Author Topic: Pay down mortgage vs refinance and pay down mortgage  (Read 1394 times)

starguru

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Pay down mortgage vs refinance and pay down mortgage
« on: May 15, 2020, 08:23:26 AM »
Im hoping people smarter than me can provide the math behind these scenarios.

We currently are 2 years into a 10/1 ARM.  Our rate is 3.625.  The initial amount was $1000000 but the current balance is $390000.  The monthly payment is about $4500. For last months payment $1200 went to interest.

We could put $100000 into the principal.  Or we could potentially refinance to a 2.875% 5/1 ARM and then put the $100000 into that.  We are not worried about the ARMs as we would pay off any balance before the rate could adjust. 

Our goal is to pay the least amount of interest possible. 

Any insights into which is the better course of action?  Math is welcome.  I was trying to find amortization calculators but none of them seem to work well for ARMS.

Dicey

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #1 on: May 15, 2020, 08:32:41 AM »
Need more info. Why so keen on ARMs? What are your goals? What do your savings/investments look like? What country do you live in? How secure is your job? Do you have a FIRE goal?

You're welcome to come play over at the DPOYM Club, where you'll find lots of smart people willing to help.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #2 on: May 15, 2020, 08:46:50 AM »
Need more info. Why so keen on ARMs? What are your goals? What do your savings/investments look like? What country do you live in? How secure is your job? Do you have a FIRE goal?

The goal is to understand how much we'd be saving in interest by making large payments on the mortgage principal, or if it's better, refinancing to a lower rate and then making a larger payment. 

We are going to pay off the mortgage in 5 years at the most.  The only reason we are keen on ARMs is they seem to have the lowest rates.

We are in the US.

We have ~$2.5M in various financial assets, plus our home equity.  Wife's job is very secure with the federal government, I work for one of those large very popular tech companies and am pretty sure I'm not losing my job.  If I did I imagine I'd get a pretty decent severance.  I was fantasizing this morning that if that happened, it might be my kick into FIRE. 


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You're welcome to come play over at the DPOYM Club, where you'll find lots of smart people willing to help.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

I will take a look at this, thanks!

talltexan

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #3 on: May 15, 2020, 02:24:46 PM »
It sounds as though you're already blasting the mortgage to the tune of $500/day in overpayment. That requires a pretty steep commitment. What values/reasons did you have in mind when you initially committed to this plan?


starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #4 on: May 15, 2020, 02:44:18 PM »
It sounds as though you're already blasting the mortgage to the tune of $500/day in overpayment. That requires a pretty steep commitment. What values/reasons did you have in mind when you initially committed to this plan?

To what plan do you refer?  The plan to make extra payments on the mortgage?  Since our mortgage is an ARM we want to make sure that when the rate can change we are in a position to pay it off if it's favorable to do so.  Plus DW just wants to do it because she feels stress having this debt.  There's also given the market uncertainty caused by covid, what sort of guaranteed return can we get on our money?  For example, last year I paid $16k in interest to the mortgage holder.  Lets say over the next 4 years I would pay $50k (I don't know if it would be this much).  If I just paid off the mortgage thats over a 10% immediate return (pay $390k to save $50k), not to mention the cash flow I free up to invest in the market. 

We have not been putting $500/day at the mortgage.  We took out the $1M mortgage on our new house but we had close to $500k in equity in our hold house, so the majority of the payoff has been when I took that equity and applied it to the new mortgage. 

What I'm really asking is a math problem

2 years in to a 10/1 ARM at 3.625%, with a balance of $390k, how much in interest is saved by making $100k payment towards principal.

or

refinance into a lower rate mortgage, then make an $100k principal payment.  Calculate how much interest is saved. 




MDM

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #5 on: May 15, 2020, 03:20:10 PM »
What I'm really asking is a math problem

2 years in to a 10/1 ARM at 3.625%, with a balance of $390k, how much in interest is saved by making $100k payment towards principal.

or

refinance into a lower rate mortgage, then make an $100k principal payment.  Calculate how much interest is saved.
Lower interest is always better.

