Not you average Mortgage Math help

[Mister Fancypants]

So I have a mortgage math question for all you mustacians out there.

My wife and I have been debating what we should do in regards to our mortgage debt; there is no right or wrong answer, just opinions… So I figured I would put some math out there and see what some of you thought.

We bought our house after the crash in in 2009 paying about $650k which was well below market, it appraised for $750k. We put down 20% so we had a loan for just over $500k for 30 years at 4.875%... Back then I thought we would never refinance, this is so cheap free money… yada yada yada…. I overpaid every month by 10% as well which would have knocked 7 years off the original loan so. The original payment was around $2700; I paid just over $3000.

Well fall of 2011 rates were even lower… we did our first refi, we did another 30 at 4%, this was just about getting a lower interest rate, we have no cash flow issues so my new payment was around $2400, however I reset the clock from 28 years to 30. I kept paying $3000.

Rates kept dropping and we wanted a liquidity backstop so in under a year we took the plunge and refi’d for the third time, this time we did both a rate and terms refi. We went from a 30 year to 20 year and our rate dropped to 3.375%. To qualify for this rate we split our loan in two a mortgage and a HELOC. The mortgage was for $417k and the HELOC had a limit of $85k we borrowed $75k, the HELOC was at 4.75%. To make this work both loans were with the same lender, however we wanted liquidity and a better rate. We immediately borrowed the additional $10k from the HELOC to pay down the new mortgage to $407k, so our total amount borrowed was still $492k ($407K mortgage/$85k HELOC). We than immediately refinanced our HELOC with another lender for a new line with a limit of $300k and a rate of 2.49%. I also had to pay down the mortgage by an additional $12k to get the appraisal in line with what the new HELOC lender needed CLTV to be. So our total mortgage balance was $391k @ 3.375% for 20 years and the HELOC balance was $85k @ 2.49% with $215k available to draw. The mortgage payment stayed within $6 of the previous mortgage payment, and we now had an additional interest only payment on the HELOC of ~$125. I continued paying the mortgage at $3000 minus whatever the HELOC monthly interest was.

So that is the long drawn out history on my mortgage to date… Based on the current path, with over payments, my mortgage will be paid off in 15 years. At some point the HELOC rate will rise above my mortgage rate at the point I will recast my mortgage and shift my current over payment, plus the recast savings currently at about $200 towards the HELOC (might put additional capital if rates sky rocket, or look at HELOC refi opportunities, but that is beyond the scope of this post as that is a big unknown, at some points rates will rise and the HELOC needs to be addressed as such). My current lender supports recasts at $250.

So the question should I refinance into a 10 year mortgage at between 2.75% to 2.875%. I will shave about 6 years off my current mortgage but my current payment will go up by about $900. I am leaning toward yes; my wife is leaning towards staying on the current path.

Doing the refi on the mortgage in a vacuum saving  6 years’ worth of payments at $2400 a month compared to adding $900 for 10 years is worth about $60k, however the payment is now higher than the $3000k I have been paying including the HELOC interest so it is about $1025 more a month and if you factor in the overpayments on the current mortgage the savings drop to about $30k. Now $30k is nothing to sneeze at over 10 years, but it ignores the interest rate risk on the HELOC which will go up and I no longer have recast ability or extra payments to through at that if rates to go up. I would be reliant on HELOC refi opportunities or additional capital sources; this is why my wife is hesitant.  My argument has always been reduce the interest as much as you can as early as you can so the principal is lower in the future so even if you have to refi at crappier rates or terms the balance is reduced so much the amount you owe is so reduced it no longer matters, as the HELOC interest rate risk is there regardless but might be understated and this $30k savings is concrete. She feels it is better to stay the course and adjust strategies within the current payment structure as rates change.

Our current mortgage balance is $352k @ 3.375% with just shy 15 years 11 months of payments left I am only 15 payments into the loan, the HELOC is $85k @ 2.49% the HELOC is prime - .75%.

What would you do and why?

Thanks,
-Mister FancyPants

[Thegoblinchief]

I'll be honest, reading that made me a bit dizzy. Have you incurred closing costs on any of these refi?

[Mister Fancypants]

I'll be honest, reading that made me a bit dizzy. Have you incurred closing costs on any of these refi?

LOL.... I did disclaim it with not your "Average" mortgage math...

