Author Topic: Reader Case Study: Pull back on retirement to refi to 15 year mortgage?  (Read 3629 times)

fallstoclimb

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Life Situation: It's just my husband and me, no current plans for kids (we are 30, I guess the clock might still start ticking but I doubt it).  Last fall I paid off my 70K in student loans, a huge goal of mine.  No debt besides the mortgage.  We bought in 2013, and at the time couldn't consider the 15 year loan due to my student loan payments.  I'm still not sure whether or not it would be worth it, hence the post.

Our FI plan is to have the flexibility to walk away from our jobs, or dramatically cut down our hours (if we still want to) when we are 45 -- basically this means we are aggressively saving for retirement now and plan to stop contributing at age 45 (or cut down to the match amount or whatever), and then only need enough money to pay the bills.  We are currently perhaps a bit behind in savings due to the prior fixation on the student loan, but are quickly catching up.  We are a bit light on cash. 

Gross Salary/Wages:  $5,375 biweekly / $145,125 annual

Pre-tax deductions: $1,457 biweekly, which includes health insurance and paying into pension.  We are putting $2,478/mo into 457 & TSP plans, which includes my 5% agency match ($170/pp).

Adjusted Gross Income: $4,035/biweekly, $108,950 annual

Taxes: $10,700 federal, $8,000 state, $8,500 social security, $2,000 medicare

Current expenses: Between 4.5K and 5.5K a month.  Last year's total spending, not including student loan payments or husband's tuition, was 60K (20K of which was mortgage).  It'll probably be a bit higher this year. 

Mortgage:
Interest rate is 3.75%
$467 principal
$866 interest
$328 escrow
~$1670 total

Assets:
$10,000 in emergency fund (contribute $500/mo, would like this closer to 20K but am comfortable with the slow increases)
$69,000 across TSP, 403b, 457
House appraised at $305,000 in 2013 sale
+some small buffer/budgeting cash funds

Liabilities:
$277,000 mortgage

Specific Question(s): Our interest rate on our mortgage is great, at 3.75%.  I believe common advice is if your interest is under 4%, you are better off investing your extra money rather than overpaying the mortgage.  However, refinancing to a 15 year mortgage from a 30 year mortgage would save us about 100K in interest even if we get the same interest rate (and my understanding is we'd probably be able to get one a bit lower).  It also lines up conveniently with the timing of our entry into stopping retirement/gaining more flexibility in life.

According to Bankrate, our P&I would jump to about $1,900 total, plus the $328 in escrow -- let's round up and say our total payment would be $2,300, or about $550/month higher than our current payments.

If we want to keep contributing to our emergency fund (which I do), and have a bit of a monthly buffer (which I do), I think we'd have to pull ~$300 or maybe even $400 a month out of our retirement contributions to be able to make the payments -- except of course taxes would eat up some of that so we'd have to pull a bit more.

We are both in the public sector and while our salaries are good, we do not expect any meaningful raises...probably ever again!  We might be able to increase retirement contributions back towards our current level but it would be a slow process.   

I am pretty happy with the amounts we are putting in retirement right now - we are on target for our quit-contributing-at-45 goal - but another complication is in the back of my head is I'm always thinking that we should put some money in a Roth IRA, as another form of semi-accessible cash. 

So is this worth looking into?  Or should we just stay the course with 457/TSP contributions?


Catbert

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I would stay the course with TSP/457.  You can pay extra on the 30 year mortgage as you have extra money.  As the years go by your ability to pay extra increase so you could still aim to have paid off in 15 years.  In the long run 3.75% is stellar.  When interest rates jump up (and they will eventually) you may decide to pay off as slow as possible instead.

Your ability to contribute to TSP/457 closes each year.  If you pay less in 2015 you can't "make it up" in 2016 or 2020. 

I'm sure someone will chime in with a math answer.

nereo

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Quote
Specific Question(s): Our interest rate on our mortgage is great, at 3.75%.  I believe common advice is if your interest is under 4%, you are better off investing your extra money rather than overpaying the mortgage.  However, refinancing to a 15 year mortgage from a 30 year mortgage would save us about 100K in interest even if we get the same interest rate (and my understanding is we'd probably be able to get one a bit lower).  It also lines up conveniently with the timing of our entry into stopping retirement/gaining more flexibility in life.

The problem with this line of thinking is that it assumes you do not put that money to better use.  If you continue with your 30 year mortgage and you continue to fund your 457/TSP, and those investments return more than 4%, you will have more money after 15 years, not less. 
True, you will pay $100k more in interest over 30 years, but you will be able to save a lot more over the first 15 year period.   

KCM5

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Even if you did want to pay your mortgage in 15 yrs rather than 30, it probably doesn't make much sense to refi. How much lower would the interest rate be? Nothing is stopping your from paying the 15 year amount with the extra going to principle every month. If you really want to do it, get some info on how much the refi would cost and what the interest rate would be. Then calculate your return. I'd bet that you'll be better off just paying extra every month.

