### Author Topic: Refinance to Invest More? Check my math  (Read 5235 times)

#### neo von retorch

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##### Refinance to Invest More? Check my math
« on: December 29, 2014, 01:46:35 PM »
OK so assuming I have a \$105,000 mortgage @ 3.335% with 12 years left (the payment is \$925)...

I took the assumption that each month I have \$925. I can put it all into the mortgage... or if I refinance (at a cost of \$3000) to a 3.875% mortgage for 30 years, I pay \$525 / mortgage, invest the \$400 and get an amazing 10% annual return. Well, right off the bat, \$108,000 accumulating 0.5% more interest costs me \$667.50 per year, and with the 30 year mortgage shrinking much smaller, that number only grows. Meanwhile, that extra \$4800 in cash is earning me ~\$480 (more if you compound each month). And it too grows thanks to compounding.

But even with the 10% returns, it was about FORTY YEARS before it was better to have invested rather than pay off the mortgage. Ouch.

#### FarmerPete

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##### Re: Refinance to Invest More? Check my math
« Reply #1 on: December 29, 2014, 02:14:41 PM »
First off, unless you have a magic hat, claiming 10% interest for 30 years is not realistic.  I'll use a more realistic 7% for my calculations.

Option B is to do nothing.  Pay off your mortgage in 12 years.  THEN invest the entire \$925 into savings.  Here is the breakdown of where you will be in 30 years:

Option A = 30 years of saving \$400 a month at 7% interest = \$490,835
Option B = 18 years of saving \$925 a month at 7% interest = \$400,741

Obviously, option A looks better.  You'll also get a little reduction in your taxes assuming you can claim interest.  Before making a decision though, how long do you see yourself staying in this house?  The average home owner only lives in a house for 5 years.  Your plan really only makes sense if you live there 12-30 years.  At 12 years in with Option B, you would own your house free and clear, but have zero saved.  If you went with Plan A, you'd have \$90,402 in savings and a modest chunk of equity.  The main difference is that with Plan B you have \$\$\$ tied up in equity earning you virtually zero dollars.  With plan A, you've got very little in equity and are compounding interest on your returns.

For most people, the problem is willpower.  It's easy to say that you're going to save that \$400 a month, but I can assure you that those \$400 will be the first thing spent when you get the spending itch.  Vacation to the Caribbean?  Sure, just skip the payment for a few months.  Need a new car?  Well, I can just grab some money from the mortgage savings.  It's a slippery slope that I know I can't navigate myself.

#### MDM

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##### Re: Refinance to Invest More? Check my math
« Reply #2 on: December 29, 2014, 03:31:40 PM »
OK so assuming I have a \$105,000 mortgage @ 3.335% with 12 years left (the payment is \$925)...
...refinance...to a 3.875% mortgage for 30 years, I pay \$525

Neither of those scenarios match the Excel PMT calculation.  Is there PMI?  Escrow payment included in your number?  I fatfingered something in the PMT formula?

#### rmendpara

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##### Re: Refinance to Invest More? Check my math
« Reply #3 on: December 29, 2014, 04:07:36 PM »
OK so assuming I have a \$105,000 mortgage @ 3.335% with 12 years left (the payment is \$925)...

I took the assumption that each month I have \$925. I can put it all into the mortgage... or if I refinance (at a cost of \$3000) to a 3.875% mortgage for 30 years, I pay \$525 / mortgage, invest the \$400 and get an amazing 10% annual return. Well, right off the bat, \$108,000 accumulating 0.5% more interest costs me \$667.50 per year, and with the 30 year mortgage shrinking much smaller, that number only grows. Meanwhile, that extra \$4800 in cash is earning me ~\$480 (more if you compound each month). And it too grows thanks to compounding.

But even with the 10% returns, it was about FORTY YEARS before it was better to have invested rather than pay off the mortgage. Ouch.

First of all, 10% returns compounded is very high for a diversified portfolio.

Second, why would you refinance to pay more interest? Your payment goes down, but the amount of interest will go up. It doesn't matter if you stretch the repayment period.

You're better off paying down your mortgage with lower total interest at the current rate, and once paid off, investment ALL excess cash flow at (your) estimated 10% return. By the end of XX years, you will come out ahead paying a lower rate.