Yes $3,500 to $5,000k per refi, those are sunk costs at this point and have amply been recouped... they were well calculated for in each refi at the time.

I would not expect to exceed $5k in costs at this refi either, most likely closer to the $3500 and those costs were included in the $30k to $60k savings.

[dandarc]

So right now, you've got 352K at 3.375% fixed for about 18 years left of 20 payment is about $2400 on this.  Also you've got 85K outstanding on a HELOC at 2.49% adjustable.  You've also got 215K of available credit with the HELOC.

The question is, should you refinance the 352K fixed to a 10 year at 2.875% fixed?  That comes out to about a $3400 payment.  total of $3600 with the HELOC.  You're already paying $3,000 per month, so the question is, is it worth it for tying up $600 in monthly cash-flow + closing costs to save the .5% interest?  I guess it will "pay-off" over the 10 years, but not sure it is worth worrying about.  I think you're over-stating the amount of interest that you'd save here (or at least the cause of it).  You'd be saving a half a percent - in year one you're saving at most $1760 in interest (352K * .005).  A large chunk of any savings come from simply paying the loan down faster, which you can do without the refinance.

What you might want to do is stop paying extra on the mortgage, and pile up your taxable account (assuming you are already maxing your tax-advantaged accounts ).  Will earn a better return depending on how you invest, and will help to mitigate the risk on the HELOC interest rate - if it gets too high, you can liquidate some or all of your taxable account to pay that off.  Take this with a grain of salt though - these numbers are so far out of my league that this is all very much hypothetical for me - I've got a 50K mortgage at 3.375% on a 125K house right now.

[Mister Fancypants]

So right now, you've got 352K at 3.375% fixed for about 18 years left of 20 payment is about $2400 on this.  Also you've got 85K outstanding on a HELOC at 2.49% adjustable.  You've also got 215K of available credit with the HELOC.

18 years left on the initial term, based on the current amount of extra payments if no additional extra payments are made the loan will be completely satisfied in just shy of 16 years. Everything else is correct.

The question is, should you refinance the 352K fixed to a 10 year at 2.875% fixed?  That comes out to about a $3400 payment.  total of $3600 with the HELOC.  You're already paying $3,000 per month, so the question is, is it worth it for tying up $600 in monthly cash-flow + closing costs to save the .5% interest?  I guess it will "pay-off" over the 10 years, but not sure it is worth worrying about.  I think you're over-stating the amount of interest that you'd save here (or at least the cause of it).  You'd be saving a half a percent - in year one you're saving at most $1760 in interest (352K * .005).  A large chunk of any savings come from simply paying the loan down faster, which you can do without the refinance.

Never said the savings were in interest, just said savings. Six years of payments at $2400 x 12 months is $172k. Ten years at $3300 x 12 months is $108k, the difference is $64k... Closing cost bring it down to $60k. Those numbers are strictly the mortgage. If you consider the ~$300 in overpayments I am making the number drops to about $30k. So the mortgage either costs me 10 years of $2400 worth of payments and then if I do nothing $172k in additional payments, if I do ~$300 in over payments $200k in additional payments or refi to the 10 year and it costs me and an additional $108k in additional payments. The HELOC cost is independent of the mortgage cost. That is what I original stated, and the number represents savings in my payment outlays.

What you might want to do is stop paying extra on the mortgage, and pile up your taxable account (assuming you are already maxing your tax-advantaged accounts ).  Will earn a better return depending on how you invest, and will help to mitigate the risk on the HELOC interest rate - if it gets too high, you can liquidate some or all of your taxable account to pay that off.  Take this with a grain of salt though - these numbers are so far out of my league that this is all very much hypothetical for me - I've got a 50K mortgage at 3.375% on a 125K house right now.

I didn't want to muddy this with other finances outside of the mortgage and HELOC, but my 401k is maxed, my IRA's are funded the legal limits and my taxable accounts funded and invested.

I am simply looking at mortgage math independently of other financial decisions.

Thanks for your response!

[Cheddar Stacker]

I am simply looking at mortgage math independently of other financial decisions.

Then get the lower interest rate.

I think your situation is likely pretty unique around here. Nothing wrong with that at all. But if you're not worried about the cash flow, investing the difference, optimizing everything else (since you've already done that) then just get the lowest rate you can. You have the cash to cover the payments right? And then some?

