will be paid off before the original one would have been, saving you interest costs in paying off your home.
Very informative thread! I have been wondering about many of these very things, so some of my questions have already been answered, thanks.
But, I have another for instance for you to consider.
Say you buy a house for $100,000, with a mortgage of $80,000. It’s a fixed mortgage and the term will be up within 24 months. The house you chose was a fixer upper in an enviable neighbourhood. Having done about 2/3 of the reno with sweat equity, reno fatigue sets in, and you’re out of funds. Conservatively, and not quite finished, the house has risen in value to about $160,000, though it would clearly be more were it completed. It might be worth close to $200,000 then.
Is it wise to access the equity in the house to finish the reno? We don’t want all the equity, only about $25,000. It would provide us the funds to finish the work. That would give us options should we decide to sell, or even rent it out and go traveling.
I’m confused about whether to refinance or wait for the mortgage term to end. There are so many fees and charges involved that I’m unsure.
I had planned to go and talk to the bank, but I swear, sometimes they are speaking Greek!
If I understand the question you are deciding whether to take out $25k to make $40k.
First of all, it doesn’t have to be a refi. If you have $80k of equity in the home, you s/b able to get a note for $25k against that equity and it will be cheaper to do so than a full refi. A home equity line of credit shouldn’t be very expensive.
Personally, if your number is accurate for the current value, I wouldn’t bother. The $200k number sounds more like a hope than a real number.
Why not let the market decide what your home is worth? Put a slightly high number on it ($175k?) and put 'er on the market. If she goes at full ask, you are happy. If she doesn’t, you might get some solid feedback on where to put in more money. And offers that come in under your ask might give you a feel for a realistic market value.
But no one can really give you decent advice on the basis of a post here…
As an aside, a fixed term loan up in 2 years? Do you mean you have two years til the interest changes or two years left for the entire term? Is it a balloon? If so then other factors come into play such as how long you want to keep the house and where you think interest rates are headed. You might want to consider a longer term fixed refi if you are gonna hang on to the house and want to lock in current rates. With all the borrowing we do as a country I can’t imagine rates not skyrocketing over the next 15 or 30 years but then if I had a crystal ball I’d be richer.
Thanks Chief!
Sorry if I wasn’t clear. We had a 7 year fixed rate which will be up in the next, actually, 12 months.
We have a line of credit we are currently paying down, for the building materials we’ve used for the renovations to date. We are not keen to put more on it. We’re new to debt and it makes us uncomfortable.
I think, but I’m not sure, the interest rates have since dropped, at least a little.
(The $200,000 figure is actually, I think, very conservative. A house of similar square footage, [but with a 2 car garage and a finished basement], right across the street was listed at $305,000. And the neighbours laughed, not possible, way, way too high. It was too high but they just sold, after six months, for $279,000! Neighbours all shocked.)