Can refinancing to a lower rate increase the amount of interest you pay?

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October 30, 2015 at 2:53 PM #21757

plm
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I’ve refinanced a few times so my original 15 yr loan will not be paid of until 19 years after I bought the house so that means I’m borrowing for 19 years instead. So even though I pay a lower rate, could I be paying more total interest at the end?

I will now make extra principal payments to shorten the time back to 15 years since I bought the house. Easier now since salary increases while mortgage payment stays fixed.

I think quite a few people refinance when rates go lower but do people make extra principal payments to correct the longer loan duration?

October 30, 2015 at 4:41 PM #790852

zk
Participant

Yes, if you don’t make extra or larger payments to pay off the loan in the originally scheduled time frame, you can pay more interest. Your principal and interest rate are both lower on your refi, but the overall time you’re borrowing money is longer. You’ll generally pay more interest on a longer-term loan.

The monthly payment on your refi will be less than your original loan, both because of the lower interest rate and the lower principal (the principal is lower because you’ve paid some of the principal off with your monthly payments).

If you increase your monthly payment on your refi to equal the payment on your original loan, your loan should be paid off before the original loan was scheduled to be paid off because your interest rate is lower (resulting in more principal being paid off with each payment than on the original loan).

If you increase your payment on your refi to the amount required to pay off your refi at the time the original loan was to be paid off, that monthly payment should be less than the original loan because of the lower interest rate.

None of that takes into account closing costs or points.

If you take either of those options, you should pay less in total interest than you would’ve on the original loan. If you don’t at least make some extra payments, you’ll likely pay more interest overall. Scenario:

If you borrow 100k at 5% for 15 year, your payments will be 790.79.

If you keep that loan for 15 years, you’ll pay $42,342 in interest. After 5 years, your principal will be $74557. You will have paid $22,004.73 in interest to that point. Now your loan is the same as a $74557 loan for 10 years at 5%. If you refinance that into a 15-year loan at 4.9%, now you have a $74557 loan for 15 years. Your payments will be $585.72. Your interest over the life of the refi loan will be $30871.79. You will pay an extra $10533.67
in interest ($22004.73 for the first loan,+$30871.79 on the second loan,-$42342.85 you would’ve paid if you’d kept the first loan).

Karl’s Mortgage Calculator is fantastic:
https://www.drcalculator.com/mortgage/

So, if your goal is to pay less interest, then you should consider making extra payments on your refi. If you have some other goal (smaller payments, cash out, etc), then maybe you don’t need to make extra or larger payments.

October 30, 2015 at 4:53 PM #790855

plm
Participant

My goal at the time of refi was to save money. So I should have been making extra payments. I’ll keep making extra payments to catch up to at least 15 years then my original goal would be met. Maybe I’ll even keep making extra payments pay off the loan earlier.

Thanks.

October 30, 2015 at 5:00 PM #790853

Hatfield
Participant

It’s a cool tool, but I don’t see a way for it to show what the effect of making overpayments. Here’s one in Excel that does. The units are in GBP but it doesn’t really matter. Download the spreadsheet, plug in the numbers for your current mortgage, and then try typing in various recurring overpayment amounts to see how much it will shorten the life of your loan and how much you’ll save in interest.

For example, even a meager $50 overpayment will shorten a $300k / 5% / 30y mortgage by almost two years. $250 will take about 7.5 years off.

http://daveaddey.com/?p=42

October 30, 2015 at 6:02 PM #790856

zk
Participant

[quote=Hatfield]It’s a cool tool, but I don’t see a way for it to show what the effect of making overpayments. Here’s one in Excel that does.

http://daveaddey.com/?p=42%5B/quote%5D

Ooh! Very nice.

October 30, 2015 at 6:17 PM #790857

joec
Participant

One thing to also be aware is near the end of the loan term, you start paying less/little interest (relative to early in the loan). Paying it off early at that point doesn’t help you lower your interest paid since the interest was front loaded and you already paid it.

You’re only paying off more principle with additional payments.

October 30, 2015 at 6:22 PM #790859

Coronita
Participant

The easiest way to figure this out is to figure out how much total interest you have left on your existing loan.

Then you figure out for your new loan, how much total interest you would have paid.

If you have a lot of years on your old loan, in the new loan’s interest rate is not significantly lower, you might end up paying more interest on the new loan versus the old, unless you plan on making additional principal payments during the loan period.

October 30, 2015 at 7:39 PM #790862

plm
Participant

[quote=joec]One thing to also be aware is near the end of the loan term, you start paying less/little interest (relative to early in the loan). Paying it off early at that point doesn’t help you lower your interest paid since the interest was front loaded and you already paid it.