#### Cassie

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##### Re: Refinance to Invest More? Check my math
« Reply #4 on: December 29, 2014, 04:40:54 PM »
It was interesting that I just watched Suze Orman & a viewer had a similar question about refinacing with a higher interest rate, etc. in order to invest & she said do not do it.

#### surfhb

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##### Re: Refinance to Invest More? Check my math
« Reply #5 on: December 29, 2014, 04:53:09 PM »
Poor idea bro :)

#### mozar

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##### Re: Refinance to Invest More? Check my math
« Reply #6 on: December 29, 2014, 08:42:05 PM »
Dude/dudette, don't refi to a higher interest rate.
I don't really understand your numbers but here's mine: bought for 118k with 12k down payment. Monthly was about \$570 at 5.1% 30yr. Refi'd to 3.5%, \$715 monthly, 15 years (put 6k in as well). \$1400 closing costs. I figured with the interest saved vs putting \$145 toward my mortgage every month and not investing (yes I am disciplined) I would break even after 15 years AND own my house with no mortgage. I have no plans to move. After 40 years yes I would make more money but I won't even need more money anymore. I'll be 82 or possibly dead.

#### CopperTex

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##### Re: Refinance to Invest More? Check my math
« Reply #7 on: December 29, 2014, 08:56:28 PM »
I like to think of things in terms of "what is going to improve my life sooner rather than later?". Or "what am I going to do with \$10M when I'm 90?". Having a huge stash when you are too old to enjoy it defeats the purpose. I've been paying down aggressively on my mortgage because that aligns with my FIRE goals (to free up cashflow). I think long term investments are only part of the equation.

#### Bob W

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##### Re: Refinance to Invest More? Check my math
« Reply #8 on: December 29, 2014, 09:13:03 PM »
Look into 30 year fixed interest only rates.  You should be able to reduce your monthly payment to 350.  Rebid home insurance.

#### neo von retorch

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##### Re: Refinance to Invest More? Check my math
« Reply #9 on: December 30, 2014, 06:34:59 AM »
Well I'm glad everyone agrees with me, except for FarmerPete. You're saying I'll have more money after 30 years with the refinance option, even with a 7% return on investments, and my calculations didn't agree. What I'm saying is the refinance would cost me more in interest than the gains in investment EVEN if I used a fairy tale 10% return on investments all the way through a 40 year scenario.

Also please keep in mind, I was just focus on the mortgage principal & interest and investment part of these calculations. In the real world...
• \$1440 goes into 401(k) each month
• \$292 gets matched by employer
• \$459 goes into the Roth
• \$1600 goes into my taxable investments
• The house is rented - I don't live there (That's one reason the refinance would cost \$3000+ instead of \$1700)

Anyway, I didn't list all that because I just wanted to focus on the math, and I don't agree that you'll flat out have more money by investing the \$400 because of the increased mortgage rate being applied to all \$105,000 from refinance time onward.

The whole point was, in theory, 7% investment is worth paying 3.875% mortgage interest. But that's only if you're able to invest as much as you're loaning. (Maybe there's a better way to word that?) If you're only investing \$400 per month but paying additional interest on \$105,000, the math takes a very, very long time to work in your favor.

#### DeltaBond

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##### Re: Refinance to Invest More? Check my math
« Reply #10 on: December 30, 2014, 06:54:19 AM »
There's another aspect to this... the more you pay on your current mortgage the less interest you pay on it, and that number can be in the thousands.  Paying less for something is important.  Whether you stay there or move in the next 10 years or so, this would be a good thing to do.
« Last Edit: December 30, 2014, 07:00:50 AM by DeltaBond »

#### FarmerPete

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##### Re: Refinance to Invest More? Check my math
« Reply #11 on: December 30, 2014, 07:14:25 AM »
Well I'm glad everyone agrees with me, except for FarmerPete. You're saying I'll have more money after 30 years with the refinance option, even with a 7% return on investments, and my calculations didn't agree. What I'm saying is the refinance would cost me more in interest than the gains in investment EVEN if I used a fairy tale 10% return on investments all the way through a 40 year scenario.

