The Myth of Refinace Savings

It is very exciting to many people that interest rates dropped below 5 percent for the first time in a few years. IF people have enough equity in their home many are rushing to see if they qualify to get in on this window of opportunity to refinance. Let's get a few points out in the open so people can make an educated decision and determine if this well worn path is the best road to travel.

Let's take a hypothetical $200,000 mortgage at a current interest rate of 5.875%. Jane and Joe Plumber have had this loan for 4 years. They pay $1183.08 in principal and interest on this mortgage. When they got the loan they contracted according to the Truth in Lending Disclosure Statement they signed to pay $425,904 over the next 30 years in total payments on that $200,000.

But hey, things are great here in 2009 and today they can get a 4.875% interest rate. They get a Good Faith Estimate and are pleased that they live in a state where with just 1 origination point and closing costs that they will roll into the loan (doesn't everybody?) the grand total only comes to an additional $4,000. Since they have made payments of for 48 months (56,787.84) they are now paying a whopping 256.53 of the 1183.08 payment toward principal. Their $200,000 original balance is now down to $188,996.

They have spent $56,787.84 (to the lender) and only $11,004 has gone toward reducing the principal and building equity for them. Who is getting the better deal here?

But let's roll the $4000 onto the loan and round the new loan amount to $192,000. Let's ignore the fact it took them 35 ½ months of making that $1183.08 payment month after month to get down to a $192,000 balance (41,999 dollars spent). With a new 30 year loan of $192,000 at 4.875% their new payment will be $1016.08 which a savings of $167 a month. Sounds good, right?

This is a habit we are comfortable with. A savings of $167 a month is worth it in many homeowners minds. It is costing nothing really, at least not out of pocket, except for maybe a $400 appraisal fee.

Let's look at some facts. They can't recoup the $56,787.84 they already paid on the last loan. Though their payment is $167 lower than the last one they are adding 48 additional payments of $1016.08 = $48,771.84.

The new TIL disclosure now shows the new total of payments they are contracting to at $388,652.77 rather than the original $425,904 for a savings of $37,251.23. $56,787 has already been spent and now they are committing to pay an additional $48,771.84 to save $37,251.23. Who loses?

I know this is what we are used to doing but would someone please show me where there was any real savings? Am I alone in seeing this as great for the banks to make money and a scam on the consumer? Quite an expensive proposition as I see it.

And we all know that the 4.875% rate is only 4.875 IF they keep that same loan for the full 30 year term, right? If they only keep it 3-5 years (again the habit) the true interest rate is much, much higher. Just don't get me started.

Yes, there is a way to break this cycle. Yes, it takes a paradym shift in the the way we look at loans but if there is a better way, when would you want to know about it? Visit www.dynamicpayoff.com for more information or contact me at bonnie@dynamicpayoff.com