You’re only paying off more principle with additional payments.[/quote]

That’s a good point. I had saved some money to invest in stocks but never did buy any and its getting zero interest. So it would be better for me to do a lump sum payment to get it down to 15 years then build up the money again to invest in stocks.

October 31, 2015 at 6:00 AM #790863

Anonymous
Guest

Yes, you will pay more in total interest. But it doesn’t matter.

It is important to understand is that a dollar in interest you pay fifteen years from now is not the same as a dollar you pay today.

The total dollar interest you pay on a loan is a very misleading number – in fact it is an essentially useless parameter. Today’s dollars are different from tomorrow’s dollars. That’s the whole point of debt financing, that’s why loans have a cost (interest.)

Much of conventional wisdom about the cost of mortgage payments is flawed (including some posts in this thread) because many people don’t really understand the basic concepts of finance. It’s not hard if you choose to learn it, but it’s not intuitive either.

[quote]That’s a good point. I had saved some money to invest in stocks but never did buy any and its getting zero interest. So it would be better for me to do a lump sum payment to get it down to 15 years then build up the money again to invest in stocks.[/quote]

I’m not sure I get what you are saying here, but it sounds like you are making a common mistake.

The cost of your mortgage is your interest rate. Period.

The return you get from paying off principal early is the interest rate of the loan. Period.

Don’t get confused by strategies involving paying early in the loan term vs. late in the loan term, etc. They are flawed.

October 31, 2015 at 6:47 AM #790864

no_such_reality
Participant

So what you’re saying is you can’t find a better use for money than 2.75% interest?

October 31, 2015 at 7:42 AM #790865

zk
Participant

[quote=no_such_reality]So what you’re saying is you can’t find a better use for money than 2.75% interest?[/quote]

Right now, anything that pays more than 2.75% (or 1.5%, for that matter) involves some level of risk. The only risk of not borrowing at 2.75% (and not investing in something else) is that you might make more doing something else with the money. Of course, in an attempt to make more, you might lose some of your principal.

So, if somebody has very low risk tolerance, paying down your loan early to save interest (or borrowing less in the first place rather than borrowing more and investing some of it) might be a reasonable plan.

NSR, do you have other ideas for “better use” for money for those with very low risk tolerance?

October 31, 2015 at 8:03 AM #790866

Coronita
Participant

For me i paid down most of my 15year 2.5% loan simply because i didnt think i could finf something stsble above 2.5%. I was thinking of paying the last $98k off early of my 15 year that will be done in 2019. But I am looking at the remaining interest left, which is about $4000 total. That comes out to be at 1.31% apr…So where can I find a 1.5% or higher return that is guaranteed over the next 3 years? Laddered CD?

October 31, 2015 at 8:19 AM #790868

no_such_reality
Participant

If you’re that risk averse, paying off may be best, hence the nothing better question. I totally get it, besides, a paid off primary is often a core step to financial independence and being able to say stuff the rat race.

That said, depending on their tax brackets, risk tolerance, being very conservative, structure a tax exempt Cali muni bond holding and use proceeds to pay off the loan at a future date. Maybe try and pick up some LA DWP bonds at 5% yield or SLO water bonds at the same rate.

A lot depends on their tax situation, if the mortgage write off doesn’t apply or they don’t have wage/ short term income to shelter, there is no tax advantage o carrying it.

October 31, 2015 at 8:47 AM #790869

Hobie
Participant

[quote=harvey]Don’t get confused by strategies involving paying early in the loan term vs. late in the loan term, etc. They are flawed.[/quote]

I’d like it if you expand on this.

October 31, 2015 at 9:27 AM #790870

no_such_reality
Participant

[quote=Hobie][quote=harvey]Don’t get confused by strategies involving paying early in the loan term vs. late in the loan term, etc. They are flawed.[/quote]

I’d like it if you expand on this.[/quote]

As he pointed out earlier, it has to do with a dollar today is not the same as a dollar 15 years from now. The issue is the total interest paid and the strategies don’t reflect that and use nominal dollars. A nominal dollar is just a dollar is a dollar.

To understand the flaw with that you need to consider inflation over the long term.

To see it, pretend you actually took your loan out in 2000. You could have done strategies then to pay off the loan early or late or something else. But to understand the flaw you need inflation. It’s tame now and was then too but back then gas was cheap. Beef was cheap. Homes were cheap. How cheap? Well gas in October 2000 was $1.82 a gallon. Today after falling precipitously from recent highs is just under $3 a gallon. Beef in 2000 had experienced a run up, ground beef was $1.70 a lb, today the usda reported average is $4.12/lb. and you know the story on home prices.

So that $50 back then would have bought 27 gallons of gas and today would buy 16 gallons. Similar with beef, the $50 prepaid would have bought 30 pounds of ground beef today will probably buy about 12 pounds
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