Refinance or pay off mortgage?

[Retireby45ish]

I started thinking that with these lower rates it might be worth refinancing our mortgage. However here is my situation.

1)
Have a 7 year ARM now at 3.75%. Currently 5 years left. A 99% chance we move before then..probably more like 2 years from now. Is it worth refinancing? Will the costs
of the process be large (can I negotiate with same lender lower for no costs?), and outweigh the benefits for the next 24 or so months which is my estimated timetable? About a 350k mortgage amt.

2)
Then, with the dicey market outlook and what I view as a larger chance of a subdued return of alternative or bond/CD/stock investments going forward, might it be best to just pay off the mortgage now? I can think of this as putting more money into fixed income bucket of investments.

I have some cash now because I sold out of some assets weeks ago and also just got a bonus and such so that’s not an issue. It’s sitting on the sidelines and I’m about to deploy it anyways over next few weeks into a mix of bond and stock funds.

They way I’m thinking about the return is as follows. I pay 3.75% mortgage but I get some tax benefits of about 10k interest paid. However, including that it just barely was better to itemize rather than for us to take the standard deduction last year, so is the 10k really a factor (bringing the effective rate down to something like 2.75% (a guesstimate). Not sure what that number would be. People always say since you get to write off part of the mortgage interest that’s good but if I’m still taking the standard deduction doesnt this get negated?

3) does it make sense to think of it as a low vol investment?

If it’s 3.75% then it seems attractive alternative to pay it off since I’d need a pre tax 4.5-5% return on bonds or something else (I hold stuff like Hyd or LQD, though I think things like BND might be more efficient) to give me an after tax return of the equivalent 3.75%. I’m in a pretty high tax bracket in a high tax state (for 2 years till I wise up).

Thanks for the help.

 

[Closet_Gamer]

I think this has to fit into an overall financial planning situation, particularly in light of the current circumstances where liquidity is pretty valuable.

If you've got the $350k sitting there, have a large cash reserve beyond that, and are comfortable a super illiquid investment that will feel a bit like a bond via the reduced monthly obligation, sure.

But the carrying cost of the loan isn't very large in exchange for a ton of liquidity right now.

I would be inclined to sit tight. Don't take on the refi costs given your short horizon and don't tie up the cash at a time when cash is super valuable.

Hang on for 90 days and revisit.

My $0.02. YMMV.

 

[DrRoy]

Not worth closing costs to refi. No closing loans are available but usually at a higher rate. The payoff is sort of your call.

 

[atmsmshr]

Ask your lender if they will recast the mortgage. If they do it is much less expensive than a new start-from-scratch closing.

 

[Retireby45ish]

I think this has to fit into an overall financial planning situation, particularly in light of the current circumstances where liquidity is pretty valuable.

If you've got the $350k sitting there, have a large cash reserve beyond that, and are comfortable a super illiquid investment that will feel a bit like a bond via the reduced monthly obligation, sure.

But the carrying cost of the loan isn't very large in exchange for a ton of liquidity right now.

I would be inclined to sit tight. Don't take on the refi costs given your short horizon and don't tie up the cash at a time when cash is super valuable.

Hang on for 90 days and revisit.

My $0.02. YMMV.

This makes total sense. I guess I hadn’t put much value in holding cash in case stuff gets crazy and great opportunities arise elsewhere (real estate, equities, etc) in the next 12 or so months. Worth hanging on and waiting even if I give up a few basis points by keeping the loan vs putting it into something less attractive but much more liquid (or just cash).

 

[Shredder]

I just paid off a 3.25% mortgage mostly because im pessimistic I can safely get a better return on investments. For us it made sense. We could have paid it off several years ago, but with our investments making 7+% it didn't make sense. Now it does, but everyone's situation and mindset is different.

 

[JoshTrent]

I just closed on my ReFi Two weeks ago. The process started beginning of March, when I called my CU about the attractive rate they were offering on their website. I had been wanting to move my mortgage from a large nationwide Bank to my CU for some time.

Come to find out, my CU was offering a no-cost ReFi to members (no matter where the loan was currently).. which made the decision a no-brainer for me.

I guess my point is.. if you want to ReFi - do some research & ask about no-cost options.

 

[harley]

I've been trying to refi a mortgage for a couple of weeks, but it's on a second home so nobody I've found is willing to do it. They say they are so busy with primary home refi's that they aren't taking on the ones for second homes yet. Doesn't make sense to me, but much of the mortgage industry's behavior seems absurd, so I'll wait for the crowds to disperse and then try again.

