Refinance Mortgage or Not?

[Standard Staples]

I'm sure there have been hundreds of these, so I apologize if this seems like deja vu, but I was hoping to get advice on our specific situation:

Current Loan
Original Loan Amount: $246,400
Terms: 30 Year Conventional Fixed (No PMI)
Interest Rate: 3.875%
Payment: $1,158.66
Current Owed: $211,136.04
Current Payoff Date (if no extra principal paid): September 2038

Refinance:
Loan Amount $210,000
Terms: 15 Year Fixed (No PMI)
Interest Rate: 2.875%
Payment: $1,437.63
Loan Origination: January 2016
Payoff Date: December 2030


I picked January to make a clean date/number comparison. Obviously, if someone was selling me this product, they would highlight the 8 years earlier payoff date. However, I wanted to compare apples to apples. Basically, if I sent in the payment difference toward principal on my current loan, what would happen? So, I added $278.97/month through December 2030 on my current loan. In this situation, I would owe $24,234.88 in January 2031. With no more extra principal paid at that point, the loan would be paid off in October 2032.

So, comparing dollar for dollar, I'd save $24,234.88 and knock off 20 months. Closing costs are built in to this loan, so I think this is a pretty fair comparison.

So, what do you think? Is it worth the effort to make this change?

 

[Animorph]

It does reduce your borrowing costs, which is nice. But it also means you're paying more up front, money that could be invested. I'm in the keep the mortgage and invest camp. Usually when I compare mortgages this favors the one with the long period and no closing costs. If you can create a spreadsheet that compares the two using a rate of return for investing the difference that would show you the difference.

However, I suspect it's not big difference. If your goal is to pay off early the 15 year loan will be worth it if you don't have any closing costs.

 

[Jerry1]

Financially, it's a better option to take the 15yr mortgage. I'm not sure how you define "worth it". Financially, yes, it's worth it. As Animorph points out, investment income from the additional money you pay every month could reduce any real savings. You'll have to calculate that, but I suspect you'll still come out ahead.

The only thing I don't like about a 15 year mortgage is that you're stuck with the higher payment if you have some financial difficulties. If the interest rates were the same, I'd go with the 30 yr and increase my principle payments as my budget would allow.

However, the interest rates are not the same so that extra 1% is what is creating the $24,000 difference. Personally, I'd like one more set of numbers - what's the current rate on a 30 yr mortgage? You've compared a new 15 year mortgage to your current loan, but you haven't compared a new 30 yr mortgage to your current loan.

 

[Meadbh]

If you were to calculate the NPV, the 15 year mortgage would come out ahead. It would be possible to calculate the required return on investment of the difference in payments in order to break even. I'm not going to do that for you, but as you are probably aware, a period of lower net investment returns is anticipated. As Jerry1 said, a fairer comparison would be with a longer term mortgage. What mortgage term could you get with monthly payments similar to those you pay now? Given the two options you present, a key variable is the affordability of the larger monthly payment. If your cash flow can comfortably cover this, it makes sense to refinance.

 

[Standard Staples]

Current Loan
Original Loan Amount: $246,400
Terms: 30 Year Conventional Fixed (No PMI)
Interest Rate: 3.875%
Payment: $1,158.66
Current Owed: $211,136.04
Current Payoff Date (if no extra principal paid): September 2038
TOTAL REMAINING w/INTEREST: $315,285.77

Refinance 15 Year
Loan Amount $210,000
Terms: 15 Year Fixed (No PMI)
Interest Rate: 2.875%
Payment: $1,437.63
Loan Origination: January 2016
Payoff Date: December 2030
TOTAL COST: $258,773.40

Refinance 30 Year
Loan Amount $210,000
Terms: 30 Year Fixed (No PMI)
Interest Rate: 3.625%
Payment: $957.71
Loan Origination: January 2016
Payoff Date: December 2046
TOTAL COST: $344,744.48

======================================================

So, a new 30 year adds 8 years to the term and would cost an additional $29,458.71. The benefit would be a $200/month free up of capital.

