Should you refinance your home loan?

A personal reflection of cost vs benefit analysis to refinance home loan.

Refinance?

This post is a personal reflection of all the various thought processes that were going in my mind and what kind of ways in which I looked at my options for the question - “Should you refinance?” given that the rates are so historically low.

My goal here is not to say which option you should choose, as it will be different for each person. Moreover, you will be the best person to make a choice. My intention here is to give you pointers on what aspects to look at before you come to a conclusion about refinancing.

Without further delay, let us dive right into what I found in my deep analysis and research and how I got my results.

Summary of Analysis & Outcomes

To make a decision on refinancing, we will have to look at this situation from various perspectives to determine the goods and bads. After the careful evaluation process, you can make the decision on whether to refinance or not.

The different perspectives to look at are:

In this post, we will take up an example of an existing home loan with the following features to illustrate the above perspectives.

Existing Loan - Features

Various Perspectives Deep Dive

1. Baseline total cost for existing loan vs various refinancing options under consideration

Before we can determine whether a refinance would be better or not, you should first understand the total spend that you will do should you choose to go with that option. You should also have an idea on how much you are currently going to spend should you choose to stay in your existing loan. This will give you an idea of how much is at stake and could be a compeling reason to pursue or not pursue.

When you do this calculation, care should be given to try and include all types of expenses so you have the true cost. Any cost that is common across the options can be ignored as they are anyways going to be same on both and are not particularly useful when comparing.

Here is the complete details of the various options that we plan to compare in this post for the given scenario.

Note: We haven’t take into consideration a 10 year term or Adjustable-Rate Mortgage (ARM). But if you feel like you can probably do either of these, you should take into consideration those choices as well before arriving at the decision.

Comparitive Loan Features

Key Takeaways

Based on the above table with various details, it is clear that there are bunch of this that we need to take a closer look at like

• Are you in a position to shell out an increase in EMI - $606 for 15 years or $108 for 20 years every single month. If yes, then look further into refinancing, else refinancing is not an option for you at this point in time.

If you decide to move further, then we need to look at a highlevel how much interest and other charges we might end up spending for each loan option.

• Clearly we can see from the rows highlighted above that 15 year loan is the least interm of interest payments at $107K, followed by 20 years at $162K and finally the existing loan at $216K
• Since you are paying increased EMI, it leads to more principal payments every month and therefore it reduces the outstanding principal on which the interest is calculated.
• One another way of looking at this is you are willing to make an investment of $606 every month for 15 years to save your interest charges ($216K to 107$). Similar argument holds true for 20 years scenario as well.

Now, the next question that comes to mind is, for the investment of $606 that you plan to do for next 180 months (15 years * 12 months), is this the best place to invest. Or, are they any other avenues where you can get more returns that can offset your current interest charges that you pay for the existing loan and still make you profitable.

We will do some calculations around this hypothesis with some perceived returns rate. You can tweak this rate up or down based on your risk appetite to make a more realistics situation for your needs.

In the section, we looked at the absolute numbers that we might end up paying in each loan term - 23 years, 20 years and 15 years. But these are 3 different time periods and comparing directly is not correct because of money value being not same for each time period.

So, lets as next step get the numbers for loans that you plan to compare at the end of same time period. This we are going to look at from two different perspectives.

The next two sections are going to address these two comparisons.

2. Compare the total worth of existing loan vs refinancing loan at the end of refinancing term

Lets get some basic facts out of our way.

If you had refinanced the loan, then at the end of the loan term (say 15 years)

• The house is yours!
• No outstanding principal
• You also have shelled out the increased EMI for 15 years

If you had stayed in your current loan, then at the end of the same 15 years time period

• The house is still not yours! Your equity in the house has increased but not 100%
• You still have some outstanding principal to be paid back
• You didn’t have to put any additional money for EMI for 15 years
• That implies that you could either have that money ($606 * 180 months) stashed as cash with no interest or put into some investments for higher returns
• If you had kept this money as invested in good investments, your money value is large than the absolute value of $606 * 180.

Lets now look into those finer details for getting the big picture.

The table below has lot of comparitive details between loans. But focus on the highlighted rows which is of interest to us.

Compare Current Loan vs 15 year term - At the end of 15 years

Key Takeaways

Lets focus on the last 4 rows of the table to make our inferences for this approach.