To the OP, no way I'd refi in your situation. There's just too short a time frame before it's paid off. Unless you can get one of those No Cost refi's like JoshTrent is talking about. I'd definitely do that.

As far as paying it off, I think it's sort of a wash. If you truly have the cash available, as well as enough cash to get you through the next few years without having to liquidate much, I'd probably do it. But if it would strap you for cash, I'd wait. I like having a healthy cash fund available, especially in "these uncertain times" (I'm beginning to hate that phrase).

 

[Montecfo]

Sounds like it may not make sense to refi now.

You are getting little benefit from deductibility however. I think your analysis relative to needing 4.5% or so to break even is accurate, given little tax benefit from mortgage.

If you have substantial equity I recommend a standby HELOC. Just something to keep in mind.

 

[troutnut1]

Secrets of a former loan officer...

Long time former mortgage loan officer and appraiser here with a short lesson on how this all works:

Normal 15 or 30 years home loans made at “par” (the going rate) generally require 1% origination fee (lender profit), appraisal fee (appraiser profit), and a multitude of “junk fees” under many different made up names (more lender profit and often split with the loan officer).

Loans made below the current market rate are available but require the payment of “discount points”. The more under market the rate the higher the points. Points equate the yield between mortgages of various rates and terms. If a lender makes a loan below market the loan is less valuable than a loan made at market. If the market says the below market loan is worth 98 cents on a dollar, two discount points would be required to equate the yield to the investor. But sometimes lenders find extra profit here by charging and “overage” which means they get three points from you and sell the loan for 98 cents on the dollar. Extra profit for them. And often split with the loan officer if they can get you to fall for it.

Loans may also be made at higher than market rates. Then instead of being sold at a “discount”, they can be sold at a “premium”. If it’s enough over market the “premium” received by the lend may be enough for them to pay the origination fee, appraisal, and junk fees for you.

Do not be fooled. There is really no such thing as a “no cost refi”. Lenders made that term up to disguise the fact that they are getting those fees by selling an above rate loan at more than 100 cents on the dollar. They get the same money, just not from you directly at the start of the loan. Still, it can make sense if you are only going to be there for a short time. The lender received the funds to pay these items from the investor they sold the loan to at a “premium”.

In light of your short plans there, it is very unlikely that any small difference in interest rate could make up for the costs involved. And if the costs are hidden inside the loan it will probably pump up the rate enough to negate any value to you. But things change daily so keep checking.

What you would want is the “no cost refi” (even though we now all know that there really are costs), and at a rate that is low enough to better your current rate, and compensate you for all the trouble, in whatever time you plan on spending there.

 

[pb4uski]

Since you have a 2 year time horizon and a pretty decent 3.75% rate, I would keep your gunpowder dry for now. Cash is king. You can always decide to use it later to invest or pay off the mortgage or if something happens to your job.

 

[rk911]

I started thinking that with these lower rates it might be worth refinancing our mortgage. However here is my situation.

1)
Have a 7 year ARM now at 3.75%. Currently 5 years left. A 99% chance we move before then..probably more like 2 years from now. Is it worth refinancing? Will the costs
of the process be large (can I negotiate with same lender lower for no costs?), and outweigh the benefits for the next 24 or so months which is my estimated timetable? About a 350k mortgage amt.

2)
Then, with the dicey market outlook and what I view as a larger chance of a subdued return of alternative or bond/CD/stock investments going forward, might it be best to just pay off the mortgage now? I can think of this as putting more money into fixed income bucket of investments.

I have some cash now because I sold out of some assets weeks ago and also just got a bonus and such so that’s not an issue. It’s sitting on the sidelines and I’m about to deploy it anyways over next few weeks into a mix of bond and stock funds.

They way I’m thinking about the return is as follows. I pay 3.75% mortgage but I get some tax benefits of about 10k interest paid. However, including that it just barely was better to itemize rather than for us to take the standard deduction last year, so is the 10k really a factor (bringing the effective rate down to something like 2.75% (a guesstimate). Not sure what that number would be. People always say since you get to write off part of the mortgage interest that’s good but if I’m still taking the standard deduction doesnt this get negated?

3) does it make sense to think of it as a low vol investment?