But in terms of investment, on a very conservative 5% return... here's the numbers when compared to the most expensive monthly option (15 Yr):

Existing 30 Year: $278.97/month for ~23 years @ 5% + $1,437.63/month for 7 years @ 5% = $352,400.14

New 30 Year: $479.92/month for 30 years @ 5% = $401,755.19

New 15 Year: $0/month for 15 years + $1,437.63/month for 15 years @ 5% = $390,877.08

4% is the bottom breakaway point between the new 15 year and the new 30 year. Anything over 4%, and the 30 year runs away with it. I feel pretty confident I could make more than 4% in the market over 30 years. The math favors a new 30. Adding 8 years to the term is just a hard mental pill to swallow, I guess.

 

[Meadbh]

OK, you are comparing the FV (future value) 30 years from now. While the current mortgage clearly has a lower FV, the difference between the two new options is only $10,878.11. After 30 years of inflation, that will be an immaterial amount. I think it is a small price to pay for owning your home 16 years earlier.

 

[Texas Proud]

I would do the refi....

This is a return that you can calculate.... it has no real financial risks....


I have not calculated this, just throwing out numbers....

Would you rather have a guaranteed 4% return..... or

Would you rather have a possible 8% return, but it could be zero.... both returns are 50/50....

 

[daylatedollarshort]

How important is the cash flow for you with the lower payments? We've had to work to keep our AGI under the ACA cliff, so for us keeping cash outflow low means keeping taxable income low, which means saving over $10K less in after tax money on health insurance premiums each year. Plus staying under the state financial aid max income limits means financial aid for college for the kids including full grants for tuition. For us keeping cash flow out as low as possible for the next several years has a greater impact on our total net worth than interest rate differentials between one mortgage and another.

This may be irrelevant to you, just thought I'd mention it in case it is something you might need to consider.

Otherwise, our strategy has always been to refinance the balance on our 30 year mortgage whenever we can get a lower rate than our current one on a no point / no fee loan. The basic strategy some homeowners follow to do this is laid out in more detail here:

http://thefinancebuff.com/cost-mortgage-refinance-stepping-down.html

 

[Standard Staples]

Thanks for all the replies. Regarding cash flow, I'd say the $278.97 monthly difference is not of significant concern, but it's always nice to have as much money available as possible on any given month. A new year 30 opens up $200.95/month for other investments, compared to our current situation.

Thinking on it again, there's another worthwhile consideration. We don't plan to stay here for a full 30 more years. I would say our timeline is relatively locked in to the range of 20 years. So, similar assumptions, in 20 years:

Current Mortgage
(-$35,289.01) Mortgage Balance
$116,227.55 cash [$278.97 invested @ 5% for 20 years]
NET = $80,938.54

15 Year Refi
$0.00 Mortgage Balance
$100,092.06 [$1,437.63 invested @ 5% for 5 years]
NET = $100,092.06

30 Year Refi
(-$95,611.79) Mortgage Balance
$199,949.58 [$479.92 invested @ 5% for 20 years]
NET = $104,337.79

Obviously, the mortgage balances are the only guaranteed numbers in these scenarios. I'm not terribly debt averse, and I understand the value of low cost long term debt, so I guess I'm still on the fence about the whole thing. The 15 year does still seem like the strongest option, in terms of guaranteed numbers.

 

[lem1955]

Would you have to pay any points or fees for either of the refinance options? Another possibility that you hinted at in your op - make additional payments to the current mortgage each month - savings ~$32,094 interest and mortgage is paid off 6 years and a couple of months earlier. If you can't or don't want to make the additional payment one month, no penalty.

 

[rayvt]

You are confusing the issue by not comparing like-to-like (comparing a 15 yr loan with a 30 year loan). And confusing yourself by adding in the interest (which is spread over 15-30 years) as a lump sum in the comparisons. And you neglected to say what the costs of the new mortgage would be -- points, fees, etc.

I'm a serial refinancer. My rule-of-thumb is to refi whenever I can lower my interest cost by $100/mo. Note: interest, not payment. You have to compare like to like, so use the interest rate of a "zero-zero no cost" loan, where the rebate brings the total closing costs to $0.