• It is clear that if you had chosen Refinance option, you would have paid those excess cash you got to keep in current loan towards principal thereby completely closing the loan.
• So that means, in the Option 1, you are able to grow that money ($112,880) to clear the a principal of$158,619
• So one thing is clear, keeping the money as CASH pile and still being on current loan doesn’t make any sense as we are actually losing money in yet to pay principal via interest charges.
• But if you were to get atleast a decent 6% return on investment for the CASH at hand, then it has compounded to more than the outstanding principal. That implies it is a better option NOT to refinance but rather be on the current loan and invest the excess money in more prudent avenues to have more yield.
• So now the question that you need to answer to chose either of the option is - Do you have confidence that you will be able to generate returns more than what you can save in interest charges in the mortgage. If yes, stay in your current loan, else refinance.

Below is a similar table if you were to compare a 20 year term with your current loan at the end of 20 years.

Again, keeping the money as just CASH is not serving any value unless your intention is not above savings but keeping them for some other purpose like emergency liquid fund or to keep you at ease knowing you have quick access to cash at anytime etc…

Compare Current Loan vs 20 year term - At the end of 20 years

3. Compare the total worth of existing loan vs refinancing loan at the end of existing term

Like before, lets get some basic facts out of our way.

If you had stayed in your current loan, then at the end of the same 23 years time period

• The house is yours! Your equity in the house has increased to 100% finally! Congratulations!
• No outstanding principal
• You didn’t have to put any additional money for EMI for 23 years
• That implies that you could either have that money ($606 * 23 years) stashed as cash with no interest or put into some investments for higher returns
• If you had kept this money as invested in good investments, your money value is large than the absolute value of $606 * 23 years * 12 months. Also include the closing cost savings. You are looking at a cash of $171,056 at hand.

If you had refinanced the loan for 15 years, then

• The house is yours for 8 years now!
• You having NO EMI to pay for the last 8 years!
• The entire EMI amount of $2,920 is a savings for you for 8 years. Which turns out to be $280,320 as cash at hand.
• If you had kept this money as invested in good investments, your money value is large than the absolute value $280,320

Lets now look into those finer details for getting the big picture.

The table below has lot of comparitive details between loans. But focus on the highlighted rows which is of interest to us.

Compare Current Loan vs 15 year term - At the end of 23 years

Key Takeaways

Lets focus on the last 4 rows of the table to make our inferences for this approach.

• It is clear that in both scenario, the house is YOURS!
• If you just stash the excess CASH without any investment for 23 years, then refinance option seems a great option.
• If you had invested in a decent investment with returns of 6% for 23 years, then the money that you were able to invest in the current loan scenario seems to have grown exponentially and is higher than what you might have been able to save in the refinance option
• The reason is the money in current loan scenario has 23 years to grow and it is sufficiently large - $606
• Whereas, though the money is vastly higher in refinance option, the number of years it could compound is only 8 years which negated its potential savings.
• The answer is clear, if you have confidence that you can grow the money at atleast 6% or more for 23 years, then staying in the current loan and making the excess money do its magic seems a great option.
• But again, what you need to watch out for is that the return rate. You can play around with this hypothetical rate based on how the banks or stock markets have returned rate in the last 30 years and also based on what you foresee in the current market.
• After doing all these, chose the option that you feel confident! Goodluck!

Below is a similar table if you were to compare a 20 year term with your current loan at the end of 23 years.

Here, the 20 years refinance seems a better choice if you are comparing at the end of 23rd year after invest. The reason being, you have very less amount invested in the current loan scenario for 23 years and though it is compounding couldn’t catch up to the huge amount getting compounded in the refinance scenario.

But again, if the return rates are different you will end up with much different outcomes. Hence the need to work out all these numbers carefully before arriving at the decision.

Compare Current Loan vs 20 year term - At the end of 23 years

4. Evaluate part payment if complete refinancing is not an option

If refinance is not an option, you can still pursue part payment to offset the interest that you pay towards your loan.

Depending on how much, how soon and how frequent you do the prepayments, the number of years outstanding and principal outstanding will change in your loan term.

This option doesn’t force you to have a dedicated extra amount to be always paid as excess EMI (if you were to refinance) or as a investment amount towards your investment option.

Its both a boon and a bane. Its boon in the sense you won’t have to worry for getting that additional money every month. Even if one month or few months you are not able to save, it is okay.

Its a bane because, you don’t have a necessity to save that money and lot of times, we excuse ourselves and justify our actions on why we spent the money rather than savings. So the perks for a religious savings regime is very less and it is based on purely our self discipline for savings and eagerness to close the loan soon.

Conclusion

I sincerely hope that this post brought you some clarity on various cost benefit analysis that you can perform for your individual needs before taking up the decision.

Personally, this analysis definitely brought me good amount of clarity onto my loan situation and helped me take a decision that I don’t regret.

See you soon with a new post. Till then, happy learning and be safe!