Mortgage rates headed down - time to refi?

[rayvt]

But, of course, he isn't actually going to start saving/investing that $2003 a month. And he truly didn't. His wife saw the extra $2003 and started planning for new furniture and family vacations and other goodies that they had sacrificed in order to make those higher mortgage payments.

After they finished "negotiating" (code work for somebody sleeping on the sofa), they bumped up the 401K contribution by $500 a month. The other $1503 got spent rather that invested.

[free4now]

One point that I don't think has been raised yet: 15 year loans may have higher rates simply because lenders get more profit when people to take longer to pay off loans. Lenders set their rates with the intention of charging you enough in interest, over and above their cost of money, that each year you hold the loan the lender gets more profit. That's why these mortgages are sold to investors in collateralized form... the buyers are paying for a stream of future profit. This is also how some mortgages can be zero cost/fees/points... in that case the lender pays the broker thousands of dollars in hopes of making it back in interest payments.

Because the mortgage companies know that people who take out 15 year mortgages are more likely to pay them off quickly, they can count on fewer years of profit, so they have to charge a comparatively higher rate on them.

Also lenders know that the higher monthly payments of a 15 year loan can be harder to pay back, so there is a somewhat higher risk of default and foreclosure. I remember when I bought my first car and I couldn't qualify for a 4 year loan but could qualify easily for a 5 year loan. Same effect.

So in a situation where the yield curve was flat, you would expect the 15 year loan to have a higher interest rate than the 30 year. This is one reason why 15 year loans can cost you extra.

[jazz4cash]

Quote:

Originally Posted by free4now One point that I don't think has been raised yet: 15 year loans may have higher rates simply because lenders get more profit when people to take longer to pay off loans. Lenders set their rates with the intention of charging you enough in interest, over and above their cost of money, that each year you hold the loan the lender gets more profit. That's why these mortgages are sold to investors in collateralized form... the buyers are paying for a stream of future profit. This is also how some mortgages can be zero cost/fees/points... in that case the lender pays the broker thousands of dollars in hopes of making it back in interest payments. Because the mortgage companies know that people who take out 15 year mortgages are more likely to pay them off quickly, they can count on fewer years of profit, so they have to charge a comparatively higher rate on them. Also lenders know that the higher monthly payments of a 15 year loan can be harder to pay back, so there is a somewhat higher risk of default and foreclosure. I remember when I bought my first car and I couldn't qualify for a 4 year loan but could qualify easily for a 5 year loan. Same effect. So in a situation where the yield curve was flat, you would expect the 15 year loan to have a higher interest rate than the 30 year. This is one reason why 15 year loans can cost you extra.

I have never seen this. I would NEVER expect to pay more for a 15yr mortgage vs. a 30 yr loan. The risk on the longer term dictates a higher rate. Did I miss something?

[free4now]

Quote:

Originally Posted by jazz4cash I have never seen this. I would NEVER expect to pay more for a 15yr mortgage vs. a 30 yr loan. The risk on the longer term dictates a higher rate. Did I miss something?

As an example of what I'm talking about today etrade mortgages lists the following rates on

https://lending.etrade.com/e/t/mortg.../mortgagerates

30 year fixed 5.875%
25 year fixed 5.875%
20 year fixed 6.000%
15 year fixed 5.750%

In this case the 20 year rate is higher than the 30 year rate! Also the 15 year rate is higher than the yield curve might predict... the treasury site lists the yield curve for today at

U.S. Treasury - Daily Treasury Yield Curve

30 year 4.58%
20 year 4.55%
10 year 3.76%

Now since they don't list a 15 year rate it's hard to compare apples to apples, but the yield curve predicts 10 year to be more than 3/4 points less than 30 year. So the 1/8 point discount for 15 year that etrade is offering is pretty clearly not a great deal.

[jazz4cash]

The 30 yr rate you posted is higher than the 15.
You could also check here.......
Bankrate.com (tm) Averages

or here

Compare Mortgages, Refinancing Rates, Calculators, Home Loans - HSH

and you will see the same pattern. These are national averages.

[Marquette]

Here's what I have... feel free to punch holes in the numbers.

I have in mind for this little experiment a 25 yr old couple purchasing their first house. They have $1600 a month that they will spend on either a mortgage, investing, or a combination thereof. They're looking at a $250k place with 20% down. Their options are a 15 yr at 5.2% or a 30 yr at 5.75% (both taken off of bankrate.com, seems like a reasonable starting point).

To keep this simple, let's put the bounds at 30 years for the experiment. Either they pay off the house for 15 years and then invest for 15 years or they carry a mortgage and invest for 30 years (or something in between). Further, I'm going to assume a 9% CAGR on investments and I'm not counting the write-off for mortgage interest (the first takes into account a moderate portfolio and the latter is too much for me to include).