At $211K @3.875% the interest is $682/mo. A 3.25% loan would have interest of $572/mo, $110 savings, so that would be my target. For a 30 yr mortgage.

The 15 yr vs. 30 yr is a separate issue. I personally think it's a smart financial move to borrow money at under 4%, and a dumb move to pay it off any faster than you have to. 4% money is the cheapest money you can find, and it is non-callable. You can easily invest and earn more than 4% (long-term).

Financially you are best off by borrowing that cheap money for as long as you can. Under 4% for 30 years is like manna from heaven.

 

[Jerry1]

I personally think it's a smart financial move to borrow money at under 4%, and a dumb move to pay it off any faster than you have to. 4% money is the cheapest money you can find, and it is non-callable. You can easily invest and earn more than 4% (long-term).

Financially you are best off by borrowing that cheap money for as long as you can. Under 4% for 30 years is like manna from heaven.

I wanted to see the 30 year because with the 30 year, you can decide whether or not you want to pay it off early but you don't have to.

I'm not sure "you can EASILY invest and earn more than 4%" but I do agree that if interest rates and inflation kick in, a 4% mortgage is going to look great and going with the 30 year mortgage is what I would do.

 

[Meadbh]

Deleted

 

[rayvt]

I wanted to see the 30 year because with the 30 year, you can decide whether or not you want to pay it off early but you don't have to.

Absolutely. You can always shorten a 30 year loan to 15 years (or 10 or 20), but you cannot stretch a 15 year loan to 30.

I'm not sure "you can EASILY invest and earn more than 4%"

For example: PSA (Public Storage, Inc.) keeps turning over their preferred stocks. Moody's rated A3. PSA-PW coupon is 5.2%. PSA-PA coupon is 5.88% . PSA-A Search Results - QuantumOnline.com
An older issue, PSA-PQ coupon is 6.5%--but the call date is 4/2016 and it will probably be called. PSA is a serial refinancer like me---rolling to a lower interest rate when rates drop and standing pat when rates go up

Historically, the S&P500 (including dividends) the worst 25 year rolling period had a CAGR of 7.2%. the 95'th percentile 25 year rolling return had CAGR of 8.1%. Median was 10.2%.
So over the lifetime of a mortgage, it is highly likely that the investment return will far outpace the mortgage cost. The main issue is being sure that you can keep making the payments in the periods where the market goes down.

 

[Standard Staples]

You are confusing the issue by not comparing like-to-like (comparing a 15 yr loan with a 30 year loan). And confusing yourself by adding in the interest (which is spread over 15-30 years) as a lump sum in the comparisons. And you neglected to say what the costs of the new mortgage would be -- points, fees, etc.

I'm a serial refinancer. My rule-of-thumb is to refi whenever I can lower my interest cost by $100/mo. Note: interest, not payment. You have to compare like to like, so use the interest rate of a "zero-zero no cost" loan, where the rebate brings the total closing costs to $0.

At $211K @3.875% the interest is $682/mo. A 3.25% loan would have interest of $572/mo, $110 savings, so that would be my target. For a 30 yr mortgage.

The 15 yr vs. 30 yr is a separate issue. I personally think it's a smart financial move to borrow money at under 4%, and a dumb move to pay it off any faster than you have to. 4% money is the cheapest money you can find, and it is non-callable. You can easily invest and earn more than 4% (long-term).

Financially you are best off by borrowing that cheap money for as long as you can. Under 4% for 30 years is like manna from heaven.

This note struck a chord with me, and I tend to agree with your sentiments. The lowest 30 year fixed I currently see is at 3.625%. Since this doesn't meet your criteria, I guess you would stick with the existing 3.875% mortgage?

 

[Pscott2019]

From personal experience I believe I would stick with the original mortgage and pay extra each month. It gives you financial flexibility that you may need in a pinch if needed. We refinanced to a 10 year note biweekly payments as my wife and I were both working good jobs and the payment was manageable. Soon after doing the refi my wife became disabled and is on SS disability. Now the payments are putting us in a bind. We are almost halfway to the goalie but it is painful. Flexibility is good. You never know what curve balls lay ahead.


