Refinancing and Your Amortization Schedule: What You Need to Know

Understanding amortization in mortgage refinancing

So, what is amortization? It is the gradual reduction of a debt over a given period. In the case of a mortgage, it details how each payment contributes towards paying off interest and principal. Initially, a larger portion of each payment covers interest. Over time, this balance shifts, and more of each payment goes towards the principal. An amortization schedule visually and functionally represents this process.

When you refinance, you create a new amortization and mortgage schedule. This affects both the total amount of interest paid over the life of the refinance loan and the speed at which you build equity within the property. For instance, if you choose a longer term, you might see lower monthly payments but more interest paid over the life of the loan. Deciding to refinance resets the amortization clock but with potential benefits like lower mortgage refinance rates or monthly payments.

Benefits of refinancing with a new amortization schedule

Refinancing can provide several financial benefits, primarily through adjusting the refinance amortization schedule. Homeowners refinance for various reasons, mainly taking advantage of lower interest rates, reducing monthly payments or changing the loan’s term. Each of these changes affects the amortization schedule and offers distinct advantages.

Potential interest savings

One of the primary reasons to refinance is to reduce the amount of interest paid. You can achieve this by securing a lower interest rate or by altering the length of the loan term. Reducing your mortgage rate by half a percentage point could save you $100 a month or more (Alexandrov & Saunders, 2023). Typically, refinancing to a new 30-year loan at a lower rate will decrease both monthly payments and save thousands in total interest costs over the life of the loan. Additionally, lowering the term of your mortgage — say from 30 years to 15 years — reduces the total interest paid till maturity.

Adjusted monthly payments

Changing the amortization schedule can either increase or decrease your monthly payments. If financial circumstances have changed, extending the loan term during refinancing can lower monthly payments, albeit at the cost of higher overall interest. Conversely, shortening the loan term will raise monthly payments but save money on interest and speed up equity accumulation.

How to calculate your refinance amortization schedule

To calculate your new amortization schedule when refinancing, you need to consider several factors, including the principal amount, interest rate and the term of the new loan. Here’s a step-by-step guide:

Determine the principal amount

Calculate the total amount that will be refinanced. This includes the remaining balance of your original mortgage and may incorporate closing costs or other refinancing fees if you choose to finance these costs as part of the new loan.

Establish the interest rate and loan term

Identify the interest rate you qualify for with your refinance. Typically, it depends on current market conditions and your credit profile. Decide on the term for the new home loan based on your financial goals—shorter terms generally have higher monthly payments but incur less interest over the life of the loan.

Choosing the right amortization term for your refinance

Selecting the appropriate term for your mortgage refinance amortization is critical. Your decision determines two major variables: your monthly payments and the total interest you will pay over the life of the loan. To make the correct decision, consider these factors:

Financial flexibility: Longer terms generally offer lower monthly payments, enhancing short-term financial flexibility. A longer term with lower payments might be the safer option if your income fluctuates significantly. Conversely, a high-income earner with a stable income can afford a shorter term with larger monthly payments. 

Interest accumulation: Shorter terms reduce the interest paid over time but require higher monthly payments.

Equity building: Freddie Mac (2024) notes that a 15-year fixed-rate mortgage enables faster equity building than a 30-year one. This is significant if you plan to sell the home soon or use the equity for other investments.

Long-term financial goals: A shorter amortization period can help you become debt-free sooner. On the other hand, lower monthly payments with a longer term can free up cash for other investments or savings.

Retirement planning: If you plan to retire soon, having your mortgage paid off by then can significantly reduce your financial burdens. Thus, align the amortization period with your retirement timeline.

Common misconceptions about refinancing and amortization

Several myths about refinancing can mislead homeowners. Here, we clarify some of the most common misconceptions to help you make informed decisions.

Refinancing only benefits those with poor interest rates

While securing a lower interest rate can provide significant savings, refinancing also offers opportunities to adjust monthly cash flow, consolidate debts or tap into home equity for large expenses.

Refinancing Is always costly

Indeed, there are upfront costs associated with refinancing. However, the long-term savings can often outweigh these expenses. Calculating the break-even point, where the savings from the new loan outweigh the costs, is essential.

Refinancing always lowers payments

Refinancing can lower monthly payments, but this is not always the case. If you opt for a shorter term, your monthly payments might increase, even though you'll save on interest and pay off the loan faster.

You cannot refinance with negative equity

While more challenging, there are programs available for homeowners with negative equity. Government initiatives like the Home Affordable Refinance Program (HARP) program help homeowners refinance even if they owe more than their home is worth. For the most up-to-date information on available refinancing programs, we encourage you to consult with your financial institution.

Refinancing is cost-free

Refinancing typically involves fees and closing costs, amounting to thousands of dollars. It’s important to calculate whether the potential savings outweigh these costs.

FAQs

Citations

• Alexei Alexandrov & Elizabeth Saunders (2023, May 24). Mortgage data shows that borrowers could save $100 a month (or more) by choosing cheaper lenders. Consumer Financial Protection Bureau. 
• Freddie Mac (2024). Finding the right loan. Freddie Mac.