Also please keep in mind, I was just focus on the mortgage principal & interest and investment part of these calculations. In the real world...
• \$1440 goes into 401(k) each month
• \$292 gets matched by employer
• \$459 goes into the Roth
• \$1600 goes into my taxable investments
• The house is rented - I don't live there (That's one reason the refinance would cost \$3000+ instead of \$1700)

Anyway, I didn't list all that because I just wanted to focus on the math, and I don't agree that you'll flat out have more money by investing the \$400 because of the increased mortgage rate being applied to all \$105,000 from refinance time onward.

The whole point was, in theory, 7% investment is worth paying 3.875% mortgage interest. But that's only if you're able to invest as much as you're loaning. (Maybe there's a better way to word that?) If you're only investing \$400 per month but paying additional interest on \$105,000, the math takes a very, very long time to work in your favor.

My numbers didn't factor in the interest you're paying, because your numbers already did that.  You said \$500 30yr vs \$925 12 yr.  Sure, one builds equity faster than the other, but really, that doesn't matter when you're talking about a 30 yr time frame, as both will be 100% paid off in 30 years.  The way I saw it, your options were to either invest \$400 a month starting now for 30 years or invest \$925 a month starting in 12 years.  The \$400 a month number starting now came out higher.  Doing the same calculation for 12 years of saving \$400 a month vs 0 years of saving \$925 means that at the end of the 12 years, you'd have \$90,402 saved vs 0 saved and a house.

Are you adding your interest on above the \$500 you said the 30yr would cost?  Personally, I wouldn't take the refi, because I value paying off my mortgage.  However, it's been pretty well established that getting the longest lowest interest rate mortgage will typically result in the best financial results long term.  The reason being that money locked up in equity appreciates at the same exact rate as debt locked up in a mortgage.  By freeing that money up, you can invest it and earn a better return than 3.825%.  Like I said, the problem is saving the extra money consistently.

#### DeltaBond

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##### Re: Refinance to Invest More? Check my math
« Reply #12 on: December 30, 2014, 07:17:57 AM »
May I ask the OP this... if you keep your current mortgage, would you pay more on that mortgage than the regular payments?  Or either mortgage, really, would you ever pay more than the payment.

And FarmerPete, are you saying that its not worth it to pay off a house early?  This is not a loaded question, I want to learn, I always thought paying things off sooner rather than later was the way - but maybe with interest rates so low it doesn't matter?

#### neo von retorch

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##### Re: Refinance to Invest More? Check my math
« Reply #13 on: December 30, 2014, 08:02:07 AM »
- Yes I'm adding interest costs... I'll rephrase my math with an example below.
- I do not plan on making extra payments, though, I'm tempted. Interest, like investments, compounds. Math is hard.
- If I refinanced, the purpose would have been to reduce the payment so I could invest more, in which case, I would no longer want to pay off my mortgage early. In that case, I would not make extra payments.

Sample Math:
Current mortgage, month one, the interest is \$293.13 (\$925 total payment, \$631.87 goes to principal.) \$0 left for investing (until mortgage is paid off.)
Refi mortgage month one, the interest is \$348.75 (\$525 total payment, \$176.25 goes to principal.) \$400 left for investing, earns \$2.33.

I increased my interest payments by \$55.62, but freed up \$400, which I invested and earned an amazing \$2.33. So the refi is worse by \$53.29 even though almost half of my money is going towards a 7% investment which is clearly enough to pay for 3.875% in mortgage interest. (But since the interest rate increased for \$105,000, it's a losing change in my finances.)

I adjusted my "formula" (Excel spreadsheet) to account for equity and I find that by the end of year 6, it actually starts to favor the investing / refi option, though.

#### Gone Fishing

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##### Re: Refinance to Invest More? Check my math
« Reply #14 on: December 30, 2014, 08:20:01 AM »
I agree with Farmer Pete's calculations.  Just for kicks, I calculated what return you would need to break even in a 30 year time frame, came in right around 4.5%.  All you are doing is leveraging your house to arbitrage the difference in mortgage rates vs investment returns.  Just like all investing, time is your friend, the additional 18 years of the refied loan outweighs the higher mortgage rate as long as you make over 4.5% annually on your investment.  The 30 year fixed mortgage, without a doubt, is the most potent leverage tool in the common man's tool box, and at today's rates, it doesn't take much of an investment return to come out ahead.