Don't look at how much interest you will save - look at how much you will pay, and/or how much money you will have left over.

From http://forum.mrmoneymustache.com/mustachianism-around-the-web/amortization-schedule-calculator/msg1219175/#msg1219175:

1. Open a new sheet in Excel
2. Press the "sheet1" tab on the bottom with a right-click
3. "Insert" --> "Spreadsheet solutions" --> "Loan Amortization"

JLee

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #6 on: May 15, 2020, 03:25:16 PM »
I would refinance your balance to a 30 year at 2.75-3% and put the remaining ~$2800/mo into an investment account.

https://www.cnbc.com/2020/05/15/mortgage-rates-just-hit-another-record-low.html

ChpBstrd

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #7 on: May 15, 2020, 04:38:24 PM »
The interest saved would be exactly as much as you’d earn if you invested the same payments into bonds with the same interest rates. So, e.g. putting a lump sum $10k toward your 3.625% mortgage has the exact same impact on your net worth as putting those $10k into a bond yielding 3.625% (aside from considerations of taxes, liquidity, and risk). So would you buy a very safe but illiquid bond at that interest rate? If yes, might as well prepay the mortgage.

To be specific, a $100k lump to the 3.625% mortgage will earn you $3,625 per year until the mortgage is paid off. The payoff date will be earlier by the amount of time it would take to pay off the last $100k of principle. This early payoff is equivalent to getting your principle back from a bond.

Should you refi? Hell yea! Even with the $100k slug your mortgage will still have $290k remaining. Looks like you could shave about 0.6% in interest right now, which would be worth (290k x 0.006) $1,740/year in your first year, declining in subsequent years as principal gets paid down. That should pay for closing costs in about 3 years. There are also deals out there where you can exchange a higher interest rate for zero closing costs.

starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #8 on: May 15, 2020, 07:08:34 PM »
I would refinance your balance to a 30 year at 2.75-3% and put the remaining ~$2800/mo into an investment account.

https://www.cnbc.com/2020/05/15/mortgage-rates-just-hit-another-record-low.html

The lowest Im finding are around 2.875 but only for ARMs. 

starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #9 on: May 15, 2020, 07:13:32 PM »

To be specific, a $100k lump to the 3.625% mortgage will earn you $3,625 per year until the mortgage is paid off. The payoff date will be earlier by the amount of time it would take to pay off the last $100k of principle. This early payoff is equivalent to getting your principle back from a bond.

Is it that simple?  I thought the thing about amortization is that the interest payments are front-loaded, and in that case it would be more complicated than that.  I mean, every payment I make the amount of the payment going towards interest decreases.

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Should you refi? Hell yea! Even with the $100k slug your mortgage will still have $290k remaining. Looks like you could shave about 0.6% in interest right now, which would be worth (290k x 0.006) $1,740/year in your first year, declining in subsequent years as principal gets paid down. That should pay for closing costs in about 3 years. There are also deals out there where you can exchange a higher interest rate for zero closing costs.

Right, but the same question applies -- if I make 100k payment now to reduce the principal, don't I achieve the same thing because all subsequent payments are lowered?




Dicey

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #10 on: May 15, 2020, 07:17:34 PM »
I would refinance your balance to a 30 year at 2.75-3% and put the remaining ~$2800/mo into an investment account.

https://www.cnbc.com/2020/05/15/mortgage-rates-just-hit-another-record-low.html

The lowest Im finding are around 2.875 but only for ARMs.
For how long a term? Dude, you have 2.5M bucks. You've made it! You really can do whatever you want. No wrong answers here. I hate prepaying though. I'm a bigger fan of lump-sum payoff. In your shoes, I'd take the cheapest ARM I could find, make every last payment, and keep investing the difference. When you have $2.5 million green soldiers, you certainly have more options. Honestly, the question you're asking doesn't really matter.

