Lower mortgage rates: should you prepay or refinance?
A 5,000,000 mortgage and 500,000 cash: compare keeping, prepaying and refinancing fairly.
01 · Mortgage and funding decisions
Start with the purpose of the cash
Yi owes 5,000,000 over 20 remaining years at a fixed nominal annual rate of 2.3%. She has 500,000 available and a hypothetical 1.9% refinancing offer. She can retain the original loan, prepay principal, or pay fees to refinance. Each addresses a different financial need. This is a fictional teaching case, not a lender quote.
Retained cash can cover unemployment, medical needs or other essential spending. Prepaid cash becomes home equity and is not normally as accessible as a deposit. Interest savings and liquidity both have value; a lower quoted rate alone cannot settle the decision.
02 · Mortgage and funding decisions
Prepayment changes the interest base in every future month
Keeping the loan requires an initial monthly payment of 26,010.68. Immediately prepaying 500,000 leaves 4,500,000; recasting over the same 20 years lowers the initial payment to 23,409.61. The monthly rate is the nominal annual rate divided by twelve, applied to outstanding principal, so a smaller balance reduces later interest.
Alternatively, keep the original scheduled payment and shorten the term. This generally clears debt sooner and saves more interest but does not immediately reduce monthly spending. The comparison distinguishes these two operations rather than presenting lower payments and earlier payoff as the same outcome.
03 · Mortgage and funding decisions
Refinancing savings come with switching costs
Assume total refinancing costs of 30,000, paid in cash now rather than financed into the new loan, and keep the 20-year term. The new initial payment is 25,058.05, with lifetime interest 1,013,932.52, compared with 1,242,564.21 on the original loan. Refinancing costs must include applicable original-loan penalties, closing fees and required new-loan charges.
Resetting the new term to 30 years may reduce payments while repaying principal more slowly and accumulating interest for longer. A comparison at the common 20-year horizon must include the remaining new-loan balance. A payment reduction is not automatically a cost saving.
- Initial payment
- 26,010.68
- Lifetime interest
- 1,242,564.21
- Upfront outflow
- 0
- Initial payment
- 23,409.61
- Lifetime interest
- 1,118,307.84
- Upfront outflow
- 500,000
- Initial payment
- 25,058.05
- Lifetime interest
- 1,013,932.52
- Upfront outflow
- 30,000
Which strategy reduces monthly pressure? ( units)
These are initially scheduled payments. Final settlement and payments after payoff can differ; the full monthly path remains available below.
Monthly remaining principal ( units)
| Strategy | Initial payment | Upfront | Lifetime interest | Obligation PV | Payoff month |
|---|---|---|---|---|---|
| A | 26,010.68 | 0 | 1,242,564.21 | 5,150,360.52 | 240 |
| B | 23,409.61 | 500,000 | 1,118,307.84 | 5,135,324.43 | 240 |
| C | 25,058.05 | 30,000 | 1,013,932.52 | 4,991,730.47 | 240 |
B payoff month: 240. The toggle changes B’s payment/term arrangement only; other teaching assumptions remain fixed.
r = 2.3% / 12；P = 5,000,000；n = 240 → A ≈ 26,010.68
First-month interest = 5,000,000 × 2.3% / 12 ≈ 9,583.33；principal = 16,427.35
P′ = 5,000,000 − 500,000 = 4,500,000 → recast initial payment 23,409.61
Displayed amounts follow the existing cent ledger with final settlement. Refinancing recalculates at the new rate and term; switching fees are upfront cash outflows, not additional principal.
04 · Mortgage and funding decisions
Use the same horizon and include upfront cash
Using a 2% effective annual rate for both discounting and retained cash, the discounted obligations are 5,150,360.52, 5,135,324.43 and 4,991,730.47 for keeping, prepaying and refinancing. They include upfront outflows, payments inside the horizon and the discounted terminal debt. These are conditional costs, not guaranteed returns or a universal ranking.
All three begin with the same 500,000 liquid budget: A retains 500,000, B prepays 500,000, and C pays 30,000 and retains 470,000. Net financial cost subtracts the common initial budget from total obligation PV. Equivalently, compare future payments and debt after deducting retained-cash PV; do not deduct that cash a second time.
05 · Mortgage and funding decisions
What counts as refinancing break-even?
Instead of dividing fees by a payment difference, evaluate each possible exit month: accumulated discounted payment savings plus the discounted difference in remaining debt, less upfront refinancing costs. The first nonnegative month is this model’s break-even; the example gives 19.
A longer term, high costs or an unfavorable rate can mean no crossing within the horizon. If the difference later turns negative, the first crossing is not a permanent advantage; the model reports whether it remains nonnegative. Unspecified future sale costs, another refinance and tax effects are excluded.
06 · Mortgage and funding decisions
After comparing numbers, check contracts and liquidity
The model assumes fixed rates, month-end payments, cent-rounded ledgers and final settlement. The shortened-term schedule uses the existing core for one-month interest and applies the original payment. Grace periods, variable rates, tax deductions and lender restrictions on recasting are excluded. Refinancing fees are paid in cash without cash-out borrowing.
A higher opportunity cost changes the value of retained liquidity, but higher expected investment returns usually carry risk. Do not treat them as guaranteed risk-free earnings. Consider income stability, emergency reserves, actual contract terms and costs before choosing a strategy.
Frequently asked questions
Can I use these outputs as an actual lender quote?
No. Confirm daily interest conventions, recasting rights, penalties and all required fees with the lender. This model uses fixed rates and monthly cent-ledger payments.
Does the first break-even month guarantee refinancing stays cheaper?
No. Check the sustained-crossing indicator and your common evaluation horizon. Changed terms, later fees and the value of liquidity can change the decision.
Sources and methodology
- Federal Reserve — A Consumer’s Guide to Mortgage Refinancings · Background on refinancing costs and break-even
- CFPB — Closing Disclosure Explainer · Example of loan-cost and term disclosures
Amounts come from this site’s deterministic models and explicitly hypothetical assumptions, not observed market data. References explain general concepts rather than local lending terms or law.
For financial education and model understanding; not personalized investment, retirement or loan advice.
Further comparison
Compare assumptions before drawing a conclusion
Compare monthly payments, total interest and funding costs across keeping the original loan, prepayment and refinancing. Adjust rates and fees to explore the trade-offs.
Explore further
Understand a concept, or calculate it on its own.
- Loan amortization
- Present value