Is there an advantage to refinancing?

Hello all,
Just a general question. Not something I am thinking of doing but something that has always left me curious.

Everyone is probably familiar that the ratio of principal to interest inside your monthly mortgage payments is weighed more towards interest at the beginning of the loan, and you don't really start to pay down your principal until later in your loan life.

Someone once mentioned to me that around the 7-10 year mark the bank may call and offer to reduce your monthly repayments. The vehicle to do this is refinancing over another 30 years, where they will generously wave the refinancing fee's. Effectively rolling you back into the zone of mainly interest payments and never really paying down your debt. I'm not sure how much this would save you on an average loan but let's say $300/month.

So my question would be...
What if you took up this offer, or approached the bank to refinance but you continued to pay the $300 saving back into your loan as a principal payment?

The extra principal repayments would reduce the life of the loan and how much interest you paid over that period. But would it be an advantage? disadvantage? or neutral?
My gut reaction was originally "neutral at best" but I've not done any math's and I reckon if I did I would miss something. I was wondering if anyone had thought of this scenario, if it's a done thing or a known trap?

Let me know what your thoughts are.
RC

 

The advantage to refinancing would be cash flow as repayments would reduce and likely a better interest rate as over time the rate would no doubt have increased.

The disadvantage as you pointed out is an extension of your loan meaning more overall interest paid.

If you simply paid the same amount into the loan though then you would reduce the interest over the life of the loan and unless I'm missing something be in a neutral position.
The benefit here from refinancing is that should something happen and you were unable to pay the extra $300 you don't have to.

That said why not just use an offset account and get the benefit of reducing the interest paid daily OR better still pay your loan as interest only and have an offset attached.

 

Periodically you should refresh all loans back to 30 years whenever possible.

You can then keep paying the same you were, but you have the option to lower payments if needed. You may need or want to when:
a) retire
b) cash flow is tight
c) you redraw to invest
etc

 

The advantage really depends on what your trying to do and your longer term goals.

For example:

If the aim is to pay down debt as fast as possible and clear the debt, increasing the loan term back up doesn't really assist you with that aim. There may be a marginal rate fall associated with refinancing, but you may be able to do this with your current lender.

In regards to your point, the overall interest burden will theoretically increase if you bump up the loan term to 30 years, but if your going to be making additional loan repayments in an accelerated manner (e.g. the same repayments as having a 10 year loan term vs a 30 year term) - than it shouldn't make a difference to the overall timeframe to repay the loan. It will still be 10 years, even though the loan term is adjusted back up.

If alternative goals are in place, particularly associated with investing; e.g.
a) to invest further,
b) seeking to increase cash flow
c) have plans to swap security to an investment later while accumulating further PPOR debt

Than you may have a benefit in increasing the loan term back up and increasing the cash flow. It could also assist borrowing capacity with some lenders (lower repayments, longer term remaining).

 

Thanks for all the replies
My curiosity actually stem's from a conversation I had with someone that insisted that refinancing over 30 years but continuing to pay the difference in the reduced rate actually reduced your overall interest paid.

However, as everyone has said there is no advantage.

To highlight this I plugged some figures into an online mortgage calculator with "extra payments" option.
I looked at what was owed on the principal after 10 years, then put that in as the starting point for a loan over 30 years (refinanced). I subtracted the monthly repayments of the refinanced loan from the monthly repayments of the original loan and found it would reduce monthly repayments by $513.

I then put the option in for extra repayments on the refinanced loan of $513 and found that it reduced the term of the loan by 10 years (effectively finishing at the same time without refinancing), and the total interest paid (plus total paid during the first 10 years of the original loan) was exactly the same as total paid for the original loan over the 30 yer period.

That is of course with the interest rate stable at 4.05%
Cheers for being a part of my pointless exercise

 

I would like to add the key advantage is reduced repayments, however, if your goal is to pay your loan sooner, take a lower interest rate from your current or new lender, and pay the same or higher amount. If you need some of the extra back, get an equity loan.

Your home is not an investment - its certainly helps grow capital wealth - but it costs money - so pay it off sooner rather than later. With the equity, consider investments including real estate which helps reduce tax and increase wealth for retirement options.