We’ve all heard the saying, “only refinance your home if the interest rate is 1% lower than your current rate.” This got out there somewhere as the “mantra” of home refinance, but no one asked the most important question – why??? Why not ¾%? Why not 1½%? Why is 1% a magic number?
I have the answer: because 1% is a nice round number. That’s it! Nothing more. People with strong financial acumen ignore the rhetoric, take out their calculator, and simply do the math. They are concerned with how much they are going to save on interest costs, NOT what the interest rate differential is.
If you had a $100,000 home loan that was 5%, let’s say. The interest on this loan would be about $5,000 a year. If you reduced your loan to 4.5% the amount goes down to $4,500 per year; a savings of $500 a year.
Not a lot of money, but still for doing nothing more than filling out paper work, it’s pretty good. Over a 30-year loan, this amounts to over $10,000 dollars. Knowing that you save $500 on a ½% change on a $100,000 loan means you’ll also know what a 1% change on a $200,000 loan is 4 times the savings, right?.
What if your loan is not $100,000? What if it’s $500,000? What if your interest rate is not 5%, it’s 7% and the savings is 2%?
Know this about interest costs, and this is the insidious part: whether you’re paying 5% on $100,000 for a home loan or 15% on $10,000 for a credit card, it feels small one month at a time. It’s not! Take the emotion out of it and know what your savings is over a year, even over a lifetime! Credit is not a short-term game. Neither is the expense you’re going to pay. Whenever possible, reduce it to the lowest possible percentage, but always understand the dollar savings because this will make it real!