How much can I save by refinancing a $40,000 loan from 6% to 3.8%, and what are the refinancing costs?

Refinancing Savings and Costs Analysis

1. Savings Calculation

We’ll calculate the potential savings from refinancing a $40,000 loan at 6% interest into a new loan at 3.8%.

Assumptions:

• Loan term: 5 years (60 months) for both loans.
• Original loan balance: $40,000.
• Interest rates: 6% (current loan) and 3.8% (new loan).

Current Loan at 6%

The monthly payment formula for a fixed-rate loan is:

\[
\text{Monthly payment} = \frac{P \times r \times (1+r)^n}{(1+r)^n – 1}
\]

• P = loan amount = $40,000
• r = monthly interest rate = 6% annual / 12 months = 0.005
• n = total number of payments (60 months)

Using the formula, the monthly payment at 6% interest is:

\[
\text{Monthly payment} = \frac{40000 \times 0.005 \times (1+0.005)^{60}}{(1+0.005)^{60} – 1}
\]

Monthly payment: $773.00

New Loan at 3.8%

• Monthly interest rate = 3.8% annual / 12 months = 0.003167

Using the formula, the monthly payment at 3.8% interest is:

\[
\text{Monthly payment} = \frac{40000 \times 0.003167 \times (1+0.003167)^{60}}{(1+0.003167)^{60} – 1}
\]

Monthly payment: $733.60

Total Savings

• Monthly payment difference: $773.00 – $733.60 = $39.40
• Total savings over 60 months: $39.40 × 60 = $2,364

2. Costs Involved in Refinancing

Refinancing typically involves several costs:

• Application fee: $100-$500
• Appraisal fee (if required): $300-$700
• Origination fee: 1%-2% of loan amount, which would be $400-$800 for a $40,000 loan
• Other fees (credit report, title search, etc.): $200-$300

Total refinancing costs: $600 to $1,500

3. Net Savings

To calculate net savings:

• Gross savings: $2,364
• Refinancing costs: $600 to $1,500

Net savings could range from $864 to $1,764 over the life of the loan.

Key Considerations

• Break-even point: Divide the refinancing cost by the monthly savings to determine how long it will take to recover the costs. For example, if the refinancing cost is $1,000 and the monthly savings is $39.40, the break-even point is approximately 25 months ($1,000 ÷ $39.40).
• Remaining loan term: The longer you keep the new loan, the more savings you can realise.

Simplified Version

1. Savings

• Current loan at 6%: Monthly payment = $773
• New loan at 3.8%: Monthly payment = $734
• Monthly savings: $39
• Total savings over 5 years: $39 × 60 months = $2,340

2. Costs Involved in Refinancing

• Application fee
• Origination fee
• Other administrative fees

These costs typically range from $600 to $1,500.

3. Net Savings

• Gross savings: $2,340
• Minus refinancing costs: $600 to $1,500
• Net savings: $840 to $1,740 over 5 years

In short, refinancing could save you money, but you’ll need to consider upfront costs and how long you plan to hold the loan.