When I re-fi home, what happens to the interest I paid up till now?

[aboose]

I'm a new home owner. I bought early 2024, so I've been making interest-heavy mortgage payments monthly since then.

My rate was around 6.5%, so I am watching rates and if it drops to around 5.5%, I am considering refinancing.

I am good at financial modeling and can model out a loan amortization, so I feel I can make a smart decision about the cost to refi versus monthly payments and total interest paid over the life of the loan.

However, I have never refi'd before and feel I still have blind sports.

The thing I am stuck on now is the payments I've already made. Let's say I've paid $10k in interest. If I were to re-fi today, this would reset my loan amortization. I see talking heads online saying "you just lost all your payments as you reset the amortization on your loan." This surely seems oversimplified but I can't figure out myself how to explain this.

For those of you who refi'd, can you walk me through your thought process particularly on the above? I am certain people smarter than me have come up with a mathematical explanation for when it is viable to re-fi.

[jebmke]

The paid interest will be reported by the lender on a 1098 for you to deduct on Schedule A.

[barnaclebob]

Interest is simply paying rent on the money you have borrowed. You "lose" any interest you pay the second you pay it just like any other way you spend money. Only Principle is retained by you. For tax purposes, all interest you've paid will be tracked on your 1098 forms.

So when you refi, you are now renting money under new terms and often times those new terms extend the loan back out to 30 years but at a reduced payment. If you were to keep paying the same amount as before you'll pay the loan off faster.

Typically I recommend refi when the break even time is around 18 months.

[bloom2708]

If you paid $2k in principle and $10k in interest, then your new refi loan should be for $2k less than your original loan.

If you borrowed $300k, paid down $2k principle and $10k interest and re-borrow $300k, then you are back to a full 30 year amortization at the lower interest rate.

If you borrow $298k at a lower interest rate, your payments will be lower.

[aboose]

Thanks guys. That makes sense. To me, it seems like interest paid is simply lost. That intuitively makes sense. So if I'm thinking about it right, it's not useful to think about that money. Rather, I'd do the amortization calc of the old loan and new loan, look at the total interest to be paid in the lifetime of the loan, and compare. Would it make sense to add the interest I've already paid to the new loan interest, since that is already out of my pocket?

I'm sure there must be a better way to think about the math. For an extreme example, in my way of thinking if you had a loan at 6.5% interest rate, you could calculate that your lifetime interest might be 1 million dollars. After 10 years of servicing mortgage payments, due to amortization you likely would pay around 400K in interest and only 50K or so in principal. If at this time you refinanced, even if your rate went down significantly, you'd basically be forfeiting 400 thousand dollars... for nothing. but I feel this must be wrong, because people refinance their homes at 10 years+. That's what I'm getting confused about.

I'm not emotionally attached to the interest I've paid till now. But I have heard that refi math is "simple" as mentioned by you guys above, which is simply "when do payments cover the refinance closing costs" and wondering how the interest paid doesn't factor in at all to that.

[jebmke]

it isn't lost any more than it would have been "lost" had you not refinanced. Refinancing is looking forward. What you paid so far was based on the deal you made at the time you took out the original mortgage. Unless you have a time machine, you can't go back and renegotiate that deal any more than you can go back and invest in stocks in 2009 when they were rock bottom pricing.

[aboose]

Total agree on that part. Am making up numbers here for a thought experiment:

Original loan interest: 1.1M total lifetime. Paid 400K in 10 years, 700K to go.
New loan interest: 700K total lifetime, reset the amort so 700K to go. Also pay closing costs to refi.

Wouldn't refinancing to the new loan actually be worse, even if the monthly payment is significantly lower? Is the argument that you refi, but still put the same money toward your mortgage so that it pays off faster to make up for this?

[barnaclebob]

Thanks guys. That makes sense. To me, it seems like interest paid is simply lost. That intuitively makes sense. So if I'm thinking about it right, it's not useful to think about that money. Rather, I'd do the amortization calc of the old loan and new loan, look at the total interest to be paid in the lifetime of the loan, and compare. Would it make sense to add the interest I've already paid to the new loan interest, since that is already out of my pocket?