I say just switch to the 10 year with the lowest rate possible.

[Cassie]

If you can afford the higher payment even with one of you losing your job I say do the 10 year.  If not stay with what you have.

[dandarc]

I was thinking about this over lunch - I think you have to equalize the pay off time for both alternatives - if you don't, then you're really not getting a complete picture of the situation.  Plugging the numbers in, I've got you paying ~ 405K with the new mortgage over 10 years.  If you pay the old one off in 10 years, the payments are $415K.  So the refinance is saving you ~10K over ten years less closing costs, so probably $6500 over the course of 10 years.  I don't think this is a point to be glossed over - of the 60K (30K) total savings you get by switching to the 10 year note, you can get 50K (20K) of savings without locking yourself in to a much higher payment for the next 10 years.

Sounds like you have a pretty decent buffer, and could handle the higher payment in a variety of situations, so committing an extra $1,000 / month to the mortgage for the next 10 years might not be that big a deal for you - your plan that you've executed for years already has you actually paying $400 more than you have to, so this is only a $600 shock to the typical budget.  Gotta decide whether being able to drop your spend by 1K per month in an emergency is worth the $650 / year it would cost you.

[Mister Fancypants]

I am simply looking at mortgage math independently of other financial decisions.

Then get the lower interest rate.

I think your situation is likely pretty unique around here. Nothing wrong with that at all. But if you're not worried about the cash flow, investing the difference, optimizing everything else (since you've already done that) then just get the lowest rate you can. You have the cash to cover the payments right? And then some?

I say just switch to the 10 year with the lowest rate possible.

Well sorry mortgage/HELOC, I know the mortgage refi in itself makes sense, but it would be the first time I increase my above the initial mortgage payment + extra payment. This what concerns my wife. We have always reduced our cash flow, never increased it, and always saved interest and time.

I think the numbers probably work out in the long term, but with the variability in the HELOC it is hard to validate. And this time I lose the extra cash flow towards that variability.

[PloddingInsight]

after the crash in in 2009 ... it appraised for $750k...
Our current mortgage balance is $352k...
What would you do and why?

LOL Since you asked, I would sell it and retire on the proceeds.

[Cheddar Stacker]

Is there a solid reason to not payoff the HELOC with the next refi to reduce the interest rate risk? I would think locking in the low rate is your best bet. Keep the HELOC open for liquidity, just lower the outstanding balance.

I understand why you wouldn't want to increase the outgoing cash flow, but it seems like a small price to pay and from previous posts I gather it wouldn't be too difficult for you to pull off.

[Mister Fancypants]

after the crash in in 2009 ... it appraised for $750k...
Our current mortgage balance is $352k...
What would you do and why?

LOL Since you asked, I would sell it and retire on the proceeds.

Thanks... we have since put about $210k into the house and the current value is around $1.15m, a friend is under contract for a house down the road for that much.

[Mister Fancypants]

Is there a solid reason to not payoff the HELOC with the next refi to reduce the interest rate risk? I would think locking in the low rate is your best bet. Keep the HELOC open for liquidity, just lower the outstanding balance.

I understand why you wouldn't want to increase the outgoing cash flow, but it seems like a small price to pay and from previous posts I gather it wouldn't be too difficult for you to pull off.

Rates only good to $417k, conforming loans, once you go into the super conforming, and jumbo's the rate goes up. So consolidation isn't really an option.

I need to leave at least $65k on the HELOC for 36 months from opening or pay the fees that we skipped upon opening, so I can pay it down but not off. The subordination fee is only $100. The closing costs that would be due if I pay if off are more like $5k.... So that adds cost and makes the deal less lucrative at least for the next 12 months.

[Self-employed-swami]

Honestly, I'd leave it alone, for the flexibility of being able to make lower payments if the need arises, from unemployment, or another investment opportunity.

[gimp]

That's some impressive juggling.

As dandarc said, most of the benefit is from a faster pay-off and not the %. So I'd leave it and continue paying more so you have the ability to pay less if you have to for some reason.

[Mister Fancypants]

Honestly, I'd leave it alone, for the flexibility of being able to make lower payments if the need arises, from unemployment, or another investment opportunity.

That's some impressive juggling.

As dandarc said, most of the benefit is from a faster pay-off and not the %. So I'd leave it and continue paying more so you have the ability to pay less if you have to for some reason.