MDM

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #11 on: May 15, 2020, 07:23:59 PM »

To be specific, a $100k lump to the 3.625% mortgage will earn you $3,625 per year until the mortgage is paid off. The payoff date will be earlier by the amount of time it would take to pay off the last $100k of principle. This early payoff is equivalent to getting your principle back from a bond.

Is it that simple?
Yes.

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I thought the thing about amortization is that the interest payments are front-loaded, and in that case it would be more complicated than that.  I mean, every payment I make the amount of the payment going towards interest decreases.
The "front-loaded" idea is a common misperception.  You are always paying the same interest rate on the current principal. 

With a compounding investment, you are always earning the same interest rate on the current balance.

Try it in a spreadsheet if you need to persuade yourself.

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Right, but the same question applies -- if I make 100k payment now to reduce the principal, don't I achieve the same thing because all subsequent payments are lowered?
If the $100K payment occurs simultaneously with the refinance, then there is no "before" or "after" the refinance.  If you wait even one month after the $100K to refinance, you will have paid one extra month of higher interest.

MustacheAndaHalf

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #12 on: May 16, 2020, 01:05:57 AM »
We currently are 2 years into a 10/1 ARM.  Our rate is 3.625.
... Or we could potentially refinance to a 2.875% 5/1 ARM and then put the $100000 into that.  We are not worried about the ARMs as we would pay off any balance before the rate could adjust. 
It sounds like you are willing to pay off the loan in 5-10 years out of a fear of the rate adjusting.  I don't know how to put "fear of rate adjustment" into a math fomula, but have you considered a 15-year fixed rate mortgage?  While a 5/1 ARM is cheaper, a 15-year fixed is close behind, at around 3% (varies with bank/credit union).  I think that could be the right balance between lower interest rates, and ensuring you don't fear the adjustment period ending.

The Fed lowered it's rate to 0% back in early March.  Banks don't like uncertainty, which is probably why they've waited to react - Ally just dropped their savings rates (from 1.5% to 1.25%) this past week.  I would wait for banks to lower mortgage rates further, by watching the rates for the next few months (May/June/July).  It's very likely home buying will be lower this summer.  I suspect that will be a wake up call for banks and credit unions that new loans are not coming in, and they might start being competitive again.

Another option is a 30-year fixed rate mortgage, which you pay down faster each month.  If your situation changes, you can stop the early payments - so it's more flexible.  But you pay a higher interest rate on the 30-year fixed than you would on a 15-year fixed.

JLee

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #13 on: May 16, 2020, 06:11:01 AM »
We currently are 2 years into a 10/1 ARM.  Our rate is 3.625.
... Or we could potentially refinance to a 2.875% 5/1 ARM and then put the $100000 into that.  We are not worried about the ARMs as we would pay off any balance before the rate could adjust. 
It sounds like you are willing to pay off the loan in 5-10 years out of a fear of the rate adjusting.  I don't know how to put "fear of rate adjustment" into a math fomula, but have you considered a 15-year fixed rate mortgage?  While a 5/1 ARM is cheaper, a 15-year fixed is close behind, at around 3% (varies with bank/credit union).  I think that could be the right balance between lower interest rates, and ensuring you don't fear the adjustment period ending.

The Fed lowered it's rate to 0% back in early March.  Banks don't like uncertainty, which is probably why they've waited to react - Ally just dropped their savings rates (from 1.5% to 1.25%) this past week.  I would wait for banks to lower mortgage rates further, by watching the rates for the next few months (May/June/July).  It's very likely home buying will be lower this summer.  I suspect that will be a wake up call for banks and credit unions that new loans are not coming in, and they might start being competitive again.

Another option is a 30-year fixed rate mortgage, which you pay down faster each month.  If your situation changes, you can stop the early payments - so it's more flexible.  But you pay a higher interest rate on the 30-year fixed than you would on a 15-year fixed.