If it’s 3.75% then it seems attractive alternative to pay it off since I’d need a pre tax 4.5-5% return on bonds or something else (I hold stuff like Hyd or LQD, though I think things like BND might be more efficient) to give me an after tax return of the equivalent 3.75%. I’m in a pretty high tax bracket in a high tax state (for 2 years till I wise up).

Thanks for the help.

pay it off. dump debt and risk.

 

[Retireby45ish]

Re-examining...

Thanks for all the answers. A lot of your comments said it depended on the cash flow I had and whether it would leave me strapped. Re-examining now wither paying off mortgage is best (after watching market rally 30% off lows). Here I paint a better picture.

I go out of some of the market when things got scary. In hindsite a bad decision. But I also had some “safe stuff” that unhinged and made me reevaluate assets and allocations.

Have about 700k in cash now due to that and some other bonuses and things that have vested last few months. That’s about 40% of total net worth. Rest is 40% stocks, 20% bonds.

So I’d be paying off a 350k mortgage. At the 3.75% rate (which I equate to about 4.5% pre tax returns).

I guess alternative is to wait to get back into market or Maybe buy some bonds now which will only return 2% or so. FXNAX is my low cost go to. Want to keep out of market because, while I hate to think I can time it, I feel it’s a bit frothy now with it almost being all time highs and this virus still out here. Seems nuts and if I miss a year or two and I’m wrong the rest of my stocks will make and I’ll take a lower return on this portion of cash.

Anyways, seems hope this paints better picture. I have enough to pay off mortgage and then have cash left if needed for ammo if market goes down.

DW and I still have jobs and hope to bank another 150-200k or so this year after expenses by year end. Hoping to FIRE in 3-4 years.

Also, can anyone clue me in on how Home interest deduction matters in this calculation? I think it barely made sense to not take stardaed deduction last year.

 

[Montecfo]

The three most important words in investing are: Stay Fully Invested.

On taxes, sounds like Ike it does not matter as from your statement, you would not be losing much in the way of a tax deduction. If true, the case for payoff is stronger.

As far as getting back into the market, going in in steps (say 25 pct per month over 4 months) can create some psychic comfort. And I would be buying quality that has not fully participated in the rally.

Good investing.

 

[Sunset]

Now with the Standard deduction, and some limits on itemized deductions for properties, it makes less sense to keep a mortgage for the deduction than it did before.

Even then it was still a debt and only the amount above standard deduction was of any actual benefit.

TaxCut software lets a person enter in all their itemization numbers, and then show which is better to take, standard deduction or itemization.

 

[Lienlord]

Long time former mortgage loan officer and appraiser here with a short lesson on how this all works:

Normal 15 or 30 years home loans made at “par” (the going rate) generally require 1% origination fee (lender profit), appraisal fee (appraiser profit), and a multitude of “junk fees” under many different made up names (more lender profit and often split with the loan officer).

Loans made below the current market rate are available but require the payment of “discount points”. The more under market the rate the higher the points. Points equate the yield between mortgages of various rates and terms. If a lender makes a loan below market the loan is less valuable than a loan made at market. If the market says the below market loan is worth 98 cents on a dollar, two discount points would be required to equate the yield to the investor. But sometimes lenders find extra profit here by charging and “overage” which means they get three points from you and sell the loan for 98 cents on the dollar. Extra profit for them. And often split with the loan officer if they can get you to fall for it.

Loans may also be made at higher than market rates. Then instead of being sold at a “discount”, they can be sold at a “premium”. If it’s enough over market the “premium” received by the lend may be enough for them to pay the origination fee, appraisal, and junk fees for you.

Do not be fooled. There is really no such thing as a “no cost refi”. Lenders made that term up to disguise the fact that they are getting those fees by selling an above rate loan at more than 100 cents on the dollar. They get the same money, just not from you directly at the start of the loan. Still, it can make sense if you are only going to be there for a short time. The lender received the funds to pay these items from the investor they sold the loan to at a “premium”.

In light of your short plans there, it is very unlikely that any small difference in interest rate could make up for the costs involved. And if the costs are hidden inside the loan it will probably pump up the rate enough to negate any value to you. But things change daily so keep checking.

What you would want is the “no cost refi” (even though we now all know that there really are costs), and at a rate that is low enough to better your current rate, and compensate you for all the trouble, in whatever time you plan on spending there.