My wife will like you both.... taking the more conservative approach to leave it alone and just keep the overpaying...

I know the overpayments do most of the heavy lifting.... I just have this internal battle going on... I hate being in debt.... I can cut a check tomorrow and pay the whole damn thing off, but that would be stupid at these rates. So I look for opportunities to save over time like this... But I need to get past my wife who reels me in when they are just a little too extreme.

This is how we balance each other out... and keep the stache going in the right direction...

[Cpa Cat]

Do you have enough liquid assets to pay off the mortgage in full?

If so, then refinance at the lower interest rate, because the $3,000 ceiling is an arbitrary one. With the liquid assets available in other investments, you could easily afford the additional payment. And since you clearly want to pay off your house, then do it.

But... if losing your job/getting sick/etc would create a hardship scenario for you at the new mortgage payment, then don't. Put the extra $600 in taxable investments. When your investments grow to the point that you can afford it, pay off your mortgage.

[dandarc]

Honestly, I'd leave it alone, for the flexibility of being able to make lower payments if the need arises, from unemployment, or another investment opportunity.

That's some impressive juggling.

As dandarc said, most of the benefit is from a faster pay-off and not the %. So I'd leave it and continue paying more so you have the ability to pay less if you have to for some reason.

My wife will like you both.... taking the more conservative approach to leave it alone and just keep the overpaying...

I know the overpayments do most of the heavy lifting.... I just have this internal battle going on... I hate being in debt.... I can cut a check tomorrow and pay the whole damn thing off, but that would be stupid at these rates. So I look for opportunities to save over time like this... But I need to get past my wife who reels me in when they are just a little too extreme.

This is how we balance each other out... and keep the stache going in the right direction...

It would be interesting to see what she says if you offered to pay-off at a rate that would get it done in ten years rather than actually doing the refinance - it is less than $100 / month more on the payment front than actually doing the refinance.  I'm on your side of doing the refinance to pay the minimum amount, given that you have ample resources, so you're not really getting much from that flexibility provided by the current mortgage.  But if she's got veto power here, that might be a compromise you can strike if it proves impossible to assuage the fears - and it doesn't cost that much more than the refinance option.

[Mister Fancypants]

Do you have enough liquid assets to pay off the mortgage in full?

If so, then refinance at the lower interest rate, because the $3,000 ceiling is an arbitrary one. With the liquid assets available in other investments, you could easily afford the additional payment. And since you clearly want to pay off your house, then do it.

But... if losing your job/getting sick/etc would create a hardship scenario for you at the new mortgage payment, then don't. Put the extra $600 in taxable investments. When your investments grow to the point that you can afford it, pay off your mortgage.

The assets have a tax consequence associated with liquidation... That would complicate the payoff, I don't think I could justify the tax burden of the payoff. It would not be advantageous to sell the equities to pay the mortgage.

When I said I could cut a check tomorrow, I guess it was more a figure of speech rather than literally... I have enough assets to cover the value of the mortgage however the after tax value would be a much bigger lose the small savings in eliminating my mortgage that much sooner.

[Mister Fancypants]

Honestly, I'd leave it alone, for the flexibility of being able to make lower payments if the need arises, from unemployment, or another investment opportunity.

That's some impressive juggling.

As dandarc said, most of the benefit is from a faster pay-off and not the %. So I'd leave it and continue paying more so you have the ability to pay less if you have to for some reason.

My wife will like you both.... taking the more conservative approach to leave it alone and just keep the overpaying...

I know the overpayments do most of the heavy lifting.... I just have this internal battle going on... I hate being in debt.... I can cut a check tomorrow and pay the whole damn thing off, but that would be stupid at these rates. So I look for opportunities to save over time like this... But I need to get past my wife who reels me in when they are just a little too extreme.

This is how we balance each other out... and keep the stache going in the right direction...

It would be interesting to see what she says if you offered to pay-off at a rate that would get it done in ten years rather than actually doing the refinance - it is less than $100 / month more on the payment front than actually doing the refinance.  I'm on your side of doing the refinance to pay the minimum amount, given that you have ample resources, so you're not really getting much from that flexibility provided by the current mortgage.  But if she's got veto power here, that might be a compromise you can strike if it proves impossible to assuage the fears - and it doesn't cost that much more than the refinance option.

