Will lower interest rate save you money?

By John Adams

For the AJC

With long-term interest rates still well below 5 percent, many homeowners are considering refinancing.

The benefits seem obvious: Locking in at lower payments is always a good deal, right?

Well, maybe.

Because your monthly loan payment is a function of rate and amount borrowed, it would seem an easy analysis. But many folks overlook the important part that your loan term will likely play in the equation.

For example, let's assume your current loan is at a fixed rate of 6 percent, and your balance is $100,000, and your payments are just short of $925. If you refinance today at 4.25 percent on a new 30-year loan, your payments drop dramatically to only $492 per month. You must be saving money, right?

Not necessarily.

A closer look reveals that your existing loan pays out in 13 years, and over that time your actual interest expense will be $44,235. In contrast, even though your new loan is at a lower interest rate, you have extended your term from 13 years to 30 years. As a result, you will be paying interest for 17 additional years. That's a total interest expense of more than $77,000.

The easy way to compare apples to apples is to first calculate your monthly interest savings, then take term into consideration.

With your existing loan, your next month interest expense is $100,000 times 6 percent divided by 12. That equals $500. The remainder of your principal-and-interest payment is principal in the amount of $425.

Under your proposed refinance loan, your next month interest expense drops to about $354, giving you a monthly interest savings of $146.

That is your actual real savings under the new loan. If you wish to pay the loan off in the original remaining term of 13 years, you would need to add another $482 of principal, giving you an apples to apples comparison of $925 to $835, or a real savings of about $90 per month.

To make things more complicated, the interest savings of about $90 will decrease slightly as the principal portion of the payment grows and the interest portion declines.

As you can see, there are many factors to consider when thinking about a refinance loan. Yes, the interest rate is the most important part of the product, but the term of the loan will have a direct impact on the total interest expense you will pay, and must be taken into consideration. For an expanded discussion of this topic, visit money99.com.

As always, I recommend that you discuss your options with your accountant, and select the loan program best suited to your needs.

Next week, we will examine the impact of closing costs and discount points in the refinance equation.

John Adams is an author, broadcaster and investor. He answers real estate questions on radio station WGKA (920am) every Saturday at noon. For more information or to comment, visit www.money99.com.