Is loan refinancing a scam? Can someone tell me if I have this right?

[NNN0LHI]

Last year I was getting ready to pay off a note on a 2004 Taurus we bought new and which had a balance of about 5 grand. Before I did I totaled up the payments still owed and compared that total against the payoff and there was only about a hundred and fifty dollar difference. In other words I had already paid thousands of dollars in interest during the first few years of the loan and there basically wasn't any interest left to pay. So I figured for that I will keep my chunk of money and give it back to them a little bit at a time.

I noticed the same phenomena on my fixed-rate house note. I can pay that off for 27 thousand now but if I keep making the regular payment for another five years I would only pay an extra 17 hundred dollars in interest. Again the bank already got the big interest money during the first years of the loan. Didn't they? So again I will keep my 27 grand and give it to them little at a time.

So by refinancing wouldn't that just start over the big interest process? Be like paying interest on the same money over and over again. Several times. It is a scam isn't it?

Can someone tell me if I have this right?

Don

[MercutioATC]

1. All commercial loans front-load the interest.

It has nothing to do with refinancing per se, all loans do it.

Your first payment on a new house is something like 70% interest/30% principle. That ratio reverses slowly as you get further into the payment schedule. If you refinance that house, you're starting over with a new loan, so the interest they're charging you is front-loaded again.

(on edit) Refinancing can do three things:

1) You can refinance at a lower interest rate, lowering monthly payments and the total interest paid.

2) You can pull cash out of a loan.

3) You can refinance for a longer term, lowering the monthly payments to free up cash but increasing the total amount of interest paid.

[NNN0LHI]

4. Wasn't always that way. I can remember when some loans had early payoff penalties

No such thing any more because they get their "early payoff penalty" at the beginning now.

Thats the way it appears to me.

Don

[yellowdogintexas]

17. some loans still do mostly the loans with very low interest that adjusts. In other

words, the loans that caused the current debacle in the first place.

If a loan opens with a 3% for 3 years then adjust to whatever the index is lined to in 3 years then there is a prepayment penalty if the loan is refinanced or paid off in full in the initial 3 year period. Some states require that the prepayment penalty is waived if the house is sold to an unrelated third party.


One of the things that the recent 'homesaving' mortgage rescues did was allow the adjustable loan to be reset to a fixed rate w/o refi costs and prepayment penalties

[slackmaster]

2. My philosophy is to refinance with a shorter term, if at all

I refinanced my house in 2003 with a 15-year, fixed rate loan.

The loan I paid off had about 21 years remaining on a 30-year term.

So I ended up shortening the time until I have the house paid off by about 11 years, with a savings of around $100K in interest payments.

The only downside, if you can call it one, is that the first payment on a 15-year mortgage is only about half interest, whereas the first payment on a 30-year loan is all interest (meaning less of a tax deduction).

It's not a scam, but you as a consumer need to be acutely aware of all of the consequences of refinancing. All relevant terms of the loan have to be disclosed, but it's up to you to understand how a loan would affect your personal financial situation. Nobody is obligated to explain that to you.

[aspergris]

3. Amortization

It's called amortizing.

And there is a reason that works that way.

In the beginning of a loan you are paying a greater %age of the payment towards interest and a lower amount of principal, and as time goes on the situation moves towards greater and greater principal and smaller and smaller interest.

example

http://www.bankrate.com/brm/auto-loan-calculator.asp?unroundedPayment=198.01198540349438&loanAmount=10000.00&nrOfYears=5.00&nrOfMonths=60&interestRate=7.00&startMonth=6&startDay=7&startYear=2008&monthlyPayment=198.01&showAmort=Show%2FRecalculate+Amortization+Table&monthlyAdditional=0&yearlyAdditional=0&yearlyAdditionalMonth=6&oneAdditional=0&oneAdditionalMonth=6&oneAdditionalYear=2008&paidOffDate=Jul+7%2C+2013

that's a calculator you can use.

It has to do with the future cost of money vs. the present, the price of risk, and amortizing both risk and price over time.

Yes, by refinancing, you "reset" the amortization table. So, whether it is worthwhile depends on the future VALUE of your money vs today (inflation, increased or decreased earnings, AND what return you can expect to get on your investments, etc.)

So, in brief, it depends.

certainly, people who only pay attention to the PAYMENT amount (not the principal paid off) and constantly refinance are morons and are yet another example of those causing their own financial distress in this housing market.

[NNN0LHI]

5. That is only partly correct

Because there is no way in hell I could get a secured loan for 27 thousand dollars over 5 years and only pay 17 hundred dollars worth of interest on that note. No one could. Amortize that once and see what the interest rate is.

See what I mean?

Don

[aspergris]

7. well yes

but you have already paid metric assloads to the bank in interest.

think "sunk costs".

again, there is no one answer. it depends, as others have also said.

generally speaking, you should have a very good reason for refinancing.

[KharmaTrain]

6. It Also Depends On Your Tax Bracket

The others hit on the major points...most loans are front-loaded and you'll pay off the interest before you hit the principal. For some this isn't a bad deal as that interest can be deducted from taxes and help offset capital gains. In many cases, you won't start seriously hitting into principal in a 30-year fixed until nearly the 18 year point, thus re-fing late into the loan seems to be a lot of money squandered. Once one can no longer deduct the interest, then it makes more sense to buy the property outright.