Sent from my iPhone using Early Retirement Forum

 

[jkern]

I'm in the pay off mortgage sooner camp (refinance to 15). Since the monthly savings from not refinancing would be DCA into investments over 23 years, that would bring in sequence of return risk. I believe the very conservative 5% return is not all that conservative.

 

[Texas Proud]

I went with the 15 year mtg.... sure, I could have spread it out to 30 years and paid a higher rate and invested the difference....

But, I looked at this as part of my bond allocation.... not just extra money into my whole portfolio.... if you do that, the lower rates looks better...

Bond funds are not paying well right now.... rates will probably go up in the near and mid term future, not down.... that would mean a loss of principal....


The big problem with any mortgage discussion is that the extremes are.... pay off the mtg as soon as possible, no matter what.... you can sleep better..... and keep the mtg as long as possible and invest.... (which also leads to the really extreme of keep getting a new mtg and take equity out and invest that also).....

Most people fall somewhere in the middle and defend which side they fall.... I think people who are closer to each end defend their position more than the people who fall almost in the middle...

Therefore, there is NO correct answer... there is only what you feel comfortable with doing.... good luck with your decision...

 

[Senator]

From personal experience I believe I would stick with the original mortgage and pay extra each month.

+1

Unless it is a zero cost refi, I would keep the mortgage you have. You will likely have an appraisal, loan origination fees, deed taxes, recording fees, wire fees, doc prep fees, etc. that all get added to the balance (as you mentioned)

Pay the 15 year payment, ($278.97 extra) every month, and even a bit extra to make up for the extra mortgage expenses you would have had added, if you can. You will be paying ~$2K a year more in interest, for a little while, but you also have the flexibility to pay a smaller payment. That is worth something in and of itself.

 

[robnplunder]

May want to consider 5 or 7 year fixed ARM if you are likely to move in the next 5 years.

I was 4 years into a 5 years fixed ARM at 2.75%. It'd turn into adjustable rate loan in 12 months. I opted to get refinance it for another 5 year fixed ARM at same rate, with about $300 out of pocket expense. Having paid off my principal for 4 years, it lowered my monthly payment a bit, and I am locked into 2.75% for another 5 years. I probably move before the 5 year is up to downsize and get the equity out.

 

[Mulligan]

Absolutely. You can always shorten a 30 year loan to 15 years (or 10 or 20), but you cannot stretch a 15 year loan to 30.



For example: PSA (Public Storage, Inc.) keeps turning over their preferred stocks. Moody's rated A3. PSA-PW coupon is 5.2%. PSA-PA coupon is 5.88% . PSA-A Search Results - QuantumOnline.com
An older issue, PSA-PQ coupon is 6.5%--but the call date is 4/2016 and it will probably be called. PSA is a serial refinancer like me---rolling to a lower interest rate when rates drop and standing pat when rates go up

Historically, the S&P500 (including dividends) the worst 25 year rolling period had a CAGR of 7.2%. the 95'th percentile 25 year rolling return had CAGR of 8.1%. Median was 10.2%.
So over the lifetime of a mortgage, it is highly likely that the investment return will far outpace the mortgage cost. The main issue is being sure that you can keep making the payments in the periods where the market goes down.

This is exactly my line of thinking, Ray. I have all sorts of investment grade preferreds yielding 6.25% to 7% that haven't missed a payment in up to 50 years since issued. Im not paying off my 3.75% note when I can use the money to collect safe 6% plus interest. Yes, the price of the preferred stock can/will drop, but that doesn't bother me either as I reinvest the money anyways and would just get a higher yield if it did.


Sent from my iPad using Tapatalk

 

[Sunset]

I would go with the 15 yr mortgage if you already have a bunch of stock investments.

The reason is the savings is a guaranteed tax free rate, and it is a hedge against 0% to extremely low growth.
There is no guarantee you will earn 5% in the market for the next 20 yrs. Just ask anyone who invested a 100K in 1927 how it felt to wait until about 1954 to be back to 100K. (my dates are rough but it really was about that long).

Also the deduction idea of a mortgage becomes worthless for most folks when you owe less than 90K (even more when interest is low like now).