Remortgage – 1 Easy Action Removes 2 Costly Bad Consequences

When you remortgage, you make many decisions. Ideally all would be good. In reality, some people make bad decisions. Some don't even know they have choices, that a decision is possible.

One area where this occurs often is the terms of the remortgage loan. Typically, home owners refinance without thinking much about the terms, only about the interest rate and the monthly payments. That ends up costing them a lot, the price of a nice Porsche or even Ferrari.

There are 2 ways to remortgage. Below are both, the first one has advantages and one big, bad consequence. The second one avoids bad consequences altogether.

Scenario 1, the one most people choose:

A home owner, let's call him Jack, buys a 3-bedroom house for $250,000. He takes a $200,000 mortgage loan at 7% amortized over 30 years to do so. His closing costs are $2,000 and he rolls them into the mortgage. So he ends up owing the bank $202,000.

After 3 years, he remortgages. His new loan is amortized over 30 years, at 6%. He does not roll the closing costs into the loan, does not take cash out.

After 4 years in the new loan, he remortgages again. This time his interest rate is 5%, and the loan is amortized over 30 years, again. Again, he does not roll the closing costs into the loan, he does not take cash out.

Here's the good in what Jack did: he reduced his payments each time he remortgaged. The 2nd remortgaging has payments that are $330.62 less than the original loan. He also reduced the amount paid over the life of the loan by $26,507.40 by the time he owns his home outright. (It takes $457,299.60 to pay off the $202,000 by remortgaging the way Jack does. It would take $483,807 if he did not remortgaged at all.)

Here's the bad in what he did. It takes Jack 37 years to own his home outright.

Scenario 2, the way most people don't do though they'd benefit:

Jack could have stuck to the original amortization period. If the 2nd loan is amortized over 27 years and the 3rd over 23 (and you pay closing costs only with the original mortgage).

Here's the good in this scenario. Jack reduces the monthly payments but less ($228.95 difference between the 2nd remortgage payments and the original mortgage payments). He reduces the amount paid by $73,908.24 by the time he owns his home outright. (It takes $409,898.76. to pay off the $202,000 loan.)

So Jack reduces the monthly payments compared to not remortgaging but less than in the first scenario. However, he ends up paying $47,400.84 less over the life of the loan compared to what he has to pay in the 1st scenario AND it takes Jack 7 years less to own his home outright.

What can you do with $47,400.84?

The later you remortgage in the life of a loan, the worse off you are if your new loan is amortized over the same period as the first loan you took out. The higher the interest rates involved, the worse off you are if you remortgage doing the 1st option vs. the 2nd option. The higher the principal, the worse off you are if you remortgage without keeping an eye on the years.

So next time you remortgage, think about how badly you really need that extra $100 or $200 monthly reduction, so you don't make a bad choice.

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