Thanks for this! Would your advice differ for someone looking to buy a new house and finance it with a 30 year mortgage? We currently own our home ($250k) but have been thinking of selling and moving to another house that more fits our empty nest lifestyle. I didn't want to sink these funds into another property, so felt the right move to either rent or buy using low rate financing.

 

[Retireby45ish]

I’m leaning towards pulling the trigger to pay it off. Anyone read post #13 above and have any last words of wisdom?

Also, I was thinking if I had a 60/40 split before maybe I go 70/30 now because this acts sort of like a fixed income or bond type asset I’m holding. Thoughts?

 

[jazz4cash]

Long time former mortgage loan officer and appraiser here with a short lesson on how this all works:

Normal 15 or 30 years home loans made at “par” (the going rate) generally require 1% origination fee (lender profit), appraisal fee (appraiser profit), and a multitude of “junk fees” under many different made up names (more lender profit and often split with the loan officer).

Loans made below the current market rate are available but require the payment of “discount points”. The more under market the rate the higher the points. Points equate the yield between mortgages of various rates and terms. If a lender makes a loan below market the loan is less valuable than a loan made at market. If the market says the below market loan is worth 98 cents on a dollar, two discount points would be required to equate the yield to the investor. But sometimes lenders find extra profit here by charging and “overage” which means they get three points from you and sell the loan for 98 cents on the dollar. Extra profit for them. And often split with the loan officer if they can get you to fall for it.

Loans may also be made at higher than market rates. Then instead of being sold at a “discount”, they can be sold at a “premium”. If it’s enough over market the “premium” received by the lend may be enough for them to pay the origination fee, appraisal, and junk fees for you.

Do not be fooled. There is really no such thing as a “no cost refi”. Lenders made that term up to disguise the fact that they are getting those fees by selling an above rate loan at more than 100 cents on the dollar. They get the same money, just not from you directly at the start of the loan. Still, it can make sense if you are only going to be there for a short time. The lender received the funds to pay these items from the investor they sold the loan to at a “premium”.

In light of your short plans there, it is very unlikely that any small difference in interest rate could make up for the costs involved. And if the costs are hidden inside the loan it will probably pump up the rate enough to negate any value to you. But things change daily so keep checking.

What you would want is the “no cost refi” (even though we now all know that there really are costs), and at a rate that is low enough to better your current rate, and compensate you for all the trouble, in whatever time you plan on spending there.

Is it correct for me to use APR to compare costs of loans with different interest rates and discount points/closing costs? It seems that lenders do not standardize on how they include fees and calculate costs (transfer taxes, e.g.) to close the loan.

 

[harley]

Ask your lender if they will recast the mortgage. If they do it is much less expensive than a new start-from-scratch closing.

Thanks for this suggestion. I've been trying to refinance for a number of months, but have run into issues. Many companies are so busy they just don't want to deal with it, and put me on a "I'll call you back when things quiet down" list. Also, when I did get through to talk to someone I ran into a debt/income roadblock. We have two mortgages, and while we have a pretty decent income we didn't meet the 35% debt to income ratio. Assets aren't taken into account. I would think the argument that since I can make the existing payments easily making the payments on a smaller amount would be even easier would count for something, but no.

I was thinking of paying off one of the mortgages, then refi'ing the other once my debt to income ratio was decreased. With interest rates what they are, holding the mortgage is less attractive than it was a few years ago. But I still believe in having a mortgage, only I'd like to do it at today's historically low rates.

So after reading the suggestion above by atmsmshr I contacted Chase (one of my mortgage holders) about a recast. It looks like I can pay off about 60% of the mortgage I have with them. There's no cost, and it would keep my existing time frame for paying it off, except with a lower payment and less interest over the life of the loan.

Once I have done the recast, my debt/income ratio will fall below the 35% level, and I can refinance the other mortgage. I haven't pulled the trigger on this yet, but I'm running the numbers and don't really see the downside. Since I can't invest the mortgage money at a rate that approaches the cost of the mortgage, decreasing it would be a positive. And I'm pretty sure that over the life of the mortgage rates will increase and the arbitrage will work in my favor again. If not, I can always pay them off completely. But I'm willing to take that chance for now.

I'm always interested in the opinions and suggestions offered here. If anyone sees anything I should think about I'd appreciate hearing it.