I'm just using the savings calculator over at dinkytown for the investment calc.

Scenario 1 - Minimum payment on the house

They'll pay $1,167 a month in interest leaving them with $433 a month to invest. At the end of 30 years, they will have paid a total of $420,170 on the loan over 360 months. Their investment account be worth $742,327.

Scenario 2 - Pay a little extra on the house

The couple wants to get ahead on the mortgage so they pay $200 extra a month on principle. They invest the remaining $233. They'll pay $1,367 a month for ~21 years. At that point, they'll have paid a total of $345,266 for the house. Their investments will be worth $166,349. At that point, they'll start putting $1600 in their investment account for the remaining 9 years. At the end of the 30 years, they'll have $623,323 in their investment account.

Scenario 3 - 15 years and then save save save!!(!)

The couple will pay $1602 a month for 15 years. At the end of the loan, they'll have paid $288,450. They will then save $1600 a month for the next 15 years. At the end of that time, they will have $590,850 in their retirement account.

Netting things out.

Scenario 1 - thirty and out: $742,327 - $420,170 = $322,157
Scenario 2 - every little bit helps: $623,323 - $345,266 = $278,057
Scenario 3 - get it over and save: $590,850 - $288,450 = $302,400

I would think scenario 1 would come out a little better if we take the mortgage deduction into account.

All of that said, I still intend to go into retirement with a paid off house. Basically, from a psychological standpoint, I know my wife and I will both sleep much better at night if our monthly expenses are as low as possible.

I think the next quick numbers to crunch would be for two 55 yr old empty nesters selling and downsizing. Their option in that point would be to pay cash for the next house or carry a mortgage and invest the lump sum. In that case, I think the yield would be lower as they're entering a moderate risk time period (at least, my imaginary people are, ymmv).

[laurence]

Those who say 10.5% - 6% = profit! I ask this, is your portfolio 100% stocks? Because that's what it will take to make the plan work. Also, that's the looong term for the S&P 500, meaning if you are in the don't buy green bananas stage of life, you run the risk of hitting a ten year bear market a la late 60's through the 70's. Young dreamers should definitely be socking their money into retirement vehicles vs. paying extra on the house, but I don't see how a 55+ retiree should be advised to have a fat mortgage and go 100% stocks.

[twaddle]

Quote:

Originally Posted by laurencewill Those who say 10.5% - 6% = profit! I ask this, is your portfolio 100% stocks?

My portfolio is not 100% stocks, but then my mortgage rate is only 4.625%, which after the tax break is more like 3.5%. I think I can clear that hurdle.

[laurence]

Quote:

Originally Posted by twaddle My portfolio is not 100% stocks, but then my mortgage rate is only 4.625%, which after the tax break is more like 3.5%. I think I can clear that hurdle.

Just curious, are you figuring that tax break discount with the standard deduction in mind? The difference between what DW and I would get from a standard deduction and what we get from our mortgage deduction is not a huge amount. We would get almost 11k from the standard and I think we pay about 12k in interest on the house. So we do save about $300 a year in taxes due to the mortgage, but as a % it's pretty insignificant.

We donate a lot, though, and that makes itemizing more worth our while.

To the point of % spreads between shorter and longer term loans, I got ~40 basis points discount at the time for going with a 20 year vs. 30 year, it's always been my personal experience there is always a discount for a shorter term. I think the argument for a paid off house is made a lot stronger in the context of choosing a shorter term mortgage at favorable interest rates vs. arbitrary early payments.

Can one get the child credits/deductions if one uses the standard deduction? Anyone?

[twaddle]

Quote:

Originally Posted by laurencewill Just curious, are you figuring that tax break discount with the standard deduction in mind?

Si, Señor.

In my case, my property taxes, sales taxes, etc are just about the same as my standard deduction. So, I get the full deduction for mortgage interest.

I do understand that not everybody would get the same break I do, but even without the tax break, it's hard to screw up by keeping a 4.625% mortgage, don't you think?

[laurence]

Quote:

Originally Posted by twaddle Si, Señor. In my case, my property taxes, sales taxes, etc are just about the same as my standard deduction. So, I get the full deduction for mortgage interest. I do understand that not everybody would get the same break I do, but even without the tax break, it's hard to screw up by keeping a 4.625% mortgage, don't you think?

I would agree considering current rates I'd ask you if you were feeling well if you refinanced! :-) How many years do you have left on that loan, on how much principle?

[myself]

Quote:

Originally Posted by laurencewill Can one get the child credits/deductions if one uses the standard deduction? Anyone?

