Chances are that your house payment makes up a big chunk of your monthly expenses. If you find yourself looking for a little extra cash flow each month, one of the solutions is to refinance your home. You could save anywhere between $100 and $500 per month, depending on your current interest rate, your new interest rate, and other factors.
How Refinancing Reduces Your Monthly Payment
Refinancing reduces your monthly mortgage payment by reducing your interest rate and, usually, extending your loan term. Often, when you refinance, you replace your current mortgage with a new mortgage — one that has a 30-year term.
You don’t have to extend your loan term to refinance, though. You can still save money if you just keep your current loan term but get a lower interest rate. If you only have 20 years left on your mortgage, you might not want to get a 30-year term. You can ask your lender to refinance you to a 20-year term with a lower interest rate and still save money.
If your original mortgage has a 30-year term and a remaining balance of $169,206.52. The rate is 6.5%, and you have 20 years left. Your current monthly payment is $1,264.14. Here are the possible simple refinancing scenarios, assuming a 4.5% mortgage rate (doesn’t include closing costs and other fees):
- You refinance to a lower rate, but choose a 20-year term instead of extending your term out to 30 years. Your new monthly payment is $1,070.48.
- Not only do you refinance to a lower rate, but you also choose a 30-year term. The new payment is $857.34.
As you can see, in the first scenario, you save $193.66 per month, just by refinancing to a lower interest rate. If you choose a 30-year term, you end up saving $406.80 per month. That’s a big difference to your monthly budget.
Cash Flow Now vs. Long-Term Savings
When refinancing, you need to balance your desire for better cash flow now with long-term savings over time. You will pay thousands more in interest over the life of your loan if you refinance to a 30-year term instead of a 20-year term. (Although you will likely save in interest over your original loan no matter what.)
Another consideration is what you will pay in fees. All loans come with origination fees, closing costs, and other expenses. Some mortgage lenders offer loans without these costs, but chances are that you will need to pay something to make the refinance happen. You might pay between $500 and $3,000 in loan costs — or more — depending on the terms of the refinance.
As part of your decision to refinance, it makes sense to consider how long it will take to recuperate the cost. If you save right around $200 per month with your lower mortgage payment, and you pay $2,000 in loan fees, it will take 10 months of savings for you to make up for the cost. If you plan on remaining in your home for at least that period of time, you can break even.
The longer you stay in your home after a refinance, the better off you are in terms of recovering the costs. If you have a 30-year refinance, staying longer also gives you a chance to build more equity, since a longer loan means that you build equity at a slower rate.
Carefully consider your current and future financial needs before you decide to refinance. You can improve your cash flow now (think what you could do with the extra money!), but you have to be willing to make the tradeoffs in overall cost for the future.