Why would a bank offer refinancing at a lower interest? Is any money saved at all, or is it just paid on a different timeline?
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Best elif I can think of: Some interest is still more interest than no interest if you move to another bank.
Banks facilitate the buying and selling of mortgages. They make money from fees. Although a bank could be the counterpart, i.e. the buyer of the mortgage, they more often aren’t.
When you loan a million dollars, someone else invested that million dollars into that mortgage, expecting to get the million dollars back plus the interests.
Every time you finance and refinance, the bank makes money from the fees associated with doing it regardless of who is the counterpart in the mortgage.
Bear in mind, refinancing a loan is a lot less risky than writing a new loan. When you refi someone, you can see that they have a payment history, and they may have developed some equity. The lower rate they give you often times reflects the lower risk. A new/first time home buyer is way more risky than a refi.
Mortgages are mostly sold not kept by the bank. So the bank gets a one time payment when the new mortgage is created and no interest.
So they are happy to make a new mortgage whenever a borrower would like.
A refinanced mortgage at a lower rate usually has an upfront cost to the borrowed and a lower payment because of the lower interest rate. That generally means the borrower saves money after some payback period often around 1 to 2 years.
Basically you take out a loan to pay back another loan. If you borrowed at 5% and rates are now 3% you borrow money at 3% and pay off your 5% loan so now you have debt at a lower rate. Banks offer it because there are processing fees that they get when you take out the new loan, and now they have the lump sum of money to do other things with, like make corporate loans at much higher rates.
If you have a 30-year loan (standard in the US) and refinance into a 30-year loan, the term of the loan also resets. Amortization has you paying mostly interest in the early years of the loan and mostly principal in the late years of the loan. So every time you reset the loan, you start over paying a lot more interest than you do principal. That’s how the bank makes its money.
Hypothetically, today, you get a mortgage for $350,000 at 6% interest. With your first payment, your principal is $348 and your interest portion is $1,750. You pay on the loan for 10 years, and your principal in September 2033 is down to $290,988.73. (At that point, your payment has evolved to $633 principal and $1,464 interest.)
At the end of 2033, you decide refinance your balance on the loan to 4%. At this point, you’ve paid $59,011 in principal and $199,095 in interest on the original loan. So you restart the clock on the loan to 0, and start making your payments again. At this point, your new payment is broken out with principal is $419/mo and interest is $969/mo. So, overall, the payment is a lot more affordable ($1,388/month for P/I vs $2,098 for the original loan), but you’ve maximized in the interest portion of your payments. (Here’s the fun bit, if you can, keep paying what you were originally paying ($2,098) by paying an additional $710 per payment, and you pay your 30 year loan off in 17 years instead of 30. You only end up paying $100,120 in interest payments over the life of the loan vs $209,132 if you just pay the base payment.
But, as with all things, there are caveats. In the US, your loan payment will also include money for property taxes and property/homeowners insurance. If your down payment was <20%, you’ll probably pay private mortgage insurance until your equity gets above the 20% line. And property taxes and insurance can go up each year, so the total payment amount will typically grow a bit from year to year.
A mortgage is just a special type of loan. It’s a loan where your house is the collateral if you default. That’s it. So in most ways its a lot like other loans.
The bank would prefer that you don’t pay it off early, but it’s also not a big deal to them if you do. So if you suddenly come into some money, you can pay off all your debts.
Well what if another bank wants your business? They can offer to pay off the remainder of your mortgage and then you owe the new bank money instead of the old bank. Now the new bank is making money off your mortgage. If they offer a lower interest rate, then that’s great for you. You save more money, the new bank is making money that they weren’t before, and the old bank got their money back and can now flip it into a new mortgage. The only loser is the old bank, but even then, not a huge loss.
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