If you’re thinking about mortgage refinancing to take advantage of today’s best refinance rates there’s more to think about than just interest rates and fees. There is a hidden cost of refinancing that brokers rarely talk about that takes a large toll on your finances. Here are several of my best tips before you refi to help you avoid paying too much for your mortgage refi.
Mortgage Loan Amortization
If you take one thing away from this article it needs to be an understanding of mortgage loan amortization. What is home loan amortization? This is the process of paying down your home loan over time. Use a basic mortgage refinance calculator with amortization tables and you can see exactly what I’m talking about by the hidden cost of mortgage refinancing.
I’m going to use a simple example to illustrate this point. Suppose you buy your home this year for $250,000 with a five percent mortgage rate. Your monthly payment on this home loan is $1,342. During the first full year of payments you’ll pay $16,104, which is simply $1,342 x 12 months. Look at your loan amortization schedule (that chart from our mortgage payment calculator) and during the first year of payments $12,416.24 of your money is applied to interest! That goes into your lenders pocket and does nothing (zero, nada, zip, zilch) to pay down the principal balance on your home loan.
The first year of your mortgage payments you’ve only paid $3,688.41 towards the balance of your mortgage. Sure you bought the house but you’re a looooooong way from owning it. In fact, it will take 16 years of payments before more of your payment goes to paying down the balance than goes into the lender’s pocket. This is what is meant by the expression building equity in your home.
Mortgage Refinancing Resets The Clock
What happens when you mortgage refinance? You reset the clock on your payments and you’re back to year one, stuffing the lender’s pockets with your cash. This is the hidden cost of mortgage refinancing that no one talks about. Sure fees are important because that’s cash out of your pocket at closing; however, you’re taking hard-fought equity in your home and sticking it in someone else’s pocket. Use a mortgage calculator with your home loan balance and look at the amortization schedule for yourself before you decide if mortgage refinancing is a good idea.
How to Refinance Without Overpaying
It’s true that today’s best refinance rates are near a fifty-year low and pretty much everyone and their dog is on the mortgage refi bandwagon. If you’ve decide to take advantage of lower payments and don’t mind resetting the clock on your mortgage loan amortization you’ll want to pay close attention to the fees you pay at closing. The reason that fees are so important on your mortgage refinance is that you’ll have to recoup these expenses before gaining any benefit from the lower payment amount. The more you pay when closing on your refi the longer it will take to break even.
One of the more common mortgage mistakes is not negotiating origination fees and other closing costs. You can comparison shop fees and negotiate to pay less on your mortgage refi every time.
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