Author Topic: Reader Case Study - Refinance or Not to Refinance, that is the question  (Read 3052 times)

FilmOtaku

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Hello Everyone,

My name is Robert and I discovered MMM in early 2012 and since then I have put his techniques into practice and went from a net worth of negative tens of thousands to over $150,000 in less than 3 years. I am almost to the point of being 100% debt free except for my mortgage. This should be a simple case study because it revolves around whether or not it is in my best interest to refinance my house. Currently I have the following debt:

Credit Card = $7,300 @ 9.65 % (paying about $100.00 per month in favor of car note)
Auto Loan = $10,000 @ 1.79 % (short term loan requiring $1,000 minimum payment every month)
Mortgage = $111,000 @ 3.50 % ($1,000 per month payment)

I already refinanced my house about 6 months ago to pull out the equity and pay off my student loans and part of the car note. Now fortune has smiled on me again and Zillow says that my house is currently valued at $171,000. During my last refinance Zillow said $125,000 and it appraised for $117,000. I know that it is a risk to keep pulling the equity out of the house when the value can drop like a rock at anytime but I'm thinking that the benefits might be worth the risk. Here are the 2 scenarios that I am currently working with:

1. Do nothing, in about 4 months I will have the car note paid off with my quarterly bonus, tax refund, and extra monthly payments. Once this is complete, I will then have the $1,200.00 that I am paying on the car to pay down the credit card and have it paid off in an additional 4 months. Once this is done, I will then be able to put that money into a Roth IRA and a Vanguard account (side note, I am already maxing out my 401k and HSA). From this moment on I will be aiming for Early retirement in about 10 years with $600,000 in 401k, $55,000 in Roth IRA, and $125,000 in Vanguard to bridge the gap for my Roth IRA Ladder. I expect to pull about $24,000 a year in retirement.

2. I refinance and pull out $50,000 in equity from the house. I will also reduce my interest rate from 3.5 % to 3.125 % for 15 years. This will likely make my payment around $1400 with taxes and insurance. The fun part is what I get to do with that money. First the car gets paid off, which allows me to drop the insurance down to about $40 a month (currently $90 for full coverage) and kill that $1000 per month payment. I will also pay off the credit card completely getting rid of the finance charges and the balance. With the left over money I will open a Roth IRA and max out the contribution for 2014 and 2015. I would then take the last of the money and open a Vanguard account and invest $10,000 in VTSAX Admiral shares. This will hopefully allow me to retire in 9 years instead of the 10 in the first plan. Of course this all depends on the stock market and economy. Any leftover funds will be put into the house, I'm interested in putting in MMM's open loop radiant floor system, but I digress.

I have always been told that with low interest rates on Mortgages that your equity would serve you better invested instead of the guaranteed 3.125% return from the money you pay every month. So my question is whether or not I should take the risk and end up paying $400 more for my house at a lower rate while getting a jump start on my retirement accounts and simultaneously destroying all of my debt? Or if I should just buckle down and ride out the storm for the next 8 months and then start my retirement accounts toward the end of 2015?

Thanks for any advice you throw my way,
Best Regards and Happy New Year,
Robert

P.S. If you have another plan that I haven't considered, please let me know, there might be a better solution than the ones I have thought of and I would appreciate the insight.

Update 1: Thanks for the suggestions and for clarification here are some answers to questions brought up so far:

The reason that I am paying so much for my car is because a year ago my credit card was paid off and I was putting $1000 a month toward the car to pay it off. Since my interest rate at the time was 3.99% I figured refinancing it and getting away from the original lender and over to my bank plus reducing the interest rate to 1.79% would save me more money in the long run. I also figured it would be easier to make payments through my own bank.

Unfortunately, I had a family emergency and I was forced to put the expense on my credit card which has been paid off until a few months ago. The reason why I concentrate on the car payment is because it requires a large payment every month. If I spend my extra cash and bonuses on the credit card my monthly expenses would be $1000 on car and around $500 on the credit card. I looked at a payoff calculator and determined that while I would pay about $100 more in interest paying off both these debts I could save several months if I killed the car before the credit card. This was my reasoning on this.

Update 2: My income is net pay of around $60,000 of which 30% goes toward maxing out my 401K and HSA through payroll deductions. The rest goes to paying down debts and other monthly expenses. I am unsure what my tax return will be this year as it is the first time that I have maxed out my 401k (before I just did the company match at 6%). Every year I usually get $100 or I have to pay $100 depending on the luck of the draw. I am vehemently against giving the government an interest free loan or paying any more tax than I have too. That is why I am maxing out the tax deferred accounts now, since I can always move or change my situation in the future to avoid paying taxes during FI.