The answer is yes. As long as they are eligible of course.
Tax credits are figured AFTER the appropriate level of taxation is determined, which is after the standard/itemized deduction choice.

[DJScrib]

Hi all, long time lurker, first time poster.

One aspect of the pay-off mortgage argument I haven't seen addressed is the "**** hits the fan" scenario for a person who is in the early stages of paying off a mortgage.

The scenario is for a 300K house, person #1 has paid 50k of it off, so has a 250k mortgage and 50k equity. person #2 has paid off 5k, and has a 295k mortgage and 5k equity.

If they wreck their car while drunk and get fired, and wind up in deep trouble for a year or so which one can survive the situation? Assuming no other appreciable buckets of money.

Person 1 can't get a home equity loan (since no job), and may be forced to sell their house and lose 6% in the process. While person 2 can dip into their savings, to survive much longer before biting the bullet.

Lastly, in the above scenario, a mortgage lender is going to foreclose person #1 first (becuase they can get some money out of it), while being more likely to work something out with person #2 since it would be an unprofitable foreclosure. In a cruel twist, the "better" mortgage holder gets penalized.

Anyhow, I've heard the above scenario outlined before and are curious if any variation of this theme enters into people's equations. Basically are you willing to sacrifice a percent or so of overall profit, in exchange for "peace of mind" in a sticky situation.

Now obviously people closer to ER probably have a large enough nest egg to raid, but again, even in that situation raiding the 401k and taking a tax penalty is not an ideal situation.

[Nords]

Quote:

Originally Posted by cute fuzzy bunny You never used an ARM with a balloon payment.

Ouch!

Quote:

Originally Posted by Marquette I have in mind for this little experiment a 25 yr old couple purchasing their first house.

One of the issues that gets batted around after the fourth of fifth iteration of this discussion is that the median homeowner tenure is seven years.

As a 25-year-old, I'd hesitate to buy a house... especially if I was in the military.

[Marquette]

Quote:

Originally Posted by Nords One of the issues that gets batted around after the fourth of fifth iteration of this discussion is that the median homeowner tenure is seven years. As a 25-year-old, I'd hesitate to buy a house... especially if I was in the military.

Well, replace 25 yr old with 'suitable horizon before retirement'. The tenure thing is interesting but irrelevant, in my opinion. If someone sells their house to buy another, they're still going to make the choice between carrying a mortgage for 30 or 15 years and deciding if they want to pay extra on principal

[cute fuzzy bunny]

Quote:

Originally Posted by Marquette they're still going to make the choice between carrying a mortgage for 30 or 15 years and deciding if they want to pay extra on principal

They are, but they cant control the rates. If they're lucky, this random distribution of mortgage acquisitions every 5-7 years will end up averaging to the average. If they're unlucky and end up moving when mortgage rates are high, while they'll be able to recoup some of that difference by periodically refinancing, its still a loss against the system. On the other hand, if they're lucky and move when rates are very favorable, they get a nice bonus.

But as I've mentioned 100 times now, looking at this from the "I pay x% and can make y%" is ridiculous. The two major factors have nothing to do with rates of excess return from the leverage.

Its about all the lack of gains from your emergency cash and gain reductions by maintaining more fixed income in your portfolio to reduce volatility because you've got payments to make, and whether you can remain a rock in your 6th or 7th year of a bear market while you're sucking the life out of your portfolio to make non-elective payments.

In short: you're taking on more risk of portfolio survival, more payment risk, and weakening your options for a "save" in exchange for a potential to improve your terminal portfolio size. TERMINAL portfolio size.

As far as the "save", someone that has to ante up 15-20k in regular expenses and another 15-20k in mortgage payments a year is going to have to go get a decent regular job to cover those if they really deplete their portfolio. With just the 15-20k in regular expenses and no debt payments, any old part time job will cough up that much.

We often point out that a major bear market in the early years of retirement can be a killer. The more you have at stake, especially in the form of leverage, the more risk of that major bear market in the early years doing you in.

Funny how dang brave some people get when we're in a bull market. Everyone breaks out their two-factor calculators to try and determine how rich they can get by leveraging themselves to the hilt. Good idea when you're young and working. Bad idea when you're 50, have been out of the workforce for 5 years, and you're living off your portfolio.

I still well remember talking about this around here back in late 2002 and early 2003. Dont remember a lot of people encouraged about yanking money out of their house and stuffing it into the market. In fact, at that time I could have gotten a 3.9% 5/1 mortgage and floated the idea of leveraging that. I dont think anyone stepped up to say it was a good idea. Five years was just too short a horizon.

So after an enormous price reduction on the S&P 500, sub 4% rates available on the cost side, but when everyones nervous...dont do it man!

