Having been in our house for a year, we are now in the process of refinancing our mortgage. Rates are as low as 4.5% for a 30 year fixed mortgage (maybe even lower in some areas for borrowers with pristine credit).
I've sort of perversely enjoyed working through the numbers on my spreadsheet, and I've learned or reminded myself about a few things in the process.
1) If you're trying to decide whether to refinance, calculate your rate of return, given certain time frames. Take the amount of savings you would generate each month, discount the savings at a particular interest rate, and then see how long it would take to break even. For example, if it cost you $5000 in closing costs to save $150 per month, that would yield a return of 5% if you stayed in your house another
three years. If you stayed in your house 4 years, you would earn a return of 19% on your $5000 investment. Of course if you only stay in your house for 2 years, your return will be -30%. It only makes sense to refinance if you plan to stay where you're at for a while.
2) I was surprised to learn that my bank's formula for the payback period for a refinance is simply:
Closing costs / difference in monthly payments.
At least in our case, we would get two benefits from a refi: lower monthly payments AND faster principal buydown. In the early years of our new loan (when the expected time value of money is greatest) we will buy more principal each month than we would with our original loan -- even though our monthly payments will be lower.
3) Paying off your loan early may be virtuous, but it might not make financial sense. If you have a low mortgage rate, additional principal payments are a good way to hide your money from yourself and lock-in a low, but ethical, tax-free or tax-deferred return. Given the recent gyrations of the stock market, this might sound somewhat appealing. But in the long run...you might need that money for something else, and you can probably find an instrument that
would yield a greater return (though you might forfeit your soul in the process).
4) If, say, 5 years down the line, mortgage rates have significantly increased, your house will be worth a lot more to you than a house with the exact same market value.
2 comments:
Without spending any more money, if your bank will take your payment from you 2 x per month (paying only 1/2 at a time) you will cut years off your mortgage.
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