Update 3: Unfortunately, the refinance will not be free. I will be getting a VA loan and the closing cost will be about $7,000 which what I paid during my last refinance. Changing my debt from one place to another is part of the reason why I have been so successful with my journey thus far. I have converted lots of high interest debt to lower interest rates to help pay them off faster. It is unlikely that I will be able to get lower rates than this in the future now that the fed is going to start increasing the rates again. Basically, By converting my last remaining debt to the house I will get the tax right off from the mortgage interest which I won't get from the car or credit card and I will get a boost to my FI goal.
« Last Edit: December 27, 2014, 09:13:40 AM by FilmOtaku »

MDM

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #1 on: December 27, 2014, 01:15:38 AM »
Any reason not to pay the minimum on the auto loan?  That is your lowest interest loan.

You could (and should) put the "quarterly bonus, tax refund, and extra monthly payments" toward the credit card.  You will pay less interest this way.
Also, depending on the size of the refund (e.g. if it is >$600) adjust your withholding so you get more take home pay each month, even if you have to write a small (e.g. <$300) check to the IRS in April 2016.

Didn't see your income but assume from the net worth increase that it is good.  Careful if you refinance that you don't get caught by the Alternative Minimum Tax.  The AMT limits your mortgage interest deduction if you refinance and take money out (unless you put that money back into the house - but that's not your plan).  Also, is the refinance free?

iluvzbeach

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #2 on: December 27, 2014, 05:43:02 AM »
I am not a fan of you doing a re-finance for exactly the same reason you bring up. I just think it's too risky and the potential is greater that you'll end up upside down on the mortgage. Plus it is very unlikely you'd be able to do so at no cost. Keep working to eliminate your non-mortgage debt as quickly as you can, then focus on building your 'stache and paying off the house simultaneously. I'm all for being completely free of debt as your requirements for living expenses then go way down and you can get by on a smaller 'stache.

Another Reader

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #3 on: December 27, 2014, 05:44:26 AM »
From what you said about your history, I would not do this.  You are not reducing your debt, you are shifting your debt over to the house.  While that refinance might have been helpful if you reduced your interest rates, you did not pay the debt off.

Why is your car payment so high?  Most people would suggest paying the minimum on the car and putting everything else towards the higher interest credit cards.

In your shoes, I would take a hard look at your income and expenses.  Find ways to reduce your expenses and increase your income.  Write up a case study and you will receive a lot of suggestions on how to do this.

It's highly unlikely that your house went from an appraised value of $125,000 to $171,000 in six months.  Zillow is notoriously unreliable.  Instead of looking at another refinance, figure out your income and expenses, treat the debt as if your hair is on fire, and get it paid off.


FilmOtaku

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #4 on: December 27, 2014, 09:44:08 AM »
Thanks for the replies and I am looking into the AMT which I have never heard of before. I am not sure exactly how it works or if I would qualify for it so I will need to play around with Form 6251 with last years taxes to see what it looks like. I agree that it is very unlikely that my house has gone up in value that much in 6 months especially since I haven't done anything to improve the property. The growth is simply due to the fact that supply and demand in my area has shifted, meaning people are willing to pay more for a smaller house. It's just like people buying tulips in Europe. This is what all the risk entails, if I refinance and the market tanks again then I will be forced to sell at a loss or rent the property. Fortunately, rents are extremely high in Denver so I could probably break even at $1,400 if I go ahead with the refinance. This of course would only happen if the trifecta occurs Lost job, No Hiring, have to move for work.

Catbert

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #5 on: December 27, 2014, 10:18:13 AM »
Another vote for leaving it alone.  Don't you remember what happened to the real estate market 5-8 years ago - you know, the crash?  Using a principal residence as an ATM contributed to people losing their houses.

Paying 7k for the privilege of stretching out your car payment for 15 years is crazy when you think about it that way. And that is exactly what you're doing.  You've already learned that family emergencies (or other random acts) can derail what seem like good ways to keep moving debt around.  Just pay it off instead.


thedayisbrave

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #6 on: December 27, 2014, 10:23:12 AM »
I'm also in the "do not refinance" camp.

I'm still confused about the car loan and CC.  I would be paying the minimum (is $1000 really the minimum?) on the car and then throwing all extra toward the CC.  Once you knock the CC out, work on paying off the car and building up a reserve/emergency fund.  If you don't you'll end up always falling back to credit cards when unexpected expenses come up and you'll never get out of this mess.

FilmOtaku

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Re: Reader Case Study - Refinance or Not to Refinance, that is the question
« Reply #7 on: December 27, 2014, 10:37:48 AM »
I'm also in the "do not refinance" camp.

I'm still confused about the car loan and CC.  I would be paying the minimum (is $1000 really the minimum?)

Yes, the minimum on the car is $1000 a month. I purchased the car just before I discovered MMM and since it is electric and I never have to buy gas I have decided to keep it. Since I was already paying $1000 a month to pay it off as quickly as possible, I figured why not refinance it for a lower interest rate and shorten the term on the loan. If I continue to pay off the car in the next 4 months then I will have only paid about $400 in interest since I refinanced the car in September 2013.