For many people, a mortgage refinance is a way to lower their monthly payment. The amount of savings you can achieve from refinancing varies greatly depending on your particular situation, but comes from three different factors. Lowering your interest rate, stretching out your loan's balance over a longer time, and eliminating additional charges that go with your old refinance can all impact exactly how the numbers shake out for you.
Lowering Your Interest Rate
Refinancing to a lower rate should bring your loan's payments down. Leaving everything else equal, going from a 30-year $200,000 mortgage at 5.75 percent to a 30-year $200,000 mortgage at 4.25 percent will lower your payment from $1,167 to $984 per month. A more significant interest rate drop has a bigger impact. For example, the payment difference between a 7-percent $250,000 mortgage and a 4.5-percent one is almost $400, since the mortgage with the higher rate costs $1,663 per month, while the one with the lower rate is $1,267.
Reamortizing Your Payments
When you refinance your loan, you also recalculate your payments based on your new balance. If you originally had a $250,000 30-year loan at 7 percent, and you had spent 11 years paying it down by making your $1,663 monthly payment, you would only owe $209,427. The payment on a new 30-year loan at 4.5 percent with a $209,427 balance is just $1,061. Since you're borrowing less, you pay less, and, in this instance, you would save around $602 per month. An offsetting factor for any loan, including a refinance, is that when you take out a loan you pay much more interest than you do principal, so the loan's balance doesn't go down very much in the first few years. For example, over 11 years, the original loan's balance went down just 16.2 percent.
Eliminating Mortgage Insurance
If your loan is subject to mortgage insurance, refinancing may get rid of it. Generally, to eliminate your mortgage insurance, your loan has to be 80 percent or less of your home's value. If you originally took out a $190,000 30-year loan on a $200,000 property at 6 percent, and you paid on it for five years, your balance would go down to $176,803. If, over those five years, your home's value grew to $223,535 -- which is 2.25 percent per year growth -- a new $176,803 loan would represent 79 percent of the home's value. That would be a low enough loan-to-value ratio to qualify you to get out of paying for mortgage insurance. If the mortgage insurance premium is 1 percent per year of the loan's original balance -- $1,900 -- that change alone would save $158.33 per month.
Refinancing isn't always a slam dunk, though. When you refinance, you restart your loan's amortization, which means that you end up taking longer to pay off your house and potentially paying more interest over time. When you refinance to a lower rate, you also lower your mortgage interest tax deduction. While you're still saving money every month, you may be saving less than you think. Refinancing isn't free, either, and if you pay your costs out of pocket, you're losing the use of that money for other purposes.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.