Despite the roller coaster-like ups and downs the housing market has experienced over the last several years, home ownership remains the key component of the American Dream for most citizens. But even considering that we’re seeing the best mortgage rates in history right now, financing the purchase of a home is a financial obligation that can put a great deal of strain on family budgets.
However, because mortgages are such large and long-lasting debts, significantly cutting their cost can be done by making fairly minor adjustments to the loan terms. It may sound impossible, but reducing the cost of your home loan by $50,000 — or much more — doesn’t require any drastic moves at all.
Two Ways to Knock Off $50k or More in Interest from Your Mortgage
Let’s use a 30-year fixed mortgage loan of $250,000 as our example. The following are two different refinancing strategies you can use to eliminate $50,000 in mortgage debt from your life.
Scenario #1: Reduce Your Mortgage Interest Rate by 1%
Mortgage interest rates have fallen dramatically in the past few years. According to HSH.com, the average interest rate for a 30-year fixed mortgage in 2008, just off the heels of the market crash, hovered above 6%. Today, mortgage interest rates for the same term average about 3.4%.
So consider the hypothetical mortgage loan above — even if you just recently obtained financing on a home within the last year or two and agreed to a mortgage rate of 5% APR, you can now refinance to, say, 4% APR. It doesn’t seem like much, but here’s how much you would save:
Using this mortgage calculator, we find that a $250,000 loan with a 5% interest rate, paid over thirty years, equals 360 payments (12 months multiplied by 30 years) of $1,342.
This equates to spending a total of $483,120 over the life of the loan. Subtract the initial principal of $250,000, and that leaves $233,120 worth of interest paid over the 30-year loan.
Now, calculate payments again with the lower interest rate of 4%. Instead, you would make 360 payments of $1,194, or $429,840 in total. Subtract the $250,000 principal and you’re left with $179,840 in total interest paid.
You just saved $53,280 on your mortgage.
Scenario #2: Cut Your Mortgage Term Length in Half
It’s easy for home owners to get caught up in the size of their monthly mortgage payments, rather than consider the entire cost of the loan. Unfortunately, lessening monthly payments often results in greatly increasing the overall amount of money you will pay for home financing.
Consider again the above 30-year fixed mortgage with a principal loan amount of $250,000 and the 4% interest rate. If instead of opting for a 30-year term, you agree on a 15-year mortgage instead — and we’ll keep the interest rate at 4% for simplicity’s sake — you will significantly reduce the total amount of interest paid over the life of the loan.
According to the above mortgage calculator, a $250,000 loan at 4%, paid over 15 years equals a monthly payment of $1,849.
This is a much larger payment required every month, but consider this: $1,849 multiplied by 180 payments (15 years) equals a total loan cost of $332,820. Subtract the $250,000 principal and you’re left with $82,820 in total interest paid over the life of the loan.
By simply opting for a 15-year fixed rate mortgage rather than the 30-year as depicted in Scenario #1, you save $97,020 in interest. That’s almost one hundred grand to put toward other important goals like a college fund, retirement savings or investing.
Should I Refinance?
While the hypothetical savings are impressive, refinancing is not a one-size-fits-all solution to saving money on a mortgage. It’s important to consider things like closing costs and how far into your current mortgage you have already paid before changing the terms of your loan.
For instance, refinancing means ending an existing mortgage and opening a new one, whether that’s with your same lender or someone else. Closing costs must be paid to refinance a loan, just as they were to obtain the original loan. Ensure that the amount of the total closing costs doesn’t cancel out the savings you would enjoy from a decreased interest rate.
Secondly, when changing the term length of your mortgage, consider how long you’ve held the current loan. Your loan amortizes according to a schedule devised by your lender, and most amortization schedules allocate a larger percentage of monthly mortgage payments towards interest rather than principal in the initial years of the loan. As the home loan gets closer to being paid off, more of your payments go toward paying down the principal.
That means if you’ve held your current mortgage for a long time, much of the money you’ve put into it has already paid down a large portion of interest. Refinancing the loan with new terms may not be a wise move.
A mortgage will likely be the biggest financial responsibility you ever take on, so it’s important to be realistic about what you can afford. But when determining that number, don’t forget to consider the long-term costs of a home loan — especially how much interest you will pay in total — and don’t get stuck on that monthly payment figure.