I'm sure there must be a better way to think about the math. For an extreme example, in my way of thinking if you had a loan at 6.5% interest rate, you could calculate that your lifetime interest might be 1 million dollars. After 10 years of servicing mortgage payments, due to amortization you likely would pay around 400K in interest and only 50K or so in principal. If at this time you refinanced, even if your rate went down significantly, you'd basically be forfeiting 400 thousand dollars... for nothing. but I feel this must be wrong, because people refinance their homes at 10 years+. That's what I'm getting confused about.

I'm not emotionally attached to the interest I've paid till now. But I have heard that refi math is "simple" as mentioned by you guys above, which is simply "when do payments cover the refinance closing costs" and wondering how the interest paid doesn't factor in at all to that.

You have the right idea comparing the amortization tables. What I do to compare the break even time is to see how long the interest savings (not total payment savings) takes to payback the costs (do not include prepaid interest and escrow) of the loan unless its a no cost refi and then it doesn't really matter.

Again, interest is "forfeited" as soon as its paid, nothing to do when the loan is refi'ed. Its a sunk cost that has no bearing on your refi. And its not for nothing, interest as a concept is paying for access to money you don't have.

[aboose]

Thanks, I think I get it now. The flaw in my thinking was the compare the lifetime interest of the two loans. What I should do is compare the REMAINING interest to be paid of the original loan to the new loan. What was already paid is in the past and is irrelevant now, but if the new loan has lower lifetime interest than the remaining interest of original loan, I'll still come out ahead, theoretically. That makes sense. Thank you all.

[barnaclebob]

Total agree on that part. Am making up numbers here for a thought experiment:

Original loan interest: 1.1M total lifetime. Paid 400K in 10 years, 700K to go.
New loan interest: 700K total lifetime, reset the amort so 700K to go. Also pay closing costs to refi.

Wouldn't refinancing to the new loan actually be worse, even if the monthly payment is significantly lower? Is the argument that you refi, but still put the same money toward your mortgage so that it pays off faster to make up for this?

Its not necessarily worse because you'd presumably be saving the money not spent on the mortgage or putting it in as an extra principle payment. Your total interest paid may go up because the total length to repay the money got longer. Run your calcs as follows to get a better idea of how the refi saves you money:

Current payment $3000/month with 20 years left. Total interest remaining is ???
Refi payment is $2500/month with 30 years left. But add $500 in extra principle each month. Now whats the total interest and payoff date?

[Hyperchicken]

If you rented apartment A for a year or two, and then move to apartment B, then what happens to rent you paid for A?

Answer: nothing happens to it. You lived in A and you paid rent for A.

To me, it seems like interest paid is simply lost.

Would you consider your rent you paid for A in the years that you lived there "lost" as well?

[one_speed]

The other factor is the life of the loan.

If you have been paying a 30 year loan for 3 years, you'd have 27 years left of paying principle + interest.

When you refinance, most companies may not give you a new 27 year loan, you may have to choose from standard options such at 15 years, 30 years. So you might have more years of payments, but at a lower rate. Considering time value of money can still a good deal, but that would be one more factor to consider.

[aboose]

I'll summarize my findings and you guys let me know if you disagree.

Most common advice on refinancing says "refinance when rates drop x% (1%, 2%, etc)" and "refinance when you breakeven". These are simplifications of the following two properties:

1) When you refinance, you will have X amount of remaining interest to pay on your loan, regardless of what you've paid up till now. If your new loan's interest is less than X, refinancing will save you money. This is actual money saved long term.

2) When you refinance, you will pay Y amount of closing cost. Your new loan will have monthly payments that should be lower than before, so Y will come back to you as a proportion of how much lower your monthly payment is than before. This is primarily about cash flow. Sometimes if you see "0 cost refinance" its basically the lender taking away issue #2 at the cost of making your true $ benefit in #1 worse (via worse interest rate or higher loan size).

#1 is the true money saver, #2 is a rule of thumb for the fact that you have incurred a cost to do the transaction.

[Hyperchicken]

The way you framed it, neither #1 nor #2 make sense to me.

[LittleMaggieMae]

I'll summarize my findings and you guys let me know if you disagree.

