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Monthly Loan Payment - How Refinancing Your Mortgage Could Reduce Your Monthly Loan Payment

principal balance forbearance rate

Due to the poor economy, many people are looking for ways to cut their monthly expenses. One expense that is typically among people’s highest monthly expenses is a mortgage payment. To lower their monthly payment, many people are looking to refinance their mortgage. Refinancing your mortgage loan could reduce your monthly loan payment a few different ways.

The first way that refinancing your mortgage could be used to reduce your monthly loan payment is by reducing your interest rate. Interest rates are near all time lows, and in most situations are low enough to reduce a person’s monthly payment by a sizable amount. Furthermore, when refinancing a mortgage loan, a person will have the opportunity to purchase points, which could be used to reduce the interest rate and monthly payment even more. Even a small change in an interest rate could have a sizable affect on a borrower’s interest payment. For example, a person with a $200,000 mortgage, and a 6% interest rate and 30-year amortization schedule will have a monthly payment of $1,200 per month. By refinancing into a 5% interest rate, their monthly payment would be reduced to about $1,074 per month. The $126 monthly savings would then add up to a total savings of $45,000 over the course of the 30-year loan.

The second way that refinancing your mortgage could be used to reduce your monthly loan payment would be to re-amortize your loan. When you get a new mortgage loan and have to begin making the monthly payments, a portion of each monthly payment will be used to pay down the principal balance. While the majority of the payment will be used to cover accrued interest, the principal pay down each month will begin to add up. When you go to refinance a mortgage, you can re-amortize your loan based on your current loan amount, not the original principal. Therefore, since your loan balance is less after making a few years of payments, your monthly payment will lower as well. For example, a person with a $200,000 mortgage at 6% interest will pay their loan balance down to about $180,000 after about 7 years. Assuming the borrower refinances their new loan balance at the same rate, and re-amortizes the loan over 30 years; their monthly loan payment will reduce from $1,200 down to $1,080.

The third way that refinancing your mortgage could be used to reduce your monthly payment would be to receive principal forbearance. Principal forbearance means a borrower will not have to pay interest or principal on a portion of their loan balance. While they are still required to pay the entire loan balance when the home is sold, forbearance can be used to reduce a payment for a period of time. Since it slows the repayment, banks normally would prefer to avoid forbearance, but are willing to give up to 30% forbearance for distressed borrowers. An example of how principal forbearance works is as follows. A borrower with a $200,000, 6% interest, and 30-year amortizing loan has a monthly payment of $1,200. If they receive 30% forbearance, they will only have to make loan payment on $140,000, or the remaining 70% of the principal balance. This would reduce their monthly payment to $840 per month.

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