Silver lining: Refi Opportunity

Blog post #455

One of the silver linings of the pandemic outbreak is the opportunity to refinance your mortgage or other loans.

You should investigate refinancing and act on this soon. The opportunity for this significant financial benefit should not be ignored.

Key takeaways:

  • If your current mortgage is at an interest rate of 3.5% or higher, and you expect to be in your current house for more than a few years, you should consider refinancing your mortgage.
  • This can be a very individualized decision and there are many options available. Please contact us to discuss refinancing and the impact on your overall situation.
  • In general, we have long been advocates for not pre-paying mortgages, as you should be able to earn more over the long-term with a diversified portfolio than the after-tax cost of a mortgage.
    • However, given the very low rate of interest that can be earned on fixed income investments and that these historically low mortgage interest rates make 15-year mortgages more realistic for more people, we think 15-year mortgages make more sense now than they were in the past.
  • With the ability to borrow at such low interest rates, regardless of whether it’s for a 15 or 30 year mortgage, we still do not think paying off your mortgage balance in full makes sense for most people, especially if you are younger than 60-70.
    • When you pay off your mortgage in full, you are using significant capital that will no longer have the potential to grow for you. While the stock market is always volatile in the short run, in the long run the stock market has outperformed these interest rate levels during almost all 10-20 year time periods. We feel that paying off a significant mortgage all at once, unless you have a vast portfolio, is not the right strategy for most people. 

Current rates: Interest rates vary based on your specific situation, but 30-year mortgage interest rates are just above 3% with no points and 15-20 year rates are now less than 3%. You can pay additional fees, called points (usually .25%-1% of the loan amount), to “buy down” the interest rate to be even lower. I was quoted a 15-year mortgage with 1 point for 2.5%.

  • Buying down the interest rate may make sense, but the payback period may take around 5 years if you pay a full point. Thus, paying additional points should only be considered if you are quite confident that you will be staying in that house for several years, depending on the cost of the points you pay.

Traditionally, most mortgages have been for 30 years. As rates are so low, or you may be many years into your current mortgage, a key question is how many years should your new mortgage be?

  • In other words, should you refinance from a 30-year to a 15-year mortgage?
  • Or should you consider a 20-year mortgage, which is less widely available? 

Let’s review some key concepts to consider in evaluating the refinancing decision process.

Should you refinance? If the savings of reduced monthly payments are greater than the cost of refinancing (and potentially any points you pay) within a few years, and you are sure you are staying in your home for at least a few years, than you should definitely pursue the refinance.

  • For most people, the answer will be yes, if your current mortgage interest rate is at 3.5% or greater.
  • If you have 30-year fixed mortgage of $400,000 at 4%, your monthly payment would be $1,910 (we are not considering property taxes or escrow payments, as these are not really affected by the refinancing).
    • If you refinance with another 30-year mortgage at 3.25%, your new payment would be $1,741 per month.
    • This is a savings of $169 per month, or $2,028 per year.
    • If the refinance costs around $3,000 for illustration purposes, the cost would be recouped in about 1 ½ years, which makes this a simple decision to do the refinancing.
    • Over the 30 years, you would save almost $61,000.

Should you consider a 15-year mortgage?

  • The interest rate may be even lower, say around 2.75% with no points.
  • However, because you are shortening the mortgage term from 30 years to 15 years, the monthly payment will go up significantly.
  • This becomes a major decision, as you must decide if you can afford to lock in a much higher monthly cost, as the payment will increase so much.
    • In our example with a $400,000 mortgage above, the payment would increase from the current $1,910 per month for the 30 year mortgage to $2,714 per month with the 15 year mortgage.
    • This would be an increase of $804 per month, or $9,650 per year.
  • The advantage of the 15-year mortgage is that you will have no mortgage payments later in life or much more equity in the house, faster. You would save more than $138,000 in interest payments in this example.
  • Going to a 15-year mortgage should be considered if you have significant excess monthly savings and you are confident that will continue, and you already have a substantial investment portfolio.
  • If you are not sure about your future income, and your income and expenses are relatively close, then you should probably pass on considering a 15-year mortgage and be pleased with the savings of refinancing to a new 30-year mortgage.

Some other things to consider:

  • Mortgage interest is deductible and if you refinance, the interest will still be deductible if your refi amount is $750,000 or less. Mortgage interest is one of the few tax deductions that remains without limitations. On an after-tax basis, mortgage interest actually costs even less than the stated interest rate.
  • If you cannot afford a 15-year mortgage as the monthly payments are too high for you, but you are part way through a 30-year mortgage, you can always pay more each month, to stay on the same time payment schedule as your current mortgage term. We can assist you in determining this. 
  • We would still advise younger people, particularly those below the age of 40, and maybe even below age 50, to use a 30-year mortgage. The longer your personal time frame, the greater opportunity you have to earn much more in a diversified portfolio than the cost of a mortgage. You can still lock in an incredibly low interest rate for 30 years and use the remaining funds to invest for the long-term.

We hope this information is helpful to you and your family.

This topic is one that you should discuss with your family members, to make sure that they are reviewing their personal situation and doing what is best for them. We would be pleased to discuss this topic with you, or others close to you.

 

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