The Value of a Mortgage Refinance

Corey —  June 17, 2010 — 5 Comments

       This is a guest post from the people at Lender 411.

       The largest investment many of us will ever make is the purchase of a home. Many people purchase this “product” at least once during their lifetime. This “product”, however, is often so expensive that only a small fraction of potential buyers can actually afford to buy it in full at any given time. Few future homeowners have $300,000 in cash in their hands. Most of us will likely earn far more money than this over our lifetime, but we don’t have access to it all at once. In the meantime, we need a place to live.

       A mortgage helps solve this problem. Banks, with access to large sums of money, agree to give you the $300,000 you need right now at a price. This price is what we call interest, and you may have heard it said that “interest is the price of money”. This is true in one sense, but in reality what you’re paying for is time. Remember, you will undoubtedly earn far more than $300,000 over the course of your career. The interest, the “price” that the bank charges you, is not buying you the actual $300,000 itself. You will eventually earn that either way. What you get is time. The bank gives you $300,000 and time, often 30 years or so, in which to earn this money. You ultimately give the bank $300,000 back plus the price of the time.

       Different banks charge different rates for their time, and of course, the amount of time you’re buying will differ from bank to bank as well and will depend on your personal situation. But at the core, this is how mortgages work.

       What’s the value of a mortgage refinance? Simply put, a refinance allows you to repurchase the time that you’ve bought from your bank at a different interest rate, one that is lower and more favorable to you. You can also extend the life of your loan, buying you additional time at this decreased rate. A refinance, then, is like purchasing additional time at a lower price. If you can find or arrange such a deal, a mortgage refinance can be immensely valuable.

       There’s the logic behind it. As you consider whether this financial step would benefit you, remember one thing. Time is a commodity. You can buy it from any financial institution. Educate yourself and learn what your options are. Find the lowest mortgage rates that are available to you, because the lowest rate will get you the best price on the time that you’ve purchased.




5 responses to The Value of a Mortgage Refinance

  1. I am disappointed to see this ad on this site. Sure, refinance can be great but there is one glaring omission-your debt has now been extended! If I am 10 years into a 30-year mortgage at 7% and refinance at 4.5%, I just reduced my principle payment and extended my loan! Plus, there is hundres (or thousands) in fees that could be used to pay down principle. It’s sad, people keep moving and refinancing and then find themselves 40 years into home “ownership” with 20 years left on their mortgage. I do not see how being a slave to debt for an extended time is assumed to be “immensely valuable” Waiting until I have a larger down payment and getting a 15-year mortgage is far more valuable. That way, my money can work for me instead of for the bank.

    Other than this post, this is a great site! Great content.

  2. Thanks for sharing your concerns, Kevin. I understand where you’re coming from and what you’re saying. However, I would still say that refinancing can be valuable despite extending the loan period and the closing costs.

    Just because you refinance doesn’t mean you have to live with the extended loan period. You have two options when you go to refinance. You can take a shorter loan period than what you had before OR you can pay more than the required payment so you pay off the new mortgage early. I know many people refinance just to lower their payment so they’ll have more to spend elsewhere. That’s almost always a foolish move and I wouldn’t recommend it. However, if you can go from a 7% rate to a 4.5% rate and use a shorter term mortgage or focus on paying it off early, I’d tell you to go for it. That’s a smart move.

    When it comes to closing costs, all you need to do is focus on your payback period. Take the closing costs and divide by your monthly savings from refinancing. If you’ll keep the mortgage for at least that many months, then there’s no problem with the closing costs. However, I’d also recommend you do everything you can to negotiate the lowest closing costs possible.

    Again, I agree that what you’re saying would be a bad way to handle your debt. But just because something can be used in a dumb way doesn’t mean it can’t be useful for those who are wise.

    And thanks for the compliment at the end. I’m glad you’ve enjoyed the site so far!

  3. Kevin, I had another though more directly related to your comment and this article. There are times when it can be useful for someone to refinance at a lower rate using another mortgage with the same term as their old one. If you’re in a tough financial situation and have cut costs in all possible areas, refinancing can be one way to lock in a lower rate and payment on your mortgage. Then, once you’re back on your feet, you can focus on paying off your debt early if that’s your goal.

    Again, I’m not saying that it’s good to do this without a plan in place. But it can be valuable in certain cases (but it’s rare that such a thing is used wisely).

  4. Good thoughts, Paul. You are right, there are situations where it makes sense.

  5. Thanks, Kevin. Please know that generally I’d agree with you. People tend to abuse their ability to refinance a mortgage and end up making things worse for themselves. But we shouldn’t dismiss a viable strategy/option just because it can be abused. Debt can be used well or used poorly. Money in general can be used for good or evil. Those facts don’t make debt or money inherently evil – it’s what we do with debt or money that matters most. Thanks again for taking the time to share your thoughts!

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