Why Refinances Tend To Have Lower Payments
I keep talking with people who don't understand that a higher interest rate on a refinance can result in a lower payment. In fact, they don't understand why refinancing tends to lower the payment at all.
Before I go any further, I need to reiterate my standard warning that you should Never Choose A Loan (or a House) Based Upon Payment. There are all kinds of games lenders and loan officers can play to manipulate your apparent payment.
Now, as to why refinancing tends to lower the payment: It's actually very simple: Because you are extending the period of the loan.
Let's say you took out a home loan five years ago for $300,000 at 6% on a thirty year fixed rate basis. Your payment has been $1798.66, and assuming you've just been going along and making minimum payments, you have paid your principal down to $279,163. Even adding $3500 in closing costs into your loan balance, if you refinance again at exactly the same rate, your payment will drop to $1611.72. If you divide the cost by the payment savings, it looks like you break even in less than two years!
However, that isn't a valid calculation. What you're doing is taking a loan with a remaining period of 25 years, adding $3500, and swapping it for a brand new 30 year loan, serving no purpose except to extend the period for which you have borrowed the money by 5 years. Your monthly cost of interest actually goes up, because you owe $3500 more on the new loan at the same rate, not to mention that $3500 in costs! Your total of remaining payments goes up by over $40,000! Even if you keep making the same payments ($1798.66), you have added nine months to your loan! This also leaves aside all kinds of games that can be played with payment in the short term.
Never choose a loan based upon payment. If you will remember this one rule, you will save yourself from more than fifty percent of the traps out there. Loan officers and real estate agents and everything else tend to sell by payment. You do need to be able to afford the payment, and I mean not just now but what it's going to go to in five years. With that said, however, remember the fact that payment can be extended out practically indefinitely. Used to be with credit cards taking 26 years to pay off by minimum payments, you could be paying off a restaurant meal 25 years after the crop it was processed into fertilizer for was harvested, costing you five to ten times the original cost of the meal. The same principle applies for real estate loans. Unless it's a cash out loan, or a higher interest rate, you're likely to cut the payment just based upon the fact that you are extending the term.
I have said this before, but just because they quote you a lower payment to get you to sign up for the loan doesn't mean it'll be that low when you actually go to sign documents. In a case like this, it is very possible for them to conveniently "forget" to tell you about prepaid interest, impound accounts, third party and junk fees, and origination points, all of which will add to the balance on your loan and have the effect of raising the payment reflected upon the final documents. So you sign up expecting your payment to drop by $180 plus, and at final signing, you've paid $10,000 more than they told you about and you are only lowering your payment by $80, but it's all done and it would be wasted effort if you don't sign these final documents, so you do - blissfully unaware that you have actually done something worse than wasting that $13,000 you added to your balance to get your loan done. In fact, you've just added about $75,000 to the actual costs of paying off your property! And the loan company got paid to talk you into this!
If you're not sure if you should refinance, ask yourself "What would happen if I keep making the same payments as now? Would I be done sooner, or would it take longer?" It's hardly a foolproof question, but taking a financial calculator to closing, and plugging the new balance and interest rate reflected on the new loan documents together with your old payment, and seeing whether it results in a quicker payoff, is certainly one good check upon the ability of slick operators to sell you a bill of goods. This doesn't work for cash out or consolidation loan refinances, obviously, but for "rate/term", where the attraction is is simply a lower payment or lower interest rate, it's certainly one question worthy of asking. An answer that's less than your current total doesn't mean it's a smart loan to be doing, but a longer payoff is a pretty universal indicator that it's not.
Refinancing to lower your rate can certainly be a major benefit to you, as I've said before, but you need to crank the numbers to see if it actually helps your situation, as opposed to stretching out your loan term to make it seem like your costs have gone down, when in fact they have done no such thing. With thousands and tens of thousands of dollars on the line, it might even be smart to pay a disinterested expert to run the calculations. Let's say you pay $200 for an hour of their time, which saves you from making that $75,000 mistake I describe above. The downside is you wrote a check for $200. The upside is that you don't end up writing checks for $75,000 more than you needed to. If you understand finance yourself, the computations aren't difficult, and that $40 financial calculator will save you as often as you ask it questions, although you might have to feed it a $2 battery occasionally. If you aren't certain how to do the calculations, or what calculations you need to do, by all means give your accountant a call.
