The main reason people refinance their home loan is to save money. But sometimes people make a crucial mistake and actually lose money.
The mistake is to refinance to a longer loan term.
Even though you might have switched to a lower rate, because your loan term has been extended, you might end up paying more over the life of your mortgage.
Imagine you decided to refinance five years into a 30-year mortgage for $500,000, and you managed to switch from a rate of 4.30 per cent to 4.00 per cent. It seems like a smart financial move, because your monthly repayments have fallen.
But if you made the mistake of refinancing to a new 30-year mortgage, instead of taking out a 25-year mortgage, you’ll actually pay more in the long run.
The numbers tell the story
If you had continued paying the old rate of 4.30 per cent for the remaining 25 years, you would’ve been charged $2,723 per month or $816,812 in total.
By paying 4.00 per cent over 30 years, your monthly repayments have fallen to $2,387, but your total repayments have risen to $859,348.
In other words, your monthly repayments have fallen by $336, but your total repayments have risen by $42,536.
The smart move would’ve been to switch from 4.30 per cent to 4.00 per cent while leaving the loan term unchanged at 25 years.
In that case, your monthly repayments would’ve fallen from $2,723 to $2,639, while your total repayments would’ve fallen from $819,812 to $791,755.