Lower Interest Rates Deliver Powerful Savings

When we go through a period of lower interest rates
as we are now doing, borrowers are always looking
for the benefits that may come with refinancing.

There are several ways that you can compare
the numbers to see if the savings that you may
experience meet your goals.

Let's take a look at a couple of examples from
recent discussions with clients:

Borrower currently has a loan that started at
$535,000 at an interest rate of 5.0%. Payments
are $2,872, balance is $525,000 and the borrower
has made 16 payments.

The quotes at the time were for a new 30-year
fixed rate loan at 4.5%. The loan fee was zero
points, (one point equals 1% of the loan amount)
and transactional costs would be about $3500.

If we compare costs to interest rate savings the
recovery period is fairly short. $3500 is .667%
of the loan amount ($3500/$525,000). The
interest savings per year is .50% (5.0% - 4.5%).
So it would only take about 16 months to
break even and start saving money (.667 divided
by .50 is 1 1/3 years, i.e. 16 months).

If we make comparisons of the monthly payments
it works out like this: $2872 current payment to
$2660 new payment is $212 per month savings.
$3500 in costs divided by $212 is about 16.5
months. Once again, a fairly quick recovery of
costs.

And if you are committed to staying in the home,
comparing the costs over the remaining life of
the loans provides another measure of the
benefits of considering the refinance.

There are 344 payments remaining on the existing
loan (360 scheduled payments minus the 16 already
made). 344 payments at $2872 per month means
that you would pay $987,968 over the remainder
of the loan term.

On the new loan, you would have 360 payments
at $2660 per month for a total outgo of $957,600
over the 30 years.

So, would it be worth it to spend $3500 to save
$30,368 with a new refinance? Many borrowers
who are committed to a long-term strategy
choose to go this direction.

I had a discussion with a different borrower. He
was definitely committed to a long-term strategy
and wanted to see how much he could save by
obtaining a lower interest rate and shortening
the term of his loan from 30 years to 15 years.

His existing loan had a balance of $408,000,
interest rate of 5.0%, payments of $2238 and
had 341 installments left.

The new proposal was for $408,000 with an
interest rate of 4.25%, with a one-point loan
fee and $3500 in costs. The new 15-year
payment would be $3069 per month.

The interest rate comparison works out like
this: $7580 in fees ($4080 + $3500) is about
1.86% of the loan amount ($7580 divided by
$408,000). The interest rate difference is
.75% (5.0% minus 4.25%). It would take about
2.5 years to recover the costs with interest
savings (1.86 divided by .75). Not a particulary
great recovery period.

It would not make sense to compare monthly
payments, because we are not comparing
"apples to apples". The monthly payment
on the 15-year loan is much higher to retire
the principal balance over the shorter period
of time.

There are 341 payments remaining on the
existing loan. At $2238 per month the total
outgo will be $763,158.

On the new loan there will be 180 payments
at $3069 for a total of $552,420.

This borrower was definite in his decision.
It was very much worth $7580 to save
$210,738!

It is important to understand whether your
goals are short-term or long-term, and then
to analyze your choices from several different
approaches. More often than not, the answer
becomes fairly obvious what will work best
for you.

As always, let me know how I can help you
with exploring your options.