Most common advice on refinancing says "refinance when rates drop x% (1%, 2%, etc)" and "refinance when you breakeven". These are simplifications of the following two properties:

1) When you refinance, you will have X amount of remaining interest to pay on your loan, regardless of what you've paid up till now. If your new loan's interest is less than X, refinancing will save you money. This is actual money saved long term.

2) When you refinance, you will pay Y amount of closing cost. Your new loan will have monthly payments that should be lower than before, so Y will come back to you as a proportion of how much lower your monthly payment is than before. This is primarily about cash flow. Sometimes if you see "0 cost refinance" its basically the lender taking away issue #2 at the cost of making your true $ benefit in #1 worse (via worse interest rate or higher loan size).

#1 is the true money saver, #2 is a rule of thumb for the fact that you have incurred a cost to do the transaction.

#1 may also incur closing fees/charges just like option 2 - you are closing out an old mortgage and creating a new one.

Are you confusing recasting your mortgage with refinancing your mortgage? Not every lender allows recasting.

[exodusNH]

I'll summarize my findings and you guys let me know if you disagree.

Most common advice on refinancing says "refinance when rates drop x% (1%, 2%, etc)" and "refinance when you breakeven". These are simplifications of the following two properties:

1) When you refinance, you will have X amount of remaining interest to pay on your loan, regardless of what you've paid up till now. If your new loan's interest is less than X, refinancing will save you money. This is actual money saved long term.

2) When you refinance, you will pay Y amount of closing cost. Your new loan will have monthly payments that should be lower than before, so Y will come back to you as a proportion of how much lower your monthly payment is than before. This is primarily about cash flow. Sometimes if you see "0 cost refinance" its basically the lender taking away issue #2 at the cost of making your true $ benefit in #1 worse (via worse interest rate or higher loan size).

#1 is the true money saver, #2 is a rule of thumb for the fact that you have incurred a cost to do the transaction.

Sometimes $0 cost is really $0.

You need to factor whatever the refi costs are into your break even duration. E.g., if you save $100/mo in interest, but closing costs are $1,000, it'll take you 10 months to break even. After that, you're better off than before.

If you sell in month 9, you've wasted money.

When I refied from 3-4% percent (I forget the exact rate) to 2.625%, I had a 6 or 7 year break even period because my loan balance is so low. As I have no intention of moving, it was worth it.

Of course, I wish I had done a cash-out refi in Jan 2022 instead of just a straight refi!

[aboose]

Sorry, wasn't trying to say that #1 and #2 are separate. They're the two levers that occur when you refinance and both occur in the same process. They are just the two factors one person might look at when deciding if its worth refinancing, mathematically.

Based on my understanding, the real value of refinancing is that you could reduce your interest paid (the difference of interest to go on original loan and total interest on new loan). That's #1. The other part is that you will have to pay a fee to do this, which is the refi cost, which can be clawed back as long as you wait long enough as your monthly payments will be lower, so #2.

I get why you guys are confused about my question though. Mathematically, if you refinance it doesn't matter if the loan term restarts or not. If the rate is lower, you will pay less interest in the loan lifetime regardless of how much you've paid or how long you've been making payments, because the principal has been being paid down as well, albeit slowly at the beginning of the loan. So there is no mathematical situation where the rate has gone down and you will somehow end up paying more total interest if you refi. Hence why people focus on the breakeven period. I think...

[BlizzardPearl]

I had done such an analysis when I refi’ed in 2011, about 4.5 years into a 30-yr mortgage. Rate was dropped from 5.7% to 4%. Same length, 30 years.

I created both amortization tables in Excel and total up the past interest paid, new interest yet to pay, and closing cost. The new loan amount was the current balance rounded to the nearest $100 (so I paid closing cost out of pocket). The only way the refi resulted in a lower total cost was to continue to pay the same monthly amount, meaning to prepaid the principal a little bit with every payment. Otherwise, due to the amortization reset, the total interest went up quite a few pennies.

Having said that, a refi decision relies on other factors as well:

1. When in the life of the loan is the refi? Early, like 3-4 years in, probably makes sense. Later, maybe not if lifetime interest paid is of concern, unless you plan to continue the same payment for a reduced total cost.

