Refinancing a mortgage: when and how
Refinancing a mortgage can be worth a substantial amount, or nothing at all. It comes down to three variables and a handful of fees that are often left out of the sums. Here is how to frame the problem properly.
What makes refinancing worthwhile
Three things work together: the gap between your current rate and the rate available, the outstanding balance, and the time left to run.
The last is the least understood. In a standard repayment mortgage, interest is front-loaded: early on, a monthly payment covers mostly interest; late on, mostly principal. Refinancing near the end therefore only affects a small remainder of interest, however attractive the rate gap looks.
The costs to include
A gross saving on interest is not a net gain. Depending on the country and the contract, some or all of these apply: early repayment charges, arrangement fees on the new loan, security or guarantee fees, and sometimes discharge fees.
Those costs are paid up front, while the saving is spread over years. That mismatch is why an apparently winning refinance may only pay for itself after several years.
Estimating the real gain
The method has three steps. First, work out the total interest still owed on the current schedule. Then the total interest at the new rate, over the term being considered. The difference is the gross gain.
Now subtract all the fees. What is left is the net gain. Finally, divide those fees by the monthly saving: that gives the number of months needed to recoup them. If that period exceeds the time left on your mortgage, the operation makes no financial sense.
Watch out for extending the term
A refinance that lowers the monthly payment by stretching the term can cost more overall, even at a lower rate: you pay less each month, but for longer.
Both goals are legitimate and opposed: cut the total cost, or free up monthly cash flow. Decide which one you are after before comparing offers, otherwise you will be comparing proposals that answer different questions. Finvygo's loan simulator lets you vary the rate and the term to see the effect on total cost and on your net worth.
A refinance is judged on the net gain after fees, and on how long those fees take to recoup, never on the rate gap alone. Applicable rules and fees vary by country and by lender: get written quotes before deciding anything.
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