All that said, are you currently maxing all of your pretax savings? If not, I'd max that before considering paying off the mortgage, but I know all of that is a personal decision.

nereo

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here's a graph detailing four simplistic scenarios. 
All assume a $200k mortgage @ 3.75%
blue line = 15 yr mortgage (after 15 years 100% of investments will be piled into savings
red, green & purple lines represent annual returns of 4, 6, & 8% respectively.
Only a 4% return will be surpased by the 15 yr mortgage, and only at year 29. 

note:  even the 4% seems super-conservative, since this is not real-adjusted, and your mortgage is fixed in today's dollars.  this would be a real return of 1-2% if inflation holds around historical levels.
« Last Edit: June 02, 2015, 09:02:43 AM by nereo »

MDM

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All assume a $200k mortgage @ 3.75%
Only a 4% return will be surpased by the 15 yr mortgage, and only at year 29. 
Never have seen a case of 3.75% beating 4.0%.  How did that happen?

nereo

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All assume a $200k mortgage @ 3.75%
Only a 4% return will be surpased by the 15 yr mortgage, and only at year 29. 
Never have seen a case of 3.75% beating 4.0%.  How did that happen?
sorry, it's in the details I didn't explain thoroughly enough.
The "15 yr mortgage" puts everything towards the mortgage for years 1-15 ($17,448/yr), then puts it all towards 'investments'
the other categories (including the 4%) put $6,324/yr into investments.  FYI $6324 is the annual difference of mortgage payments between 30yr and 15yr mortgages of a $200k note @ 3.75%.

even though the 15yr mortgage is able to put more than double the amount towards investments after15 years, it never catches up to all but the most conservative projections.

fallstoclimb

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This is all super helpful. I knew the math said no, but I didn't know it was quite so clear!   We probably should focus more on reducing taxes anyway, at our income levels - we are not yet maxing out our space.  I am occasionally swayed by the idea of being debt-free at 45, but we can also just sell the house to accomplish that, so NBD.

nereo

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This is all super helpful. I knew the math said no, but I didn't know it was quite so clear!   We probably should focus more on reducing taxes anyway, at our income levels - we are not yet maxing out our space.  I am occasionally swayed by the idea of being debt-free at 45, but we can also just sell the house to accomplish that, so NBD.
exactly - this was the most simple of projections, if you are able to invest in tax-advantaged accounts that will continue to favor keeping the 30yr mortgage.  If you believe we will see more than 4% growth not adjusted for inflation then it favors keeping the 30yr.  FWIW, the worst 30 year period returned 3.2% after inflation (almost 6% pre-inflation - same as the green line on the graph).

There are other ways of making a similar point - if you run the numbers through 'historical simulators' like fireSIM you can see that $6324 invested annually has returned a median of $517k over 30 years.  Compare that with $445k median for investing more money during the last 15 years while holding a 15yr mortgage vs a 30yr one - on average you will come out about $72k ahead after 30 years.

OTOH, it looks like you might be able to get a 15yr mortgage at ~3.1% as opposed to 3.75%  However, even assuming no refinancing fees (hahaha!) when I spit that reduction into the scenario you save an extra $768/yr, but the outcome doesn't change a lot - the 6% and 8% non-inflation-adjusted returns still outstrip getting a 15yr mortgage.

Do what makes you most comfortable.  IF you keep the 30yr you always have the option of just paying it down sooner.

MDM

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even though the 15yr mortgage is able to put more than double the amount towards investments after15 years, it never catches up to all but the most conservative projections.
Try as it might, it just never does catch up at all.  As long as the investment interest rate is greater than the mortgage interest rate, investing always wins. 

Assumptions:
  - Option 1: the difference between the longer and shorter mortgage payment is invested each month over the life of the longer mortgage.
  - Option 2: the amount of the shorter mortgage payment is invested every month after the shorter mortgage is paid, up to the length of the longer mortgage

In each case, the amount of the shorter mortgage payment is being used in some fashion each month.

E.g., for the calculations below the longer mortgage comes out ~$8,680 ahead.

P200000Mortgage Principal
i0.0375Mortgage interest rate
r0.04Investment interest rate
n130Mortgage length, option 1, yr
n215Mortgage length, option 2, yr
Pmt/yr12Number of payments per year
Pmt1=PMT(B2/B6,B4*B6,-B1)Mortgage payment, option 1
Pmt2=PMT(B2/B6,B5*B6,-B1)Mortgage payment, option 2
FV1=FV(B3/B6,B4*B6,-(B8-B7))Results from investing the difference in mortgage payments for n1 years
FV2=FV(B3/B6,(B4-B5)*B6,-B8)Results from investing the option 2 payment for (n1 - n2) years

Of course, if one decides to assume that actual investment returns will be lower than the mortgage rate, or simply wants a paid mortgage, then paying the mortgage will be better.
« Last Edit: June 02, 2015, 10:25:22 AM by MDM »

nereo

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even though the 15yr mortgage is able to put more than double the amount towards investments after15 years, it never catches up to all but the most conservative projections.
Try as it might, it just never does catch up at all.  As long as the investment interest rate is greater than the mortgage interest rate, investing always wins. 
[MDM's methodology]
hmmm... i think the differences lie in that I was 'lazier' and just calculated contributions and returns annually.  your method is more exact.
Still goes to show you that foregoing investments in order to pay down a mortgage at 3.75% is a fairly risky proposition, especially when they are can be put into tax-advantaged accounts like the OPs 457/TSP.