Mortgage Interest Inflection Point

[REatc]

We are about to refinance to a better rate. I was looking at how long it would take of minimum payments to reach the inflection point, more than 10 years. Does it make any sense to pay down your mortgage aggressively to the inflection point, then make minimum payments?

We are going to move in 5 years and I am wanting more equity when we move for a larger down payment.

[SwordGuy]

Then what you are doing doesn't make a lot of sense to me.

If you want a bigger down payment for a new house in 5 years, why lock up that money in your old house.  That means you have no down payment UNLESS you have ALREADY sold your old house or you borrow it back at interest via a HELOC.

I think you're probably much better off putting that money into an interest-earning location where it won't lose much value in an economic downturn.   

What's your current mortgage interest rate?   Is it really high or close to 3% or less?

[MDM]

How do you define "Mortgage Interest Inflection Point"?

Note that one is always paying the mortgage interest rate on the unpaid balance.  The ratio of principal to interest in any given payment  is pretty much irrelevant.

[SwordGuy]

How do you define "Mortgage Interest Inflection Point"?

Note that one is always paying the mortgage interest rate on the unpaid balance.  The ratio of principal to interest in any given payment  is pretty much irrelevant.

I had to look it up.   The definition I found was that more than 50% of the payment was going to principal.

[REatc]

Yes that is what I mean by inflection point, more of your monthly payment going to principal than interest. The current rate is 5.125%.
The thinking behind this is the majority of the interest is front loaded, if you get to the inflection point as fast as possible, you pay less interest total. I’m not worried about illiquidity, I don’t need the money until I sell and move. (I wouldn’t move first, then try to sell). I’m not that worried about a down turn as well, I’m expecting one, and if one did happen my rate of return would be positive.

[Another Reader]

Unless this is a rental property, this is a high interest rate.  What about refinancing the balance over the remaining term at a much lower rate?

[MDM]

The thinking behind this is the majority of the interest is front loaded

You pay more interest at the beginning because the principal you owe is greater then.  You are paying exactly the same interest rate throughout the payback.  Do you understand why that is so?

if you get to the inflection point as fast as possible, you pay less interest total.

You pay even less interest if you don't take out a loan at all (or pay it all back immediately). :)

Whether you come out ahead by paying debt faster, or paying debt minimums and investing instead, will depend on the after-tax return on those investments vs. the after-tax cost of the debt.

[REatc]

It’s not a rental, just a normal house. I should add the inflection point I’m talking about is on a 30yr mortgage. The 15yr starts out 1.5:1 principal to interest ratio, and separates from there.

[secondcor521]

If I were planning on moving in five years, I wouldn't refinance unless I could recoup the refinancing costs within about three years or so, probably even less.  There is probably some risk that the planned move in five years could happen earlier, and I would want at least a year or two of savings after reaching the break even point.

Whether to pay down a mortgage or not depends on a lot of factors.  Generally it would depend on what other alternatives were available, and one's risk tolerance.

[Telecaster]

Yes that is what I mean by inflection point, more of your monthly payment going to principal than interest. The current rate is 5.125%.
The thinking behind this is the majority of the interest is front loaded, if you get to the inflection point as fast as possible, you pay less interest total.

I think you are confusing a couple of different concepts.   Mortgage interest is not front loaded.  You pay more interest in the early years because you owe more money. 

If you are going to move in five years, why would you stuff money into the house instead of keeping it liquid? 

[REatc]

I was doing the math on our balance of 160k, at 110k is where the inflection point occurs on a 30yr. That seems to me the math is front loaded, maybe I’m wrong.
And I’m wanting, maybe, to stuff money into the house because it’s a guaranteed low return, it hedges my 100% stock allocation to my TSP and taxable account, and most importantly I think when I sell and buy a new house in 5years I’ll have a certain amount of equity vs a speculative amount in my taxable account, which will follow the market. I think there’s got to be a down turn within this time frame...

[Radagast]

You may be best refinancing to a 5/1 ARM, those often have low upfront costs, but do the math, probably with an online calculator.

5.125% is actually a pretty high interest rate. If you are sure refinancing doesn't make sense, it may actually make sense to pay it off, most especially as a lump sum but maybe as a series of smaller payments if your income is secure, provided you are comfortable with having the money locked away until you sell.

There are a couple of rough estimates for the rate where mortgage payoff may make sense: 1/CAPE10+inflation, and 10-Year Treasury Rate + 3%. 1/CAPE10+inflation is pretty close to 5.125% right now depending on what inflation you assume, and 10YR+3% is 4.73%. You may be in pay-off territory.