How ya gonna feel when you've just eaten the "price reduction" on your portfolio, your cost is 5-5.5%, and you're freshly introduced to a lot of nervousness.

[Marquette]

But CFB, I don't recall ever stating or implying that someone should arb their house into the market, much less someone in their 50's. I was showing the numbers for a first-time buyer in their young earning years.

Further, I'll stand by my statement that statistically moving every 7-8 years is irrelevant. Having a 15 or 30 year mortgage on your current house doesn't change your interest rate on your new house. Additionally, one would be stupid to choose to move if rates were prohibitive (understanding that not everyone has a choice on if they move or not, but the vast majority of people I see are simply trying to trade up houses or neighborhoods).

I would by the argument that, if you're planning to move anyway, then a shorter mortgage would make sense as it may give liquidity and allow one to make a bigger down payment on their next house. However, that would assume that, if a bear market hits, it doesn't affect housing prices at the same time.

Your point about losing jobs and bear markets and terminal portfolio value is pertinent when doing a whole personal finance plan, but, for the young earners in my scenario, it seems like they would be even better served by not paying off the mortgage. A 15 yr is a higher hurdle to clear if one doesn't have a job, and pre-paying on the 30 year doesn't help either since your monthly payment doesn't go down. So, in that case, having a larger pot of money available free of the house would help on all fronts...

I assume you were partially just using my post as a springboard for other points you wanted to make about a topic that's been discussed to death, but I never discussed retirees, 50 year olds, or ARMS. I was just presenting the numbers for one couple early in life. One could use those numbers to extend any argument they chose, but that would be their interpretation, not mine.

[twaddle]

The munis are tax-free, so today we're in a fairly remarkable situation in which one could pay their mortgage interest using the income from a super-conservative tax-free investment, and you'd still pocket the tax break from the mortgage deduction and have a little left over from your muni investment by the end of your mortgage.

That's the conservative case. Since cash flow isn't an issue for me (my investments already throw off more than I can consume), that means I can afford to take a bit more risk.

If you wanted to, it's a fun exercise to modify an amortization spreadsheet and model the monthly outflow vs inflow, annual taxes, etc using a variety of investment assumptions. Use the munis as the most conservative case (in which you'd have to continuously reduce the principal invested), and compare to CPI-linked investments, dividend yielding investments with low growth and low volatility, and higher return higher volatility investments.

We can all make different choices depending on our unique situations, but the bottom-line for me is that it's hard to lose even if you choose the most conservative investment approach.

As far as investment opportunities coming and going, I've only talked about those that are available today. You can lock those yields in for the life of your mortgage.

[ERD50]

Well, we keep talking about the risk associated with a mortgage, but I haven't seen any numbers. So I started doing some FireCalc runs, with the same methodology I used in that "FireCalc Dips in NW..." thread I started. Seems to me the best measure of risk is what your NW balance is after the worst periods in history. We can all relate to that.

I'm finding some 'interesting' results and some data that (I think) has never been discussed before - but I want to triple check these numbers before presenting.

In the mean time, I've seen that CFB brought up the interesting and often overlooked point that there may be a tax hit for the mortgage payer because he needs that extra cash flow to pay the mortgage. Interesting observation, but I think it is not apples-apples. It appears to be ignoring the tax impact on the guy that does not have a mortgage. Consider:

Two people retire and buy retirement houses. Mr Cash has $1M in his portfolio after buying the house, Mr Mortgage takes out a $200K mortgage, so has $1.2M in the portfolio. So, what were the tax impacts of Mr Cash pulling out that $200K to put towards the house? The simplest assumption is it was MM money with no gains, so no tax impact - OK. But to keep it comparable, that means that Mr Mortgage also has $200K with no gains. That will pay the first 15 years of a 30 year mortgage with no added tax burden. And Mr Mortgage might get the interest write off, offsetting (to some degree) any tax paid in those last 15 years.

I'm bleary eyed from the FireCalc runs, I'm not up to figuring the tax savings on the declining interest of a 30 year mortgage vs added tax on the last 15 years, but I'd love to see it if anyone else is more motivated at this point. What is a decent assumption? 5.5% mortgage, with a 25% marginal tax rate?

-ERD50

[twaddle]

Quote:

Originally Posted by ERD50 I'm bleary eyed from the FireCalc runs, I'm not up to figuring the tax savings on the declining interest of a 30 year mortgage vs added tax on the last 15 years, but I'd love to see it if anyone else is more motivated at this point. What is a decent assumption? 5.5% mortgage, with a 25% marginal tax rate?

The tax savings on a 15-year fixed 5.5% $400,000 mortgage for somebody in the 25% tax bracket would be $47,075. Take the total interest of $188,300 and multiply by 0.25.