Also, remember, re-fing means a new round of fees and all sorts of other charges...a big reason people are advised not to refinance unless you see a significant (8 to 5 points for example) drop in the rate...and as another poster suggested to go with a shorter loan rather than starting from absolute scratch.

Cheers...

[dysfunctional press]

8. we refinanced a 30-year loan 2 years in for a lower rate and a shorter term...

and at the same time we took out an extra 40k.

so no- refinancing isn't a "scam".

btw- didn't they teach you about how mortgage interest works in high school economics?

[NNN0LHI]

9. But the first 2 years of payments you made were mostly interest

Where does that go? Into the wind?

Don

[bullimiami]

10. jesus its not rocket science.

you pay interest on whatever your outstanding balance is.

every month you pay enough in principle so that it will be paid off in the specified time.
thats amortization.

you pay less in interest every month because you have less outstanding loan every month.
its not a scam or front loading or any sort of trick.

you might pay points up front, thats front loading, but the finance charges are what they are ... your outstanding balance * your finance rate.

for a house you add that to your principle each month plus your escrow for taxes and insurance, and maybe PMI (which is a scam imo) and you get your payment.

[NNN0LHI]

12. Then how can I only owe 17 hundred dollars of interest on 27 grand over the next 5 years?

Amortize that and tell me what the interest rate is.

The loans original fixed interest rate is 5 and 3/4 percent.

Don

[SoCalDem]

18. Because home loans are set to pay off interest-only

or near that, in the beginning, and after they have gotten the bulk of their interest, you finally start whittling away att he principal.. You could get a new loan for the pay-off amount, and start over, with just that amount financed, but why do that? Once the tax write off of interest goes away, why not just pay the house off, and have no mortgage payment at all..and the security of a paid-off house :) Sounds like heaven about now:)

[yellowdogintexas]

19. because the proportion of your payments is mostly now going to principal

and you have equity in this item.

[Telly Savalas]

23. You can't at the interest rate you cited.

At 5.75% interest, steady payments of about $520/month will pay off $27K in 60 months.

In the first of these months, that $27K accrues about $130 in interest -- roughly speaking about 1/12 of the 5.75% of the amount owed (the precise amount depends on how the interest compounds for your loan). So that first payment of of $520 takes care of that $130 interest, and the remaining $390 is subtracted from the $27K in principal you owe, so after 1 month you owe only $26,610. Thus in month two, that $26,610 accrues interest which is a little bit less than the $130 you paid the month before, so more of your $520 payment goes towards paying down the principal.

And this process kind of snowballs.

Two years down the road, you'll only owe about $17K, so the monthly interest on that amount runs about $80, and thus $440 of your monthly payment goes towards paying down the principal.

At 5.75% interest on $27K over 60 months, you ought to be paying in the ballpark of $4K in interest, not $1,700.

[NNN0LHI]

24. I was paying over 2 grand a year interest on this loan until very recently

Right now the P/O is 27,452 and the Principal balance is 29,179 with a a difference of about $1700.

So I must have paid most of the interest on this loan in the previous years is all I can think of.

Don

[tkmorris]

21. Sorry friend, but you have that wrong.

Interest on a loan of the sort the OP is talking about (and just about any other) IS in fact front loaded. In particular your statement "you pay less in interest every month because you have less outstanding loan every month." is a perfect example of where everyone gets it wrong. People assume that is how it works intuitively, but it isn't. You see, the issue is what portion of each payment you make goes towards reducing principal, and what goes towards interest. Early on in a loan each payment goes primarily towards the interest. Not for that month, but the interest over the whole life of the loan. Late in the payment schedule most of the interest has already been paid and your payment primarily reduces principal. A proper explanation really demands charts and graphs, or at least someone more cogent than I to describe it.

[NNN0LHI]

25. I assumed (incorrectly as you point out) that is how it works intuitively

Took me 53 years to figure out I had it wrong all along.

I am glad I did.

Don

[dysfunctional press]

14. that's just how it works.

that's what you pay for the sake of being granted a mortgage.

but by refinancing the loan to a shorter term with a lower rate, and by making one extra payment per year, we'll pay off the loan sooner, and ultimately pay less in interest than had we stayed with the 30-year loan.

[SoCalDem]

16. It's how the financial industry builds those big shiny buildings..

:)

The deductibility of home loan interest, is a prime reason why so many people do "consolidation loans".. They turned unsecured credit card debt into 30-yr secured mortgage debt (at best) or A.R.M. mortgage debt (at worst)..and then many of them just ran up the card debt again, and kept doing re-fis:(

The lender always sets the terms..the borrowers either agree to it, or walk away..More and more people these days are high-risk, and have to swallow some pretty awful terms for a temporary "fix"..

The modern-day banking/lending industry is little more than Dope Dealers, Inc..and their "customers" are eager junkies , with outstretched hands, saying "may we have some more, sir?"

[DebJ]

11. lots of people don't get high school economics. I just talked to

two kids today that I'm working with over the summer, and the only economics they got was a week of it that their high school history teachers decided to do, outside of the curriculum, for the sake of the students.

[leftofthedial]

13. all of capitalism is a scam

the top of the food chain feeds off of everyone and everything below. If you believe you are more ruthless and venal than the wealthiest families in the world, go for it. Otherwise, capitalism is a sucker's game. The house always wins.

[Lex]

15. What was your original loan amount, interest rate, and term?

nt

[MasonJar]

20. Quite simply the answer to your question is "yes."

[lonestarnot]

22. Buying cars on time sucks ass!