She could care less if I increased the payment as we both know it can be reduced anytime. I liked the financial engineering of the refi idea... just increasing the payment by another $100, $200, or $300 doesn't do much for me. I know at 3.375% I should be putting the money into investments. The over payments started as just 10% when it was 4.875% just to knock the 30 years down to 23. As we refinanced over time I just kept the payment the same... Several things have happened over the past 5 years, we have become much wealthier and instead of looking at the mortgage as something that everyone has now I see it as just a PIA. Secondly I have reduced the time to payoff so much I enjoy looking for creative ways to beat it down more. Its kind of a pass time of mine.

Oh and we both have veto power... it keeps us in line... :P

[dandarc]

Oh and we both have veto power... it keeps us in line... :P

Really is the only way!  Any way, no real bad choices here - just different degrees of optimization for different priorities.  Good luck - maybe there will be a slightly further dip in the next few weeks / months that will make the refinance an even better deal!

[Bank]

Interesting perspectives here.  I had a similar situation with 75% value on a conventional 30-year at 3.75% and 10% on a HELOC at a slightly higher rate.  I paid down the HELOC as quick as I could, but I love, love, love my mortgage and would never dream paying it off early.  It's a big, fat inflation hedge just sitting there.  I look forward to paying my mortgage twenty years from now when that amount is a pittance.  YMMV.

[Mister Fancypants]

Interesting perspectives here.  I had a similar situation with 75% value on a conventional 30-year at 3.75% and 10% on a HELOC at a slightly higher rate.  I paid down the HELOC as quick as I could, but I love, love, love my mortgage and would never dream paying it off early.  It's a big, fat inflation hedge just sitting there.  I look forward to paying my mortgage twenty years from now when that amount is a pittance.  YMMV.

I know looking at our finances as a whole keeping the mortgage for as long as possible or even refi the terms into a longer product at the current low rates makes sense. However our overall financial picture is in very good shape... I'm not worried about inflation or future expenses... So since I really dislike debt if I can avoid it even cheap debt that makes sense I like to eliminate it ASAP even if it is at the expense of potential higher earnings in the market.

My investment portfolio is by no means suffering or lacking.

I do appreciate your stance and perspective... As someone I admire once said... "That's why they make Chevys and Fords".

[Cheddar Stacker]

..As someone I admire once said... "That's why they make Chevys and Fords".

Awesome!

Your situation makes me think of this thread: http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/

A few quotes:

[quote from: arebelspy on April 20, 2014, 09:22:23 PM]

I like his idea of "when you've won the game, stop playing."

Quote from: warfreak2 on April 22, 2014, 08:53:16 AM

It's not that you are no longer comfortable with the safety of your earlier asset allocation, it's more that you have new, safer option that wasn't available before.


You have a new, safer option. You've won the game. So since you dislike debt, you're just going to stop playing. I get it.

[Mister Fancypants]

..As someone I admire once said... "That's why they make Chevys and Fords".

Awesome!

Your situation makes me think of this thread: http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/

A few quotes:

[quote from: arebelspy on April 20, 2014, 09:22:23 PM]

I like his idea of "when you've won the game, stop playing."

Quote from: warfreak2 on April 22, 2014, 08:53:16 AM

It's not that you are no longer comfortable with the safety of your earlier asset allocation, it's more that you have new, safer option that wasn't available before.


You have a new, safer option. You've won the game. So since you dislike debt, you're just going to stop playing. I get it.

I just read most of that thread... I am in the rich category not the very rich... I'm a 1%'er not a .1%'er. However my mindset and philosophy probably aligns more with .1% crowd... Once family money comes into play http://forum.mrmoneymustache.com/ask-a-mustachian/how-does-dynastic-wealth-affect-your-fire-plans/ we get a lot closer to the top of the crowd so our upbringing went in that direction.

Anyway I don't plan on retiring that soon and I already have more than most here would consider enough to FIRE with, so like you said I'm just looking at ways to make myself feel better about things... I can afford to leave the excess returns of the stock market on the table to reduce my mortgage because that makes me feel better. Just like I would prefer not to take the tax hit by selling equities to pay off the mortgage, that would not make me feel better.

Either way that is just moving assets around to optimize my situation, my current assets exceed my current liabilities and my future spending is accounted for based on my portfolio and its expected growth and draw downs.

No shopping carts under the overpass for me... Just optimizing a good thing :)