Refinance vs extra mortgage payments

[wideopenspaces]

Howdy friends!

We've been in our current house 3 years and plan to stay here . . . forever. We initially chose a 30 year mortgage because we wanted the flexibility to pay less after I had our second child and I cut down my hours. Well, we've had the kid, I've cut back the hours and we've continued to pay an extra $800-$1000/month on the mortgage, as we've been doing since day 1. The goal has always been to pay it off in 15 years. Now that we know we can continue making the extra payments, I'm wondering if we should just go ahead and refinance in to a 15 year mortgage. The interest rate is about 0.5 % lower than our current rate and would cost 5k in closing costs. Current mortgage is 300K. I'm trying to decide if we will save more than 5k in interest to make it worth it to refinance or if we should just keep paying the extra payment each month. I can't seem to find any calculators that tell me this. Anyone have any ideas?

Thanks!

[Zaphod]

wideopenspaces wrote:

Howdy friends!

We’ve been in our current house 3 years and plan to stay here . . . forever. We initially chose a 30 year mortgage because we wanted the flexibility to pay less after I had our second child and I cut down my hours. Well, we’ve had the kid, I’ve cut back the hours and we’ve continued to pay an extra $800-$1000/month on the mortgage, as we’ve been doing since day 1. The goal has always been to pay it off in 15 years. Now that we know we can continue making the extra payments, I’m wondering if we should just go ahead and refinance in to a 15 year mortgage. The interest rate is about 0.5 % lower than our current rate and would cost 5k in closing costs. Current mortgage is 300K. I’m trying to decide if we will save more than 5k in interest to make it worth it to refinance or if we should just keep paying the extra payment each month. I can’t seem to find any calculators that tell me this. Anyone have any ideas?

Thanks!

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If you're currently making extra payments of that amount, your effective rate is already likely more than that % without any closing costs or obligations. You can look up what your effective rate is online with a calculator or with a spreadsheet for sure. I would always check that before just refinancing to hit a number, in all likelihood you've hit it or can do so without refinancing. As you're essentially already doing that with prepayments.

[DMFA]

This is my favorite calculator for this: http://www.calculator.net/mortgage-payoff-calculator.html keep in mind you should use your tax-adjusted interest rate, since mortgage interest is tax deductible. So if you have a 3% mortgage in the 33% bracket, you're only actually losing 2% because you get 33% back at tax time (which should be worked into your year's taxes).

Depending on your overall goals, there is *probably* better use for your money than the amount you'll save on finance charges from your mortgage. Take the amount you would have saved, raised to the inverse power of years over which it would have been saved, and that's an estimate of the "equivalent" CAGR you "earned." For instance, if your current payment rate would save you $50,000 in interest over the next 10 years, and you currently owe $250,000, then you'd "earn" {[1 + (50,000/250,000)] ^ (1/10) } - 1 = (1.2^0.1)-1 = 1.84%. I'm not really for or against paying mortgages early; you just should know exactly what it's doing for you, including beyond just the balance sheet, before deciding to do it or not.

If you're paying 15-yr principal amounts on a 30-yr interest rate, then divide the closing costs by the amount not spent in interest, and that's how many months it takes you to break even. When I refi'd from a 30-yr at 4% to a 15-yr at 2.875% a couple years ago, it cost me about $8,000 (rolled into the principal) and I would have broken even at about 25 months.

So once you know what your break-even point would be, if you're going to stay in the house longer than that, then refinancing will likely be of benefit. However, if your tax-adjusted rate is 2% or less, which is about the annual rate of inflation, you should probably wonder if your money could be better invested in another asset with a higher gain.

[Donnie]

Rough math is that saving 50bps (0.5%) on a 15 year, $300k mortgage is $300k x 0.5% per year x 7.5 years (avg. life of mortgage) is $11.25k, so it is worth it from a numbers perspective. You would have to use a spreadsheet or calculator to figure out the precise numbers.

Overall, I would prefer to have the lower mandatory payment and longer term because it provides more flexibility. The $5k upfront fee is roughly half your interest savings, so paying 25bps or even 50bps more interest rate for extending term by 15 years seems worth it for me.

[StarTrekDoc]

Congrats on the kid --- is his 529 funded?  How about future expenses on anticipated with family expansion.

Those are factors that come into play with the additional payments that you're putting into the mortgage -- so question is --- is there better place for the additional $1000/month or not.

Pure math comparison 1:1 says refi wins, but you commit yourself to that path alone.   I'm of the opinion that mortgage is cheapest money around to do more interesting things than equity when you're in growth mode.

