Today we are publishing the first article from a new local contributor, Byron Pits. Byron is the Retail City Executive for Branch Banking and Trust in the Blue Ridge Region.
If you are like me, you have been approached several times during the past year by a financial institution suggesting that you refinance your mortgage. Turn on the television or pick-up a newspaper and financial analysts and news articles are hailing the lowest mortgage rates in years. So, is it really worth the cost and hassle to complete the process? I wish the answer was either yes or no, but as life has taught us these questions are never that simple. So let’s explore some of our options!
The first step is contemplating your reason for refinancing. I believe most borrowers refinance for several different reasons. The first is to lower their interest rate and therefore save money. This can easily be accomplished, but it could be detrimental as well. If you have paid 10 years on a 30-year mortgage and you decide to refinance the loan, you now need to settle on a term. You can refinance it for another 30 years and lower your payments, but you will be adding an additional 10 years to your loan and could be paying more interest because of the longer term. I advise borrowers to either keep the same term, in this case a 20 year note, or decrease the term; depending on the new interest rate, your payment may actually remain same. In this case, you not only pay off the loan sooner, but you will decrease the amount of interest you pay as well. So, the option is yoursâ€¦.lower your payment and/or decrease the term. Personally, I would prefer to be mortgage free in a shorter period of time.
I learn best by examples, so let’s use a scenario to illustrate the benefits. Alpheus Branch purchased his cottage 5 years ago with an original loan amount of $175,000.00 with monthly principle and interest payments of $1,106.12 and an interest rate of 6.5%. Today the balance on the loan is roughly $162,600.00. For the sake of argument we’ll say the market rate for a 20-, 25-, and 30-year loan is 5.25%, and the 15-year rate is 4.49%.
If Alpheus settles the 30 year note, he would be losing the 5 years previously paid on the loan but he would be lowering his monthly payment about $210 and saving another $2,500 of interest over the life of the loan…not bad!
If Alpheus could decide to go with the 25-year loan and basically just lower his interest rate by keeping the loan term constant. In this example, he would lower his monthly payment $133 and save $33,450 of overall interest. I’d say that should grab your attention!
After some thought and discussion with his spouse, Alpheus considers the 20-year term. In this case, his payment will basically remain unchanged, but he will pay your loan off 5 years earlier and save about $62,800 in interest. Amazed yet?
Alpheus is starting to feel ambitious and gallantly opts for the 15 year loan. His payment would increase $140 per month, but his loan will payoff 10 years earlier and he will save $102,000 in interest. I bet you are thinking now!
I hope this sheds some light on the value of refinancing. It is easy to complete this analysis with the large interest rate spread from the previous example. The savings you realize will decrease as the difference between the new and old rate shrink. With a larger loan amount, a smaller interest rate spread can still reap benefits. I hope this was helpful in navigating this quandary. For additional questions, or a benefits analysis, talk with your local banker.
About Byron Pitts: Byron works for BB&T in Berryville as the Retail City Executive of Clarke County. He spent his childhood in Gainesville Virginia before moving to the Shenandoah Valley in 2000. He is a graduate of Shenandoah University with a degree in Business Administration with concentrations in accounting and marketing. He is also currently pursuing a Master’s degree in International Commerce and Policy at George Mason University.