I’m asked frequently when does it make sense to refinance. The answer is almost never cut and dried. There are many reasons why a refinance might make sense and just as many as it may not make sense. It really does depend on the individual person and their specific situation. But, for the sake of this article let’s talk about my approach when talking with someone.
The Long View:
If they are looking only to lower their interest rate I usually recommend a savings of 1/2% in the rate that usually makes the most sense, but even in this case, it might not make sense. It also depends on the loan amount. Here are a couple of examples:
Both examples assume the following. They are two years into a 30 year fixed mortgage, their rate is going from 3.50% to 3.00%, they have 25% equity, or 75% loan to value. We are only going to consider savings on principal and interest payments. For the sake of this demonstration, their credit score and debt to income (DTI) are not a consideration.
The first example is a property worth $400,000 and the new loan amount for a 30 year fixed mortgage would be $300,000.
Although only saving $82.32 per month over 30 years they will save $29,635.91 in payments and $29,361 in interest. Not insubstantial numbers. If they invested that $82.32 savings per month over the next 30 years in an S&P 500 fund, averaging 10% annual return, over thirty years you would have invested a total of $29,635.20 and earned $157,998.86 in interest for a final balance in 30 years of $187,634.06. Even if they don’t invest the monthly savings of $83.32 per month they will save $29,535.91 in out-of-pocket monies.
The second example is a property worth $150,000 and the new loan amount for a 30 year fixed mortgage would be $112,500.
Although only saving $30.87 per month over 30 years they will save $11,113.46 in payments and $11,010 in interest. Also, not insubstantial numbers. If they invested that $30.87 savings per month over the next 30 years in an S&P 500 fund, averaging 10% annual return, over thirty years you would have invested a total of $11,113.20 and earned $59,249.57 in interest for a final balance in 30 years of $70.362.77. Even if they don’t invest the monthly savings of $30.87 per month they will save $11,113.20 in out-of-pocket monies.
A note about the numbers. There is a slight rounding error in my two systems which accounts for a difference of under a dollar out of pocket in both scenarios over 30 years.
In summary, the math tells the story of these refinances. In almost any scenario, if you look at the long view, you end up coming out far ahead by a refinance. Obviously the greater the difference between your current rate and the new rate the more you stand to save or save and earn, over 30 years if you choose to invest. It also goes without saying that just because the S&P 500 index has an average return of 10% over the last four decades, there’s no expectation that will continue, or won’t, for that matter. Investing comes with risk. Savings, don’t.
If you’d like me to run specific numbers for you don’t hesitate to reach out at firstname.lastname@example.org or if you are ready to get your refinance started go to https://www.approvedbycharles.com/apply