2. Are you refi-ing for cash flow even if total cost is higher?

3. Do you expect to sell before the end of the loan so the total cost can be truncated?

If you’re somewhat familiar with EXCEL, I’d encourage you to run the amortization tables and see for yourself.

[BlizzardPearl]

If the rate is lower, you will pay less interest in the loan lifetime regardless of how much you've paid or how long you've been making payments, because the principal has been being paid down as well, albeit slowly at the beginning of the loan. So there is no mathematical situation where the rate has gone down and you will somehow end up paying more total interest if you refi.

I don’t believe that’s true. You can run your own amortization tables and see. There is a cross over month in terms of months into the first loan, then even if you refi into a lower rate, the total interest (accumulated interest paid from the first loan + all interest yet to paid for the refi loan) would be higher than the total interest of just the first loan. If the refi rate is sufficiently lower, however, your statement would be correct.

[Dottie57]

If you rented apartment A for a year or two, and then move to apartment B, then what happens to rent you paid for A?

Answer: nothing happens to it. You lived in A and you paid rent for A.

To me, it seems like interest paid is simply lost.

Would you consider your rent you paid for A in the years that you lived there "lost" as well?

I see what you are saying. But interest on a mortgage is more “rent” on the money that was borrowed. As payments are made and loan is paid back, interest becomes less and principal becomes more of each payment made.

[Hyperchicken]

I see what you are saying. But interest on a mortgage is more “rent” on the money that was borrowed. As payments are made and loan is paid back, interest becomes less and principal becomes more of each payment made.

That is exactly what interest is.

[aboose]

I had done such an analysis when I refi’ed in 2011, about 4.5 years into a 30-yr mortgage. Rate was dropped from 5.7% to 4%. Same length, 30 years.

I created both amortization tables in Excel and total up the past interest paid, new interest yet to pay, and closing cost. The new loan amount was the current balance rounded to the nearest $100 (so I paid closing cost out of pocket). The only way the refi resulted in a lower total cost was to continue to pay the same monthly amount, meaning to prepaid the principal a little bit with every payment. Otherwise, due to the amortization reset, the total interest went up quite a few pennies.

Having said that, a refi decision relies on other factors as well:

1. When in the life of the loan is the refi? Early, like 3-4 years in, probably makes sense. Later, maybe not if lifetime interest paid is of concern, unless you plan to continue the same payment for a reduced total cost.

2. Are you refi-ing for cash flow even if total cost is higher?

3. Do you expect to sell before the end of the loan so the total cost can be truncated?

If you’re somewhat familiar with EXCEL, I’d encourage you to run the amortization tables and see for yourself.

If the rate is lower, you will pay less interest in the loan lifetime regardless of how much you've paid or how long you've been making payments, because the principal has been being paid down as well, albeit slowly at the beginning of the loan. So there is no mathematical situation where the rate has gone down and you will somehow end up paying more total interest if you refi.

I don’t believe that’s true. You can run your own amortization tables and see. There is a cross over month in terms of months into the first loan, then even if you refi into a lower rate, the total interest (accumulated interest paid from the first loan + all interest yet to paid for the refi loan) would be higher than the total interest of just the first loan. If the refi rate is sufficiently lower, however, your statement would be correct.

Thanks both, this is very helpful. It's exactly the question I was trying to get answered -- is there a chance refi can actually put you in a worse spot, depending on the circumstances. I will make sure to model out scenarios. For what it is worth, I'm fairly sure if I refi'd now I would be vastly advantaged, but it was more of a thought/finance math experiment for me.

[cleopold73]

I had done such an analysis when I refi’ed in 2011, about 4.5 years into a 30-yr mortgage. Rate was dropped from 5.7% to 4%. Same length, 30 years.

I created both amortization tables in Excel and total up the past interest paid, new interest yet to pay, and closing cost. The new loan amount was the current balance rounded to the nearest $100 (so I paid closing cost out of pocket). The only way the refi resulted in a lower total cost was to continue to pay the same monthly amount, meaning to prepaid the principal a little bit with every payment. Otherwise, due to the amortization reset, the total interest went up quite a few pennies.