 

[wideopenspaces]

DMFA wrote:

 

If you’re paying 15-yr principal amounts on a 30-yr interest rate, then divide the closing costs by the amount not spent in interest, and that’s how many months it takes you to break even. When I refi’d from a 30-yr at 4% to a 15-yr at 2.875% a couple years ago, it cost me about $8,000 (rolled into the principal) and I would have broken even at about 25 months.

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Can you give me concrete numbers to explain this? I'm not sure I'm following and I'd like to calculate the break even point.

With the mortgage deduction, if you fall into the 33% tax bracket, you get a full 33% back of the mortgage interest you paid? Even if only part of your income is taxed at 33%?

And I know this is not the best thing we could be doing with our money, but I can't help it! I just really really really hate debt and I want to get rid of the mortgage. For me, this is the balance between using all extra cash to pay it off ASAP and dragging it out for 30 years and putting all available cash into our retirement funds.

Thanks, your reply was really helpful!

[wideopenspaces]

Donnie wrote:

Rough math is that saving 50bps (0.5%) on a 15 year, $300k mortgage is $300k x 0.5% per year x 7.5 years (avg. life of mortgage) is $11.25k, so it is worth it from a numbers perspective. You would have to use a spreadsheet or calculator to figure out the precise numbers.

Overall, I would prefer to have the lower mandatory payment and longer term because it provides more flexibility. The $5k upfront fee is roughly half your interest savings, so paying 25bps or even 50bps more interest rate for extending term by 15 years seems worth it for me.

Click to expand...

We plan to stay in the house long term, so the mortgage would be 15 years. So rough savings would be about 22k. Seems like the refi might be the way to go. I don't anticipate we'll ever have another year with as little income as we've had this year (I normally make about 100k more and I anticipate being back at that salary by the end of next year) and we've had no problem with cash flow with the lower income, so I don't think we need the flexibility anymore.

[Donnie]

wideopenspaces wrote:

Donnie wrote:

Rough math is that saving 50bps (0.5%) on a 15 year, $300k mortgage is $300k x 0.5% per year x 7.5 years (avg. life of mortgage) is $11.25k, so it is worth it from a numbers perspective. You would have to use a spreadsheet or calculator to figure out the precise numbers.

Overall, I would prefer to have the lower mandatory payment and longer term because it provides more flexibility. The $5k upfront fee is roughly half your interest savings, so paying 25bps or even 50bps more interest rate for extending term by 15 years seems worth it for me.

Click to expand…

We plan to stay in the house long term, so the mortgage would be 15 years. So rough savings would be about 22k. Seems like the refi might be the way to go. I don’t anticipate we’ll ever have another year with as little income as we’ve had this year (I normally make about 100k more and I anticipate being back at that salary by the end of next year) and we’ve had no problem with cash flow with the lower income, so I don’t think we need the flexibility anymore.

Click to expand...

Sorry, I wasn't clear.  The 7.5 years is the average time until a $ of principal is repaid assuming you pay the mortgage down over 15 years.  It's not exactly 7.5 years.  Average life will be a little longer because interest payments mean that you pay down less principal each month in the early years than the later years.

Your total interest over the 15 years will be equal to average life x principal x rate.  Using 7.5 years as a rough estimate of average life gives the $11.25k savings above over 15 years.  It will actually be a little bit more that $11.25k of savings.

I think having the option of making the extra payment or not is worth the additional interest expense, but if you have a rock solid income and want to force yourself to pay it down quick, the refi is probably for you.

[wideopenspaces]

StarTrekDoc wrote:

Congrats on the kid — is his 529 funded?  How about future expenses on anticipated with family expansion.

Those are factors that come into play with the additional payments that you’re putting into the mortgage — so question is — is there better place for the additional $1000/month or not.

Pure math comparison 1:1 says refi wins, but you commit yourself to that path alone.   I’m of the opinion that mortgage is cheapest money around to do more interesting things than equity when you’re in growth mode.

 

Click to expand...

Thanks! No 529 yet. Maybe I'm a pessimist, or just a jerk, but who knows if this kid is going to college! Right now he just sits around trying to eat every piece of trash he can get his hands on. But seriously, my husband and I haven't decided about paying entirely for college. Neither of us had any help from our parents, we both worked and had scholarships and graduated with no undergraduate debt. So I'd like some element of that for our kids. We'll see though. For our 9 yo, we put in about 4k/year and will start doing that with the baby in a year or two.

As for additional costs, I got a 15% raise since having the baby, so once I'm back to my usual 0.75 FTE, the raise will cover daycare expenses. And then we do public school, so for us, the second kid won't be too much more expensive than the first one.

And I know we could always put more into retirement, but we're already nearly a year ahead of where I planned to be at this point with retirement savings (I made a spreadsheet to project where we need to be each year to meet our retirement goals) so while it's a better financial move, I feel ok with where we are there.

