By Jeff Brown
Homeowners are in a refinancing stampede, eager to lock in today’s dirt-cheap interest rates. But in the rush to slash monthly payments by hundreds of dollars, are they cheating themselves for the long term?
That can happen if the homeowner replaces an older mortgage with a new one for 30 years. In exchange for the lower monthly payment, the borrower commits to more years of interest charges.
To avoid that, follow a simple rule of thumb: Pick a new loan that won’t take any longer to pay off than the old one
Today you can get a 30-year fixed-rate mortgage charging a miniscule 5 percent, while a 15-year loan goes for 4.7 percent, according to the BankingMyWay.com survey.
Imagine you used a new 30-year loan to replace a 30-year mortgage taken out 10 years ago at 7 percent, once the average rate. If the original loan was for $200,000, you’d be paying $1,331 a month, and you’d still owe nearly $172,000 in principal, according to the BankingMyWay.com Refinance Interest Savings calculator.
Pay that remaining debt with a new 30-year loan for 5 percent, and monthly payments would fall to $921, saving $410 a month.
If you kept the old loan, you’d pay nearly $148,000 in interest over the next 20 years. But with the new one, you’d actually pay more, $160,000 over 30 years -- adding that 10 years can really hurt.
Instead, suppose you replaced the old loan with a 15-year loan for $172,000, charging 4.7 percent. The new payment would be $1,331 a month, the same as your old payment.
But on the 15-year loan you’d pay just $68,000 in interest over the next 15 years, compared to $160,000 with the new 30-year loan.
The shorter term, on top of the slightly lower rate, makes the 15-year loan the hands-down winner.
Of course, you may not plan to keep your home for 15, 20 or 30 years, so what if you were to sell in 10 years?
With the original loan, your remaining principal would be $114,600 after another 10 years. Take out the new 30-year loan and you’d still owe $139,600 at that time. With the 15-year mortgage, you’d owe just $71,000 after 10 years.
Over the next 10 years, you’d pay $102,600 in interest on the original loan, $78,500 for the new 30-year one and just $59,000 on the 15-year deal. Interest charges are lower on the 15-year deal mainly because principal is paid off so much faster.
Bottom line: Refinancing with the 15-year deal instead of the 30-year one leaves you more than $87,000 wealthier after 10 years, when you count both interest savings and reduced principal.
With each loan, you pay off principal at a different rate. You can find these numbers by clicking the “View Report” button on the Refinancing calculator.
Use the BankingMyWay.com shopping tool to find the best mortgage deal. And, be sure to look at local banks and credit unions in addition to big national firms like Wells Fargo (Stock Quote: WFC) JPMorgan Chase (Stock Quote: JPM) and Bank of America (Stock Quote: BAC).
—For more ways to save, spend, invest and borrow, visit MainStreet.com.