April 07, 2009

This Isn't Rocket Science

My wife and I have recently been contemplating whether or not we should refinance our home to a lower interest rate. As we have researched the advantages and disadvantages of refinancing, we stumbled across some “exciting math” that could save individuals large sums of money. I understand that most people may already know how this happens; however, I believe most individuals simply don’t take full advantage of the opportunity. Let’s take a look at a common scenario.

Given:

Purchase Price: $150,000
Term: 30-year fixed
Rate: 5%
Cash On-hand: $5,000
Loan Amount: $145,000

Let’s say the above mentioned criterion describes your current situation. That being said, you would have a monthly principle and interest payment of around $780. However, over the life of the loan you will pay approximately $135,000 in interest. That is a large amount of money going to someone else besides you. But assume that you are a bit more aggressive and pay an extra $50 per month on your loan. What would this do? Could you scrape together another $50 every month? If so, you will save over $20,000 in interest over the life of the loan and cut almost four years off the term. Those are definite savings!

Some will say: “Big deal, I am not even going to be in my house that long.” Well that’s just fine, but say you still pay the extra $50 per month anyway; what would that do for you when you go to sell your home in say 10 years? Well, first you will most likely be able to sell your home for about $180,000 based off a yearly average appreciation rate of 2%. If you sold it at that price you will see gross proceeds in the amount of $70,000 versus $62,000. Still you may say: “big deal, what is $8,000.” Based off of your proceeds and a 20% down payment this could be the difference between moving into a $290,000 home versus a $250,000 home. In short, your $6,000 investment over ten years could buy you $40,000 worth of more home. In short, by putting more money towards the principle, you build your equity quicker. This isn’t rocket science just common sense and self discipline.

Posted By: Brian Morris