[wideopenspaces]

Donnie wrote:

wideopenspaces wrote:

Donnie wrote:

Rough math is that saving 50bps (0.5%) on a 15 year, $300k mortgage is $300k x 0.5% per year x 7.5 years (avg. life of mortgage) is $11.25k, so it is worth it from a numbers perspective. You would have to use a spreadsheet or calculator to figure out the precise numbers.

Overall, I would prefer to have the lower mandatory payment and longer term because it provides more flexibility. The $5k upfront fee is roughly half your interest savings, so paying 25bps or even 50bps more interest rate for extending term by 15 years seems worth it for me.

Click to expand…

We plan to stay in the house long term, so the mortgage would be 15 years. So rough savings would be about 22k. Seems like the refi might be the way to go. I don’t anticipate we’ll ever have another year with as little income as we’ve had this year (I normally make about 100k more and I anticipate being back at that salary by the end of next year) and we’ve had no problem with cash flow with the lower income, so I don’t think we need the flexibility anymore.

Click to expand…

Sorry, I wasn’t clear.  The 7.5 years is the average time until a $ of principal is repaid assuming you pay the mortgage down over 15 years.  It’s not exactly 7.5 years.  Average life will be a little longer because interest payments mean that you pay down less principal each month in the early years than the later years.

Your total interest over the 15 years will be equal to average life x principal x rate.  Using 7.5 years as a rough estimate of average life gives the $11.25k savings above over 15 years.  It will actually be a little bit more that $11.25k of savings.

I think having the option of making the extra payment or not is worth the additional interest expense, but if you have a rock solid income and want to force yourself to pay it down quick, the refi is probably for you.

Click to expand...

ah, ok, thanks for the clarification! Something else to take in to account . . .

[Zaphod]

wideopenspaces wrote:

StarTrekDoc wrote:

Congrats on the kid — is his 529 funded?  How about future expenses on anticipated with family expansion.

Those are factors that come into play with the additional payments that you’re putting into the mortgage — so question is — is there better place for the additional $1000/month or not.

Pure math comparison 1:1 says refi wins, but you commit yourself to that path alone.   I’m of the opinion that mortgage is cheapest money around to do more interesting things than equity when you’re in growth mode.

 

Click to expand…

the second kid won’t be too much more expensive than the first one.

And I know we could always put more into retirement, but we’re already nearly a year ahead of where I planned to be at this point with retirement savings (I made a spreadsheet to project where we need to be each year to meet our retirement goals) so while it’s a better financial move, I feel ok with where we are there.

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You'll be surprised, they are just as spendy as the first.

I dont think you can ever be too far ahead unless you feel like you are actively depriving yourselves. If you ever get too far ahead you can always just quit altogether.

[wideopenspaces]

You’ll be surprised, they are just as spendy as the first.

I dont think you can ever be too far ahead unless you feel like you are actively depriving yourselves. If you ever get too far ahead you can always just quit altogether.

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haha, I just meant that our first kid hasn't been very expensive, outside of montessori school for 3 years.

And for retirement, I just meant that I'm more than comfortable with where we are right now. I know you (and probably others) think I'm crazy for doing this . . .

[Zaphod]

wideopenspaces wrote:

You’ll be surprised, they are just as spendy as the first.

I dont think you can ever be too far ahead unless you feel like you are actively depriving yourselves. If you ever get too far ahead you can always just quit altogether.

Click to expand…

haha, I just meant that our first kid hasn’t been very expensive, outside of montessori school for 3 years.

And for retirement, I just meant that I’m more than comfortable with where we are right now. I know you (and probably others) think I’m crazy for doing this . . .

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Not at all, just hard to see the why go through the trouble when you're already basically doing it anyway. I ultimately dont care at all what people wish to do with their money, i just say stuff and like to argue.

[DMFA]

It's just like every other tax deduction. Mortgage interest is tax deductible. A tax deduction reduces your taxable income. Hence it affects whatever your marginal rate is. So yes, your taxable income is reduced by your mortgage interest, thereby giving you back a percentage equal to your marginal bracket, hence the example I have.

Say you paid $6,000 of mortgage interest in a year. That reduces your taxable income by $6,000. If you're into the 33% bracket, then that's $1,980 you didn't have to pay in taxes, hence you only lost 67% of your interest...so your "effective" rate is 67% of what it was.

...this is how tax deductions work, and why they're so important when you're in the high brackets.

[wideopenspaces]

Zaphod wrote:

i just say stuff and like to argue.

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Haha, I may or may not be married to someone who also likes to do this ;-)

I do enjoy hearing your perspective though. It makes me wish I could be more rational about debt.