Having said that, a refi decision relies on other factors as well:

1. When in the life of the loan is the refi? Early, like 3-4 years in, probably makes sense. Later, maybe not if lifetime interest paid is of concern, unless you plan to continue the same payment for a reduced total cost.

2. Are you refi-ing for cash flow even if total cost is higher?

3. Do you expect to sell before the end of the loan so the total cost can be truncated?

If you’re somewhat familiar with EXCEL, I’d encourage you to run the amortization tables and see for yourself.

If the rate is lower, you will pay less interest in the loan lifetime regardless of how much you've paid or how long you've been making payments, because the principal has been being paid down as well, albeit slowly at the beginning of the loan. So there is no mathematical situation where the rate has gone down and you will somehow end up paying more total interest if you refi.

I don’t believe that’s true. You can run your own amortization tables and see. There is a cross over month in terms of months into the first loan, then even if you refi into a lower rate, the total interest (accumulated interest paid from the first loan + all interest yet to paid for the refi loan) would be higher than the total interest of just the first loan. If the refi rate is sufficiently lower, however, your statement would be correct.

Thanks both, this is very helpful. It's exactly the question I was trying to get answered -- is there a chance refi can actually put you in a worse spot, depending on the circumstances. I will make sure to model out scenarios. For what it is worth, I'm fairly sure if I refi'd now I would be vastly advantaged, but it was more of a thought/finance math experiment for me.

Yea to see how you can get to a worse spot, we can consider an absurd example. Say you had a single month left in your original loan, and suddenly decided to refinance that last remaining payment into a new 30 year amortization, you would almost certainly pay more in interest than you would just making that last payment on your original loan even if the new loan was at a vastly lower rate. But your new payments for the next 30 years would be a tiny fraction of that original loan's last payment.

[toast0]

I don't know if this is really going to help, but I just need to voice an objection to adding up the interest payments made at different times and using that to compare two options. $1000 Oct 1, 2024 isn't the same as $1000 Oct 1, 2025. If you want to compare the interest paid in two different series of payments, you really need to assume a reasonable risk free rate of return, and use that to compare the present value of those payments.

If you don't want to do rigorous financial calculations, that's fine too. In that case, I'd set up comparisons on two a/b scenarios and compare things that are simpler than present value. In either one, you'll need to determine the closing costs of the refi.

Scenario 1 A: pay the estimated closing costs on your current mortgage, and determine when your payments would end
Scenario 1 B: refinance, but keep paying the current payment, and determine when your payments would end

In this scenario, the difference in dates tells you how far in time your refi puts you ahead if you don't change your payment.

Scenario 2 A: just keep paying your current mortgage payment
Scenario 2 B: refinance, but figure out how much the payment would be if you pay enough extra every month that your payments still end at the same time as your current mortgage term.

In this scenario, the difference in payment amount tells you how many dollars per payment your refi puts you ahead if you don't change your term --- you can divide the closing costs by the difference in dollars and get a number of months until the refi breaks even, assuming 0% interest rate; although again you should really use a present value with reasonable rate of return.

Once you've figured these out, you then have a different choice of if you want to pay the current payment, the payment calculated in scenario 2, or a lower payment and extend your term. But you've figured out if and how much your refi puts you ahead, if you carry the loan for that long. Once you're here, it's really a question of if you must pay X, and could pay Y, can you get a better return putting Y - X into something safe or paying your mortgage, and that might vary month to month.

Where you lose in a refi is if the closing costs are too high, or if the payoff date is many years in the future and you sell the home before you've broken even on the costs, in which case you would have been better off not re-financing. You can make the same analysis if you do multi refis, but in either case, you can't go back in time and not do the refi you did, so if it was a good idea at the time you did it, it's fine. If your chosen threshold for break even is 18 months, and rates drop 3 months after your last refi so that a new refi breaks even in 18 months, you should do a new refi even though your old one hasn't broken even yet; you're still lowering your payments compared to the last one; again you'd have been better off without the first refi, but you can't go back in time and not do it.

[avalpert1]

There is a massive misunderstanding being presented here - most of the answers are misguided.

Ignore amortization tables that come with the loans - they are irrelevant to comparing refinancing. Likewise ignore any interest already paid, its gone and irrelevant, and ignore 'lifetime interest' its confusing you.