Caveat Emptor
Categories
Mortgagesblog advertising
--Blogads--
blog advertising --Blogads--
My Links
-
Heavy Lifters
- Instapundit
- Michelle Malkin
- Scrappleface
- Volokh Conspiracy
- Captain's Quarters
- Wizbang
- Victor Davis Hanson
- Eject! Eject! Eject!
- Michael Barone
- The Victory Caucus
- The Truth Laid Bear Places I get to as often as I can
- The Command Post
- Good News Central
- Icerocket
- Life Liberty Property
- MEMRI
- Raging RINO Community
- Technorati
- Transparency International
- Wide Awakes
- The Anchoress
- Argghhh! R
- Armies of Liberation R
- Asymmetrical Information
- Austin Bay
- Belmont Club
- Big Lizards
- Tim Blair
- Cox and Forkum
- Dr. Sanity
- Kevin Drum
- Gateway Pundit
- Hugh Hewitt
- Iraq the Model
- Jeff Jarvis
- Jihad Watch
- John Leo
- Lileks Screed
- Little Green Footballs
- Josh Marshall
- Mudville Gazette
- Neo-neocon
- WSJ OpinionJournal
- Politburo Diktat R
- Powerline
- Powerline News
- Protein Wisdom
- Q and O L
- Real Clear Politics
- Mark Steyn
- Stop the ACLU
- Strategy Page
- Don Surber R
- Vodkapundit
- Watching America
- Matthew Yglesias
- Michael Yon Personal Finance, Economics and Business Sites
- Bloodhound Blog
- Consumerism Commentary
- Eidelblog L
- The Entrepreneurial Mind
- Finance Blog
- Financial Rounds
- Free Money Financea>
- In Cash Flow We Trust
- I Will Teach You To Be Rich
- Mortgage Fraud Blog
- No Credit Needed
- Old Niu's Blog
- Pacesetter Mortgage Blog
- Personal Finance Advice
- pfblogs.org
- Social Security Choice
- Students for Saving Social Security Other sites I've linked and visit
- Accuracy In Media
- Ace of Spades
- The Agitator
- All Things Jennifer R
- Ann Althouse
- American Citizen Soldier
- The Anarchangel L
- Angry in the Great White North L
- Antigravitas L
- The Anti Idiotarian Rottweiler
- Art of the Blog R
- Atlas Shrugs
- aTypical Joe R
- Professor Bainbridge R
- Baldilocks
- Barcepundit
- Beldar
- Belgravia Dispatch
- Below The Beltway L
- Blackfive
- The Buck Stops Here
- Catallarchy L
- Chapomatic
- Chequer-Board of Nights & Days
- Clarity and Resolve
- Classical Values R
- Combs Spouts Off L
- Common Sense and Wonder
- The Counterterrorism Blog
- Countertop Chronicles R
- Coyote Blog
- Daily Howler
- Daily Pundit R
- David's Medienkritic
- Dean's World R
- Decision '08 R
- De Doc L
- Brad DeLong
- Democratic Peace
- Different River
- Digger's Realm R
- Done With Mirrors R
- Drink This
- Drudge Report
- DUmmie FUnnies
- enrevanche R
- Eschaton
- Evolution R
- Fearless Philosophy L
- Forward Biased L
- Generation Why?"
- Happycrow's Eyeball Factory L
- Hold The Mayo L
- Huffington Post
- The Idiom
- IMAO
- INCITE L
- INDC Journal R
- Inside Larry's Head R
- Inoperable Terran
- Iowahawk
- It Comes In Pints?"
