Calculating the Net Benefit of a Refinance
Calculating the net benefit of refinancing can be a challenging task if you do not understand what to calculate. We are going to focus on the net benefits of refinancing from the standpoint of lowering your interest rate and the corresponding payment. Although there are several reasons to refinance, lowering your mortgage rate to save on interest payments over the term of the loan is the most popular. Calculating the actual savings can be tricky, unless you know the difference between the cash flow savings and interest savings. If your refinance objective is to only save on the interest by lowering your rate, then the interest savings should be done with the calculations below:
Calculating Interest Savings:
(Loan Amount x Interest Rate) / Months in year = Interest paid per month
($200,000 x 6%) / 12 = $1,000.00
*Remember to do the calculation in the parentheses first*
We now know that you are paying $1,000.00 per month in interest. You should take the new interest rate you are getting with your refinance and calculate what your new interest payment will be:
($200,000 x 5% or .05) / 12 = $833.34
Now we need to find out the difference between the two interest rates.
Current Interest Payment - Proposed Interest Payment = Interest Savings
$1,000.00 - $833.34 = $166.66
Now you have figured out that by dropping your interest rate 1% on $200,000, you will be saving $166.66 per month or about $2,000.00 per year.
Net Benefit Formula (Break Even):
(Closing Costs - Escrows) / Interest Savings = Month of Break Even
($6,000.00 - $1,000.00) / $166.66 = 30 Months
In other words, it will take 30 months for you to recoup the cost of your refinance. If you plan to keep your mortgage for a least 30 months, then you should consider refinancing with Uwharrie Bank.
Okay, now we can calculate your net benefit for refinancing with one more calculation.
(Monthly Savings x Months you plan to keep mortgage) - (Closing Costs - Escrows) = Net Savings
($166.66 x 120 Months) - ($6,000.00 - $1,000.00) = $14,999.20
If you kept the mortgage for 120 months (10 years) you would save $15,000.00.
Calculating the net benefits of a refinance is crucial in determining if it is worth our effort to refinance.
Frequently Asked Questions:
Q: I heard that I should only refinance if I drop my interest rate by at least 1%, is that true?
A: No, that is not true. Depending on your loan amount and the prevailing interest rates, it is often worth refinancing when you can drop your rate by 1/2%. Every mortgage is different and it only takes one call to Uwharrie Bank Mortgage to figure this out.
Q: Why can't I just compare my current payment to the proposed payment and figure out my net benefit?
A: You could just compare the two payments if you wanted to find out your cash flow savings, but the current and proposed loans may have two different amortizations. Let's say you have a 15 year mortgage currently and you are comparing to a 30 year mortgage. If everything is the same (interest rate, loan amount, etc.) except for the amortization your interest savings per month would be $0, but you are going to show a cash flow saving because of the longer amortization.
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