How much can refinancing save you? A step-by-step tutorial with mortgage calculators

Should you refinance? With money saved from your monthly payment, should you pay down your mortgage early or put it in savings account? How much money can you save in the end, anyhow? As mortgage rates continue to hover near historic lows, it's worth understanding how to use online refinance calculators and other mortgage calculators to game out different scenarios.

Here are step-by-step examples you can follow to determine your monthly savings with a refinance mortgage, and how to calculate how much money you can save over time -- including if you pay your new, lower-rate mortgage early, or if you bank the difference over the life of the loan.

In this example, we'll go through a simple rate-and-term refinance, but keep in mind there are other features you can vary when you shop for a new mortgage too.

Step 1: Gather your current mortgage terms

Throughout this article, let's assume that your current mortgage has the following terms. (For your specific situation, substitute your original and current mortgage balances, original and current mortgage rates and payments accordingly.)

  • Original loan balance of $250,000
  • Funded three years ago at 5.75 percent, 30-year fixed
  • Monthly principal and interest payment of approximately $1,460 per month

After three years (36 months) of payments, the current balance is approximately $240,000.

Step 2: Estimate the terms of a refinance mortgage

To see how much you can save, you'll need to know what current mortgage rates are and what you would qualify for now, given your property and personal financial situation. Keeping tabs on the mortgage market on websites such as this one or HSH.com can give you a good idea. Once you have a good idea that you want to refinance, you can also enter in your information to get quotes from mortgage lenders.

Let's say that you think you can get a new mortgage with these terms:

  • Mortgage rate of 4.75 percent, 30-year fixed
  • Loan cost of $2,500, which you're rolling into the loan balance of the refinance mortgage

This brings your new loan amount to $242,500 ($240,000 remaining loan balance plus the $2,500 in costs).

Step 3: Calculate savings from a new mortgage rate

Using this refinance calculator, input your original loan balance ($250,000), interest rate (5.75 percent), total length of current loan (30 years), time remaining on current loan (30 year minus 3 years since you funded = 27 years).

Next, input the new loan information: 4.75 percent rate, 30-year term, zero cash out and $2,500 in costs. In the menu options, select that the closing costs will be "rolled into the new loan."

Click "calculate," and a new screen will appear that shows your savings. On your principal and interest payment, you will save $194 per month with your new mortgage. Over the life of the loan (30 years) you will save a total of $17,296 in interest charges. Not bad.

Step 4: Calculate additional savings with lower rate and early payoff

However, it's important to realize that your savings from getting a lower mortgage rate is offset by the fact that you're extending your loan term three years beyond your current mortgage payoff date. That is, you're trading 27 remaining years on your mortgage for a new 30-year loan term. You're paying more in total interest to stretch repayment across those additional three years.

With any mortgage, if you can pay the principal off more quickly with prepayments, you'll save big on the interest payments. This means that, with the refinance above, you could actually save much more than $17,296.

How much more? We can determine this by calculating the number of years of payments (in terms of your original loan) you save by refinancing.

Let's say you take your monthly savings and plow them into your mortgage balance. You're essentially looking to continue the same payments you had been making before your refinance -- $1,460 per month -- which is more than your required monthly payment under the refinanced mortgage.

By using an early payoff calculator, you can back into your $1,460 mortgage payment by changing the estimate of early payoff. In the early payoff calculator, input the new loan balance (again, that's $242,500, which is the remaining mortgage balance of $240,000 plus transaction costs of $2,500), the new loan term of 30 years and the new mortgage rate of 4.75 percent. Input zero months for the number of payments made, since this is a new loan.

Now you're ready to play with different payoff periods. Simply start with any number less than 30; say, 20 years for the loan payoff period. Click "compute," and you'll see that your new mortgage payment would have to be $1,567.09 per month to pay off the new mortgage in 20 years. This is about $100 more than you are paying now, which means 20 years is too short a loan term to keep your existing mortgage payment the same.

Now, let's try a slightly longer loan term (which means a slightly lower monthly payment). Click "start over." Keep all of your information the same, but this time, input 22 years for payoff. Again, click "compute." You will see your new mortgage payment to pay off your refinance mortgage in 22 years is $1,482.28 per month -- which is very close to the $1,460 per month you are paying now.

What this means is this: By paying just about the same amount per month on your refinanced mortgage at 4.75 percent as you are paying on your current mortgage at 5.75 percent, you will cut about five years off your mortgage payments. (The five years is the difference between the 27 years you'd have left on your original mortgage and the 22 years to pay down your newly refinanced mortgage if you prepay each month.)

Avoiding five years' worth of payments at your current payment of $1,460 will save you $87,600. The end result is that you've saved a total of $87,600 without changing your monthly cash flow but by changing your mortgage rate through a refinance.

Step 5: Calculate even more savings by investing the difference

What if, instead of prepaying your mortgage principal with the difference in your monthly payments, you took the monthly savings and invested it?

As you remember from the results of the refinance calculator, our refinanced mortgage has a monthly payment of $1,265, which would save you $195 per month. Using the down payment savings calculator, you can calculate how much you can accumulate in a savings account or investment account by faithfully depositing your $195 monthly mortgage savings and letting the balance grow with interest. That is, every month when you make your new mortgage payment of $1,265, you also have $195 automatically deposited into your savings account or investment account -- and you don't touch the money in that account.

To calculate your savings on the savings calculator, input $195 for monthly investment, 324 months for the term (equivalent to 27 years) and 3 percent for the rate (which is an assumed average rate of return for the next 27 years). Click "compute" and you see that you will grow your savings account balance to over $97,500 if you follow this investment regime for 27 years.

Why 27 years? That is when your current mortgage is expected to be paid in full, and you're trying to compare against your baseline situation if you didn't change anything about your mortgage. By saving or investing your monthly mortgage savings, you can pay off your new mortgage yourself at the end of 27 years and still have over $55,000 left in your account.

To see how we got to this $55,000 figure, use an amortization calculator. Input your new loan information ($242,500 loan balance, 4.75 percent interest rate, 30-year repayment period) and click "compute," then "amortization chart." In the results, scroll down to the principal remaining when there are three years left on the loan, or after 324 months of payments. You'll see that the principal balance is $42,365.92. If, at that point, you had $97,500 in your bank account from investing $195 per month, you could use that to pay off the mortgage balance and still have over $55,000 left in your account.

To truly benefit from the historically low mortgage rates available to you today, combine the information you can obtain using free mortgage calculators online with some financial discipline. Instead of looking at a refinance as a financial move that might save you a couple of hundred bucks a month, look at how you can leverage today's low mortgage rates to save tens of thousands of dollars in total -- which can set you up far better for retirement, your kids' college costs or simply more financial security tomorrow.

Posted By :

Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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