If you’re like many other homeowners, paying for your house at the beginning of each month can be painful. After working for weeks to earn your paycheck, it seems to be gone with a single stroke of the pen after writing out the mortgage check. Ouch!

Like many other homeowners you may wonder if there is a better way. Well, you’re in luck because an interest rate reduction refinance loan may provide you with some relief now by lowering your monthly payment, and then giving you even better relief by allowing you to pay less for your home over the life of the loan.

Here’s how it works.

Using the Power of Equity

Banks like equity. Equity is what’s left when you take the current value of your home and subtract what you owe on the house. For example: Your home is worth $250,000, you owe $200,000, that leaves $50,000 in equity or 20% of the homes value ($50,000 / $250,000). For them, the 20% of equity in your home gives them added security when making a loan. Added security (more equity) often results in favorable loan terms.

Think about when you first purchased your home. Depending on the type of loan, the bank may have required you to put down 0% – 20% of the purchase price of the home. What you put down allowed the bank to have some cushion (equity) in case you defaulted on the loan and they had to sell it in foreclosure. Typically, the more you put down, the better loan terms you can get because the bank is taking less of a risk on the money you borrow. They are more comfortable because you have more “skin” in the game and are less likely to default. Generally, the only exception to this is a VA loan, which will require no money as a down payment because the government is essentially guaranteeing the loan.

Now, fast forward to the current market. Depending on when you purchased your home, you may be seeing higher selling prices on homes similar to yours. You may also see lower advertised interest rates. This is good news! As the value of your home goes up, and the amount you owe on the home goes down, your equity increases. With more equity to work with, and lower interest rates, you may quality for a loan with a lower monthly payment.

Lower Payments, Now and Later

First, let’s cover the immediate relief an interest rate reduction refinance loan will provide. Your monthly payment is calculated from:

• Interest
• Principal Reduction (amount applied to your loan balance)
• PMI (Private Mortgage Insurance) *if your original loan balance was 80% LTV or greater
• Escrow Account/Impound (optional, for collection of taxes and insurance)

For this example, we will use the same loan amount for each scenario and assume the original loan included PMI. These numbers are estimates and for demonstration purposes only:

When the interest rate on your loan goes down, so does the payment

• Original Loan Amount: $200,000 @ 7% = $1648/month
• New Loan w/lower interest: $200,000@5% = $1390/month

That’s a savings of $258/month!

Now, let’s assume that the value of your home increased since you purchased it. When you get your refinance loan, the Loan to Value (LTV) is less that 80% and the lender no longer requires PMI because you have more equity in the home.

By using your home’s equity and eliminating the need for PMI, the payment is even lower and gives you a savings of $325/month.

What could you do with an extra $325 in your pocket every month?

Plus, when your interest rate improves, you have the potential to pay less for your home over the long term. Every month, more of your money will be applied toward the principal balance, and less toward interest.

You can see exactly how this works when you use an amortization calculator (many can be found online for free). However, don’t let that confuse use. Basically, because you are paying less in interest each month, you will pay less in interest over the life of the loan. In many cases, that savings will be substantial.

In our example:

That’s a savings of $92,506!

A Little Bit Goes a Long Way

As you can see, small adjustments in the interest rate can bring big rewards. Talk with a trusted adviser to find out if an interest rate reduction refinance loan is right for you.

If you have any additional questions about mortgages, refinancing, or buying and selling homes, please contact Brad and Kelli today!