- The Jawa Report R
- Just One Minute
- Justus for All R
- Kausfiles
- Ezra Klein
- Daily Kos
- La Shawn Barber
- Liberals Against Terrorism
- Libercontrarian RL
- Libertarian Leanings R
- Liberty Papers
- Carol Platt Liebau
- Llama Butchers R
- Mensa Barbie
- The Moderate Voice
- Mossback Culture R
- Mover Mike L
- Mr. Completely L
- National Review Online
- No Angst Zone L
- Normblog
- Brendan Nyhan
- Ogre's Politics & Views L
- One Fine Jay R
- Owlish Mutterings L
- Patterico's Pontifications
- Peter Porcupine L
- Bradford Plumer
- Pole Dancing In The Dark L
- Political Calculations
- POV R
- Publius Pundit
- Radio Equalizer
- Reasoned Audacity
- Respectful Insolence R
- Rhymes with Right L
- Riehl World View
- Right Place
- Right Reason
- Right Thoughts R
- Right Wing Death Beast
- Right Wing Nut House
- ROFASix
- Samizdata
- Say Uncle RL
- Debbie Schlussel
- SCOTUS Blog
- Roger L. Simon
- The Strata-Sphere R
- TacJammer
- TalkLeft
- TAPPED
- Target Centermass L
- Technography R"
- Tempus Fugit
- Texas Best Grok L
- Tigerhawk
- Link Text
- Tinkerty-Tonk R
- Tom Rants RL
- Unalienable Right
- Uncommon Insanity L
- Unrepentant Individual L
- Villainous Company
- Oliver Willis
- Willisms
- The World According to Nick R
- World Wide Rant R Link Exchanges, etcetera
- But That's Just My Opinion
- Condo Buzz NYC
- Crazy Rants of Samantha Burns
- DANEgerus R
- A Dollop of Sour Cream
- Dust My Broom L
- Generic Confusion R
- Grim's Hall
- Heartless Libertarian L
- individ L
- Kesher Talk R
- Leaning Toward The Dark Side R
- Libertopia L
- Liberty Corner L
- Medary L
- Mondo QT L
- Nose On Your Face R
- Pererro R
- Pratie Place
- Random Fate R
- Ravings of John C. A. Bambanek L
- Signifying Nothing R
- The Skwib L
- Tel-Chai Nation
- TF Sterns Rantings L
- DC Thornton R
- Wake Me Up On Judgement Day R
- Windypundit L Consumer and Research Sites
- Better Business Bureau
- Consumer Reports
- NASD Home
- California Department of Real Estate
- California Licensee Lookup
- California Department of Insurance
- National Association of Insurance Commissioners (NAIC)
- Do Not Call Homepage
- IRS Charities Search
- Internet Fraud Complaint Center
- SEC Home Page
- Stop Mortgage Fraud
- Report Mortgage Fraud Debunking Many so-called Real Estate Gurus
- John T. Reed Other research
- FactCheck.org
- Babel Fish Translation
- Snopes Worthwhile Web Comics
- Sluggy Freelance
- Day by Day
- User Friendly
- Kevin and Kell It is site policy to list the main page of every site I reference. Sometimes the real world intervenes and I haven't gotten to it yet, or one falls through the cracks on a long post with multiple references. It is also site policy to list the main page of every site that lists this one on their equivalent roll, as well as the main page of all sites that are members of any of the same groups this site is a member of. Please send me an email with a link to the main page of your site if I've overlooked you (dm at the domain name). For the clue-challenged, note that it is a requirement for your link to appear on every page of your site, just like mine does, and I will not link to spam sites. Honor Roll of Sites Banned by Paranoid Repressive Governments: (be the first on your block to submit a link!)
Requests for reprint rights, contact dm (at) searchlightcrusade (dot) net! Subscribe to Searchlight Crusade
C'mon! I need to pay for this website! If you want to buy or sell Real Estate in San Diego County, or get a loan anywhere in California, contact me! I cover San Diego County in person and all of California via internet, phone, fax, and overnight mail.
**********
Contact me! dm (at) searchlight crusade (dot) net (Eliminate the spaces and change parentheticals to the symbols, of course)
Leave a comment