Calculate How a Refinance Will Work

Know Whether you should Refinance or Not

a close up of a mortgage refinance loan application
••• Courtney Keating/E+/Getty Images

Before you refinance, it’s important to understand what you’ll get out of it and what it’ll cost you. Most online calculators only tell you your breakeven period -- how long it will take to recoup any closing costs required to refinance. That may be helpful, but you really need a better understanding of how interest costs will be affected if you refinance. To see how refinancing truly affects your finances, follow the steps below. You’ll learn everything you need to know about your existing loan and the potential replacement.

Calculate Your Original Loan

Yes, you already know what your monthly payment is, and how much you still owe. However, you also need to know how much of each payment goes towards your interest cost, and how much of it actually repays the money you borrowed. To figure this out, you’ll need an amortization table, which you can get from a variety of sources. I prefer to use Excel to calculate amortization, but you can also use an online calculator or any other spreadsheet software.

For this description, I’ll explain how to calculate your refinancing options using Excel, but the process is the same if you use’s amortization calculator or another program (it is best to use a spreadsheet, as the numbers will be more accurate). We’ll assume the following as we work through an example:

  • Original loan amount: $180,000
  • Original loan date: 7/1/2003
  • Today’s date: 7/1/2012
  • Interest rate on the loan: 5.4%
  • Loan term: 30 years

To get the details of your original loan, enter them into your chosen amortization calculator. If possible, enter the actual month and year that you originally borrowed money. Use your original loan amount -- not the amount that you currently owe.

Figure out Where You Stand

Take note of where you stand with your current loan. Scroll down to today’s date, and see how much you still owe on the loan. In our example, it’s $152,160.64 (your numbers may vary due to rounding depending on the software you use and how precise it is).

Calculate the Replacement Loan

Figure out what your new loan would look like if you refinance. For this example, we’ll assume the following:

  • Loan amount: $152,160.64 (copied from above)
  • Loan start date: 7/1/12
  • Interest rate on new loan: 4.25%
  • Loan term: 30 years

You’ll notice that your monthly payment will drop to $748.54 if you refinance (vs $1,010.76 for the original loan). This is appealing, but it should not come as a surprise, since your new loan is smaller and it comes with a lower interest rate. Saving on the monthly payment may be important to you, but it’s just one of several important factors.

Make Some Assumptions About How Long You’ll Keep the Loan

Unfortunately, there’s rarely a clear cut answer when you’re deciding whether or not to refinance. You have to decide what you think will happen and make your decision based on your assumptions. So, try to estimate how long you’ll keep the new loan. Will you stay in the same house for the next 7 years? Will you stay there for the full 30 years? It’s okay if you don’t know -- you can do several “what-if” analyses.

Look at Interest Costs

Now you can look under the hood and see what happens if you refinance. Figure out how much you’ll spend on interest with the old loan and the new loan. Go to each amortization table and tally up the total amount in the ‘Interest’ column. Start with today’s date, and continue on down until you think you’ll get rid of the loan (7 years, or when it’s paid off, or whatever you choose).

This is easiest if you calculated each loan with a spreadsheet, or if you can copy and paste your amortization table into a spreadshee. See an example of how to do it here, or use the SUM function in OpenOffice, Google Docs, or Excel. In our example, there are some interesting differences:

  • If you keep the existing loan until it’s paid off, you’ll spend $103,236 in interest from today until 2033
  • If you refinance and keep the loan until it’s paid off, you’ll spend $117,313 in interest from today until 2042

Is it worth roughly $14,000 over the next 30 years to get the lower monthly payment? Maybe it is and maybe it isn’t. But what if you’ll only keep the loan (or stay in the home) for 10 years?

  • If you keep the existing loan, you’ll spend $69,565 in interest between now and July of 2022
  • If you refinance, you’ll spend $58,545 in interest between now and July of 2022

In that case, refinancing looks more attractive. Not only do you get the benefit of a lower payment, you also save on interest costs (because you’re not going to keep paying interest for the full 30 years).

Figure out a Way to Deal With Any Closing Costs

When you refinance, you may have to pay closing costs. You’ll also have to take these costs into account as you decide what to do. You might consider the opportunity cost of using those funds: could you have earned interest on that money? If so, is it still worth it to spend the money on closing costs?

You can also consider the traditional refinancing breakeven formula: how long will it take you to recoup the money you spend, assuming your monthly payment decreases (divide the monthly savings by your total closing costs to figure out how many months this will take). Will you stay in the house long enough to recover those costs? Whatever you do, make sure you don’t ignore closing costs because they are an important piece of the puzzle.

If you financed the closing costs or had them 'wrapped into' the new loan (or if you got a loan with no closing costs) you may not need to do anything additional -- the costs are already accounted for in your larger loan balance or higher interest rate.