Penfed is advertising 2.875 for 30 -- https://www.penfed.org/mortgage-center

starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #14 on: May 16, 2020, 07:04:46 AM »
I would refinance your balance to a 30 year at 2.75-3% and put the remaining ~$2800/mo into an investment account.

https://www.cnbc.com/2020/05/15/mortgage-rates-just-hit-another-record-low.html

The lowest Im finding are around 2.875 but only for ARMs.
For how long a term? Dude, you have 2.5M bucks. You've made it! You really can do whatever you want. No wrong answers here. I hate prepaying though. I'm a bigger fan of lump-sum payoff. In your shoes, I'd take the cheapest ARM I could find, make every last payment, and keep investing the difference. When you have $2.5 million green soldiers, you certainly have more options. Honestly, the question you're asking doesn't really matter.

Thanks,  I would agree I have options for life in general, but the question of "how do I pay the least amount of interest to the bank" with the money Im willing to lump sum definitely has optimal and suboptimal options.   

Now help me convince DW a model Y is a good idea. ;)

starguru

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #15 on: May 16, 2020, 07:06:50 AM »
The "front-loaded" idea is a common misperception.  You are always paying the same interest rate on the current principal. 

Ok, I definitely learned something, thanks!

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Right, but the same question applies -- if I make 100k payment now to reduce the principal, don't I achieve the same thing because all subsequent payments are lowered?
Quote
If the $100K payment occurs simultaneously with the refinance, then there is no "before" or "after" the refinance.  If you wait even one month after the $100K to refinance, you will have paid one extra month of higher interest.

I think what you are saying is the lower interest rate with the lump sum payment results in least amount of interest paid? 

MDM

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #16 on: May 16, 2020, 03:27:03 PM »
I think what you are saying is the lower interest rate with the lump sum payment results in least amount of interest paid?
Yes.

MustacheAndaHalf

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #17 on: June 05, 2020, 05:30:39 AM »
@starguru - Just so you don't get burned waiting, it might be a good time to check mortgage rates.  Two reasons I'd suggest doing so now: first, recently home buying activity really picked up as people decided they'd rather live in a more spacious house if COVID-19 continues.  So there might be more mortgage activity, which keeps mortgage rates competitive.  And second, the 30-year treasury yields are moving upwards: back in mid-May the yield was 1.3%, and it's now 1.6%.  I read an article claiming the rise in yields was due to the economy reopening, which suggests there may be more increases to come.  (I'm assuming mortgage rates and treasury yields move in the same direction)

In your situation, I'd check mortgage rates soon and make a decision based on current rates.

habanero

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #18 on: June 05, 2020, 05:46:17 AM »
"how do I pay the least amount of interest to the bank" with the money Im willing to lump sum definitely has optimal and suboptimal options.   

If you want to pay as little interest as possible on your mortgage you have to have as little mortgage as possible, preferably none at all. And the sooner you get it down to zero the less interest you will pay in total. I would not do that, however, given how low rates are now and how small your mortgage (probably) is compared to your income and assets.

So the minimizing strategy would be to get the lowest nominal interest rate now available to you, then lump sum as much as you can to get rid of the mortgage and continue throwing money at it until it's gone as soon as possible.

I have done the complete opposite of you. I have an ARM and I have just stopped paying down the principal completely. For me now paying down has a guaranteed return of about 1% after tax and that's a negative return after inflation. Not a good investment, so only reason to pay it down would really be if I really wanted no debt (aka an emotional argument). I don't want a lot of debt relative to income/assets, but Im fine with some debt when its cheaper than free like is the case now.

But you are well set, you'll be fine regardless of what you do.

Stachless

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Re: Pay down mortgage vs refinance and pay down mortgage
« Reply #19 on: June 08, 2020, 07:52:36 PM »
I would suggest questioning the goal of 'paying the least amount of interest to the bank as possible'.   This falls into one of those tricky psychological / behavioral finance traps known as compartmentalization.

A better goal might be 'which action nets me the most $$$ at the end of (whatever) time period'.  If one course of action simultaneously nets you more $$$ BUT also involves paying more interest to the bank...would it still be 'sub-optimal'?

Cheers,