Refinancing a loan—most often a mortgage—means replacing your existing loan with a new one, often to secure a lower interest rate, reduce monthly payments, or change the loan term. While refinancing can offer significant financial benefits, it also changes your amortization schedule—the breakdown of how each payment applies to principal and interest over the life of your loan.
What Is an Amortization Schedule?
An amortization schedule is a table showing each periodic payment on a loan (such as a mortgage), how much goes toward interest, how much goes toward paying down the principal, and the remaining loan balance after each payment. At the start of a loan, most of your payment goes toward interest. Over time, more of your payment is applied to the principal.
How Refinancing Affects Your Amortization
When you refinance:
1. Your Payment Structure Resets
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New Loan, New Schedule: Refinancing creates a new loan with its own amortization schedule, usually starting the clock over.
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Term Length: If you refinance to a 30-year loan after already paying 5 years on your original 30-year mortgage, you’re stretching your payments over another 30 years—potentially increasing your total interest paid.
2. Monthly Payment Changes
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Lower Rate, Lower Payment: If you secure a lower interest rate, your monthly payment typically drops (unless you choose a shorter term).
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Shorter Term, Higher Payment: Choosing a shorter term (like refinancing from a 30-year to a 15-year mortgage) increases your monthly payment but can save you thousands in interest.
3. Interest vs. Principal Proportion
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Back to Square One: Early payments on a new loan (even a refinanced one) mostly go to interest, not principal.
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Equity Impact: If you reset to a new long-term loan, you’ll build equity more slowly at first compared to sticking with your old schedule.
4. Total Interest Paid
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Potential to Save or Spend More: A lower interest rate can save money, but stretching out payments over a new, long term could mean paying more interest over the life of the loan—even with a lower rate.
Example: Before and After Refinancing
Suppose you have a $200,000 mortgage at 5% interest, 25 years left. You refinance to a new 30-year loan at 4%.
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Old Schedule: Higher payments, more principal paid off each month as the loan ages.
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New Schedule: Lower payment, but initially, most of your payment is interest again. You’ll pay less each month, but potentially more total interest if you keep the loan for the full term.
Should You Refinance?
Consider these factors:
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Interest rate difference: Is the new rate significantly lower?
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Loan term: Will you extend or shorten your payoff timeline?
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Closing costs: Fees may offset your savings.
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Your goals: Is your priority lower monthly payments or paying off the loan faster?
Key Takeaway
Refinancing can lower your monthly payments or total interest, but it restarts your amortization schedule. To maximize the benefits, aim for a lower rate without extending your loan term unnecessarily. Review your new amortization schedule to understand how much of each payment goes to principal versus interest, and consider making extra payments if you want to build equity faster or pay off your loan sooner.