Refi’s – more than just money in your pocket

  • Do today’s low mortgage rates have you considering a refi?
  • Are you thinking about moving when the real estate market picks up or gets back to “normal”?
  • Do you find yourself checking mortgage interest rates every Sunday?  
Many of my clients are asking if they should pay off their mortgages. There’s no one right answer, but I would suggest that there are a number of options available beyond paying it off in full, or maintaining the status quo. No matter which option you choose, in most cases I recommend that you consider paying it off more quickly.  Perhaps you make extra payments and request that they be applied to reducing the principal; maybe you pay a little extra toward the principal in every mortgage payment; or perhaps you switch to a 15-year mortgage or 30-year mortgage with a lower interest rate.
No matter how attractive today’s mortgage rates might be, if you are looking at moving in three to five years, my first thought would be to disregard the idea of a re-fi.  There are expenses built into every refinance, plus you will start over at the beginning of an amortization schedule.  [Remember when you made your first mortgage payments, and almost none of the payment went to reduce the principal?]
When you consider whether to refinance your mortgage, do you look at how much your monthly mortgage payment goes down or up?  What will this change do to your cash flow?  
Being curious I decided to put my financial planning software on the task.  I used a male, age 64, who plans to live in his home another five years before downsizing, gave him a $150,000 salary, $40,000 pension, social security, and a $14,400 property tax deduction.  I know that’s not you.  It’s probably the LAST person you might think should consider a good candidate for a refi.
Here are the four scenarios:
Keep the current mortgage –  $290,000 loan amount at 5.5% that will be paid off in 24 years, $1,942 monthly payment
Continue the current mortgage, but make two extra payments a year.
Refinance into a 15 year loan at 3.75% fixed, incurring $3,000 of set up costs, $2,109 monthly payment
Refinance into a 30 year adjustable rate mortgage that has a five year fixed rate of 3.125% and a lifetime cap rate of 8.125%
Here are the Pro’s and Con’s for the four choices:  
Keep the Current Mortgage – (Baseline Scenario) 
Pro’s                                                                       Con’s
Avoid $3,000 of expenses                                      Miss out on interest savings. 
Net Worth Advantages
     $15 in ten years
Keep the Current Mortgage and Make Additional Payments
Pro’s                                                                       Con’s
 $52,000 in total interest savings                           $14,000 additional income taxes
Flexibility in making higher payment                      Requires discipline
Net Worth advantages:                                          Net Worth disadvantages:
      $222 in five years                                                  $15 in ten years
      $17,000 in 15 years
      $45,000 in 20 years
 Refinance Into a 15 Year Loan
Pro’s                                                                      Con’s 
$93,000 in total interest savings                            $30,000 higher taxes over 22 years     
                                                                                    $2,000 less available to spend/year
Net Worth advantages:
      $9,000 in five years
      $23,000 in 10 years
      $30,000 in 15 years
      $46,000 in 20 years
Refinance Into an Adjustable Rate Mortgage (ARM)
Pro’s                                                                      Con’s
Save $25,000 in taxes                                               Pay $96,000 more in interest with the worst case 
Flexibility with mortgage payment in first five years 
– I assumed additional $700 paid and applied to the principal.
Net Worth advantages:
      $12,000 in five years
      $66,000 in 10 years
      $60,000 in 15 years
      $14,000 in 20 years
Are you surprised?  I am.  I did not expect that it would be better to refinance, in the short term, five years, regardless of whether it’s a 15 year loan or an ARM.  I am not surprised at all that the ARM may cost the most under the worst case scenario.  It’s interesting that you can almost duplicate the impact of the 15 year refinance with the extra principal payments after 20 years.  
In order to qualify to finance, many factors need to line up:  the value of your home must be well within the loan amount; you need to demonstrate steady income; be able to demonstrate stability in your work, and have a favorable credit rating.
This ezine is not meant as a recommendation to refinance. However, it is a recommendation that before you make such an important decision, you first discuss your options with a financial planner, preferably an independent planner who does not sell financial products and works on an hourly basis only.
Now that’s an easy decision!