Interest accrues monthly on whatever the outstanding balance amount is. The term of the loan is the maximum term, not the term you have to borrow the money for - if you pay more principal than is due your term will be shorter.

The only things that matter with a refinance is the interest rate and the costs to refinance. If there are no costs, there is no situation in which you won't be better off refinancing to a lower rate - it does not matter if you have another 29 years on the current mortgage or 1 - if you choose to pay the same in principal you will have lower interest expense. You could of course decide to borrow the money for longer with a new mortgage - but that is your choice and thus shouldn't negatively influence the refinance decision.
If there is a cost to the refinance than you have to determine how long it will take for the interest savings to cover the costs.

[corpgator]

By the way, you shouldn't wait until rates hit 5.5%. Refi now and keep refinancing every time you save money. Check out the refi mega thread for how to do no cost refis.

[AZDiamondbacks23]

By the way, you shouldn't wait until rates hit 5.5%. Refi now and keep refinancing every time you save money. Check out the refi mega thread for how to do no cost refis.

Was coming to say the same thing. I’m a mortgage broker (full disclosure), but unless you believe this is the bottom and rates won’t go further, do a no cost refinance, take the savings and then you still have the flexibility to refinance 6+ months later. If rates go up, you’ve already locked in your savings. If rates go down, then you refi again. Most go back to a 30 year and they can throw that savings back at the mortgage and pay it off faster, or you can take a shorter term, match your current payment, and then again pay off your mortgage early.

Some lenders raise the loan balance (and you can if you don’t want to come in with any $), but most of the time, I match up the payoff (what it takes to pay off the loan) with the new loan amount.

[CaptainT]

There is something in economics called "sunk cost" it refers to money/effort/time that has already been spent and you have no way to get it back so should ignore for future calculations. Your interest is sunk cost.
Ignore your previous interest paid
Compair
Mortage 1 =current mortgage interest rate ect pay off date
Mortgage 2= Best 30 year mortgage you can get including all fees and costs of refi and pay off date

If you were buying the home again which would you choose? Pick that one.

I refinance 3 times
6.8% 30 year start
about year 6moved to 20 year 5.2%
about year 10 moved to 15 year 3.8%
about year 12 moved to 2.5% 10 year. So each time I lowered rate and lowered time left andeither kept same or lowered payment(I do not expect to in 7 years left ever refi again. Will have paid my home off in 22 years)

[lazydavid]

I see what you are saying. But interest on a mortgage is more “rent” on the money that was borrowed. As payments are made and loan is paid back, interest becomes less and principal becomes more of each payment made.

That is exactly what interest is.

Yep. It is best to think of mortgage interest as a monthly expense. Every month, a portion of your mortgage payment is comprised of the expense (based on the interest rate) that the bank is charging you to continue borrowing the remaining principal balance after last month's payment. The rest of the payment reduces your principal (and therefore your future interest).

So if your interest rate is 6.0% (just to make the math easy) and your loan balance after your September 1 payment was $296,000, then the interest you owe on October 1 is $1480 (296,000 x 0.5%). This will be true no matter the duration of your loan, or how many payments you've made. The only factors in this month's total interest is the periodic interest rate (annual rate / number of periods) and last month's balance.

Then if your total mortgage payment is $2500, your October 1 payment will also reduce your balance by $1020. So on November 1, your interest portion will be $1474.90 (294,980 x 0.5%), and your principal balance will be reduced by $1025.10. Your new principal balance is $293,954.90.

[CAsage]

One mistake that can be made with refinancing well into a mortgage, is to reset the purchase loan term. For example, if you have a 30 year loan, and you refinance in the first couple years for a lower rate, people generally get another 30 year loan. Ok, fair, they only market these in certain durations, but if possible - continue to pay it off a the higher original payment, so that you will actually enjoy that lower interest and retire the loan sooner. If you refinance after 10 years, try a 20-year new loan, so that you have a lower rate and the same original term (payments will still be lower due to lower interest rate).
Basically, when you consider refinancing, the only calculation is current loan balance, current vs new interest rates. You know the current payment term. One can juggle the new term by either choosing a shorter loan (and 10~15 year mortgages are often lower rates) or paying extra principal.