If let’s say your interest rate is 6% but you want to refinance to 4% and it costs 2% to refinance, doesn’t that just make it the same number in the end? Google says the cost of refinancing is roughly 2-6% of the full loan. I don’t get how it makes it cheaper to refinance? Just seems like you’re paying the money upfront then. Please eli5! Feel like I’m missing something.
In: Economics
Lets say you take out a $300,000 mortgage at 6%. Your monthly payment would be about $2000/month. After 5 years you’ll have paid about $120,000 on your mortgage. You’ll have paid about $70,000 in interest and paid off $50,000 of your principal. This means you still owe $250,000. If you don’t refinance the TOTAL COST of your $300,000 mortgage will be about $500,000. You’ll pay back the $300,000 you borrowed, plus another $200,000 in interest. This means at the 5 year mark you’re still going to pay another $130,000 in interest.
But lets say you refinance at that 5 year mark. You pay 2% on your principal (the $250,000) and your rate drops to 4%. That means now, instead of owing $250,000 you now owe $255,000. But because your interest rate is lower, you’ll pay less in interest over the course of the loan. You’ll only pay $65,000 in interest on the the remainder of the loan. So some quick math, it costs you $5,000 to save ($130,000-$65,000) = $65,000.
You pay a little extra right now to save *a lot* over the long run.
In this situation if you refinance at the 5 year mark, you save $65,000 on the total amount you have to pay for your house. Instead of your $300,000 house costing $500,000, it costs $435,000.
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