#### neo von retorch

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##### Re: Refinance to Invest More? Check my math
« Reply #15 on: December 30, 2014, 08:42:56 AM »
OK fixed all my terrible formulas and have found that by around the 3 year mark, the investment returns (assuming 7%) start to exceed the additional interest, and halfway through the 9th year, I've paid back the cost to refinance (\$3000) and break even. From there on out, it's gravy. But it does take a while to make back that refinance cost and additional interest. If at any time during that timeframe, I get tired of dealing with the rental and decide to sell, there's the potential that I'm worse off (not to mention the unpredictable investment returns.)

I feel like, long-term, it's probably a good idea - time in market is key. But given that even 12 years now, when the original mortgage will be paid off, I'd only have netted \$6000 assuming consistent 7% returns, I'm not sure if it's worth the trouble and risk. (But I would have \$80,000+ additional invested funds...)

#### FarmerPete

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##### Re: Refinance to Invest More? Check my math
« Reply #16 on: December 30, 2014, 09:31:43 AM »
Your math is confusing me and I don't think you're doing it right.  For that reason, I am advising not to do it.  You seem to be adding interest payments into this equation, but you shouldn't.  Either interest is included in the \$525 payment, or it's not.  If it isn't, than my numbers are all wrong.  If it is, than you need to stop worrying about the interest as it's already included.  You're comparing your investment interest vs mortgage interest is dumb.  Look at the compounding total values and you'll see that you'll more than break even in 30 years.

The forum is fairly torn on the mortgage vs pay-it-off argument.  Do some searching and you'll find a plethora of posts.  The result is that paying off your mortgage makes you feel better emotionally and improves cash flow by reducing expenses.  Investing it ultimately earns you more money, because mortgage debt is crazy cheap right now.  Earning 7% on money while paying 3.875% is a net win of 3.275%.  Plus taxes saved if you can deduct it (I don't think you can do this on a rental, but I am not a CPA)  When mortgage rates go back up to +6%, you wont be able to make the same arguments.

Personally, I've owned my house for 7.5 years now, and I've refinanced it 3 times in those years.  Every time I went down in interest and eventually shortened it down to a 15yr 3.25%.  I've got 13 more years to go and owe ~80k.  Even though I know on paper it would be better to refinance and pay it off slower, I'm just not going to do it.  My wife would punch me in the face...literally.  I like the idea of cutting my yearly expenses by 7-8k a year.

#### Bob W

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##### Re: Refinance to Invest More? Check my math
« Reply #17 on: December 30, 2014, 09:55:59 AM »
One assumption that I find startling here is that equity is being built by leveraging a house. (that's called a mortgage).   Perhaps since I was a house builder during the crash of 08 that I'm a bit jaded with this thinking.

Fact is it could varies drastically by market and that there is a pretty good likelihood that the 100K home would be worth just 65K in 10 years.    I wouldn't call that building equity exactly.

House mortgaging is a risky business.  There is upside potential as well as downside.

To offset that risk one should invest in companies via stock IMHO.

Best strategy -  Mortgage a modest house that you can easily afford.   And I mean very easily with less than 10% of one person's income.  Have the cash to purchase it outright.  Borrow as much on it as you can at 3.5%.  Dump the cash into the stock market.

I also think that 7% return on stocks over the next 12 years is very optimistic.  Since the market has run like hell it is very overvalued and a return to the mean is in order.   A 3% return might be a more reasonable assumption for the next 12 years.

#### neo von retorch

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##### Re: Refinance to Invest More? Check my math
« Reply #18 on: December 30, 2014, 10:00:47 AM »
Here's my spreadsheet so you can check my math.

I do not plan on doing it. (I'm on the phone with my credit union to cancel the process. I "accidentally" started the process a week ago by clicking "Continue" too many times while playing with the refinance tool on the web site.)

Quote
Earning 7% on money while paying 3.875% is a net win of 3.275%.

Yes - but the math is NOT this simple. The refinance, in this case, specifically, increases the interest rate on the entire principal. Meanwhile, the investment return is only on the difference in payment amount (\$925 -> \$525). For this reason (and the cost of a refinance), the investment returns only trump the costs after 8.5 years.

By the way, \$925 and \$525 are "principal and interest" payments - the interest is included in that. Yes, in 30 years, it's definitely mathematically better to start investing now, with a refinanced mortgage. But I'm just not feeling it.