 

[troutnut1]

Is it correct for me to use APR to compare costs of loans with different interest rates and discount points/closing costs? It seems that lenders do not standardize on how they include fees and calculate costs (transfer taxes, e.g.) to close the loan.

Well the feds came up with APR as a way to compare mortgages considering the costs as well as the interest over the entire loan term because they noticed exactly what you noticed. There is no standardization. And it is easy to be fooled. So it might be a little helpful, or at least ring an alarm bell, when the apr on one loan is significantly different than another. Hidden costs or sneaky methods will also affect the apr and may be a tipoff that something is wrong. But it is not necessarily true that a lower apr will always be the right loan.

Example: As a young whipper snapper I wanted to add AC and a redwood hot tub to a house when the 30 year interest rate was about 12%. A fast talking salesman told me he could get me a second mortgage at 10% to finance both (about $10,000 at the time) and I said sign me right up for that! When I got the loan papers the APR was sky high. Turns out he was using what he called “add-on” interest. He took the entire $10,000 x 10%, multiplied that interest times the 5 years of the loan, and divided by 60 months. Of course, that is is not how regular mortgages are calculated, and the APR gave it away.

Not long ago I helped my mom get a home equity loan that had a higher APR than a regular fixed rate 30 year loan. But she doesn’t need the money for 30 years, and the costs were very low. So it made sense even thought it was a higher rate and apr.

Another way of looking at it would be to consider your own “personal APR” in view of what you plan to do. A friend is now planning to invest $7000 in costs to refi a house she is only planning on keeping a few years. When you consider all the fees and appraisal, plus the interest, over only 3 years instead of 30, the APR will be HUGE. Because all those other costs are amortized over 3 years instead of 30. Neither does apr really consider differences in loan types, fixed, adj rate, etc. Its just one tool.

APR is simply a tool the feds gave us many decades ago to help compare loan costs and fees as if they were interest, and as if they were amortized over the entire loan term. Rarely do we actually pay of the loan over its entire term. The average person probably keeps the 30 year loan for 5 years. By then they have either sold, refi’d, lost it in foreclosure, died, etc. Lenders know this too. And calculate their yield over much shorter periods than the loans are written for.

Hope this helps!

 

[Montecfo]

Third Federal out of Ohio has a low cost 5 year ARM at 2.99 pct with only $295 closing cost. And you can relock at any time during the loan for another $295. They have other terms available soon.

Right now with rates low and so much uncertainty I would not be paying off the mortgage.

 

[jazz4cash]

Third Federal has pretty good HELOC programs also ( and the stock looks interesting too FWIW).

 

[jazz4cash]

Thanks troutnut1. That confirms my understanding. I’m always surprised how often someone will cite their refi rate without reference to the APR, especially with the depth of experience on this board. A borrower can pick from a variety of rates if they’re willing to pay or cash out at closing. Comparing APRs puts things on a nearly even basis.

 

[Retireby45ish]

Update: It’s been a few months since my first post and I’m pretty sure I’m going to pull the trigger on paying off mortgage next week.

As a refresher: I have about 40% of my net worth in cash and this uses about 40% (375k) of that to pay off the mortgage. And it still leaves me with the other 20% in case the market takes a tumble. I’m about 40/20/40 before this.

I guess last few months I kept comparing it to BND which yields 2.5%. comparing post tax for the two.

BND - 2.5%*(1-.25) =1.875% post taxes
Pay mortgage @ 3.75% —>> 3% after tax deductions
So, 3%/(1-.25%) = 4% post tax equivalent.

So it’s better by 2.125% or about $7970 a year, and with rates at historic lows the upside of BND doesn’t seem great vs the downside.

I hate losing the liquidity but it’s certainly the right thing to do for me since I figure I’ll get a lot of this back slowly since DW and I are still banking plenty of cash (10k+) each month from our J@bs.

Am I missing something? Let the collective wisdom speak now or forever have me make a mistake.

 

[troutnut1]

With my background in real estate, loans, and appraisal, I can probably think of lots of decent reasons to have our home financed, especially at these rates. But, we really love having a paid off house. We sleep better in a paid off house. And we haven’t ever (yet) felt like it was any kind of mistake. It occupies a different and unique part of our investment portfolio. A part we don’t fiddle with. A part that can’t be figured out with a calculator. My wife figures if everything else goes to he!! in a hand basket, we will still have a nice home on a river in Montana that suits us perfectly. I think you are smart and ready!