[MDM]

I was doing the math on our balance of 160k, at 110k is where the inflection point occurs on a 30yr. That seems to me the math is front loaded, maybe I’m wrong.

Calculate for each month: (interest paid) / (unpaid principal).

E.g., for a $100K, 30 year, 5% mortgage
Month #1 = $416.67 / $100,000    = 0.0041667
Month #2 = $416.17 / $99,879.85 = 0.0041667
...
Month #120 = $339.75 / $81,539.35 = 0.0041667
...etc.

0.0041667 = 5%/12.  In other words, one pays exactly the same interest rate for each month of the mortgage.  One hears the phrase "front loaded" but it's not a good description of what is actually happening.

The oft-debated issue of "pay mortgage or invest" is another question. ;)

[REatc]

MDM: Thank you for your description. That makes perfect sense now.

Radagast: Those mortgage calculations are exactly what I’ve been looking for. We have a meeting with the bank coming up, I’m curious what the  rates will be but I’ve been 50/50 toward refinance and just pay the thing off at 5.125%. Plenty of emergency fund, my income is secure, and I could pay it off in under 3 years. Decisions...

[Telecaster]

I was doing the math on our balance of 160k, at 110k is where the inflection point occurs on a 30yr. That seems to me the math is front loaded, maybe I’m wrong.
And I’m wanting, maybe, to stuff money into the house because it’s a guaranteed low return, it hedges my 100% stock allocation to my TSP and taxable account, and most importantly I think when I sell and buy a new house in 5years I’ll have a certain amount of equity vs a speculative amount in my taxable account, which will follow the market. I think there’s got to be a down turn within this time frame...

And how exactly do you realize that guaranteed rate of return?  You payments remain exactly the same.  You don't put an extra single, thin, dollar in your pocket unless you retire the mortgage early.  And you don't intend to do that.   

The amount of equity goes up, but it only increases by the amount of the extra payment.  You can increase your net worth by the exact same amount by stuffing the money under your mattress.

So, since you intend to move and will need the money presumably for a downpayment and other moving expenses, why on Odin's green earth would you put it in the house where only a banker will allow you to access it? 

[REatc]

Telecaster: I would realize the return when I sell the house, wouldn’t I? Wouldn’t sticking it under the mattress be worse than putting it into the mortgage? Under the mattress gets eroded by inflation, into the mortgage gets the return of the interest rate.

[Radagast]

I threw the POYM bomb on purpose ;). I’ve been in the DPOYM camp pretty strongly until now and I would not pay off my 3.0 mortgage unless stocks and bonds both go parabolic to a high power. But those are the numbers I have been using to justify my stance and they are starting to go your way. I got the 10YR+3% one from @MDM, so he can’t claim innocence and walk away!

Of course the whole thing depends on you selling the house easily and for more than you paid for it. And don’t underestimate refinancing until you have seen the costs, I refinanced from 4.8 to 3.0 and it was worth it in like 20 months. It hasn’t been five years yet but obviously it more than paid for itself.

[MDM]

I got the 10YR+3% one from @MDM, so he can’t claim innocence and walk away!

Not claiming innocence (or admitting guilt) - just ignoring that issue while working on the "front loaded" misconception. :)

[vand]

compounding works on mortage principle too..

It's the same principle if you compound $100 at a constant rate with the goal of reaching $100,000... you will only pass the $50,000 deep somewhere during the 2nd half in terms of the overall time taken.

The higher your rate of compounding, the later the inflection point is delayed, although at today's typical mortgage rates its much of a muchness around 55-60% of the way through the term

you can check this on a mortgage repayment calculator which gives you a annual breakdown, eg: https://www.moneysavingexpert.com/mortgages/mortgage-rate-calculator/

[kenmoremmm]

without running numbers (too lazy), i'm certain your breakeven point between keep old mortgage vs get refi and roll closing costs into the new mortgage is somewhere under 18 months. you almost have a 2% spread right now. in the past, i refi'd from 6% something to low 5s and it was breakeven, with costs, in 15 months. likewise, on my current mortgage, i had 4.125% in 2014, and 5 months later refi'd to 3.375% because the breakeven was <2 years.

[REatc]

Got some papers from the bank today. They are offering 4.0% interest on a 30yr with closing cost of $3300. Both of these numbers seem ridiculous to me. Apparently the interest rate is high because it’s a condo? And the closing costs I’m not sure how they calculate that. We are going to meet in person tmrw morning to discuss other mortgage types and rates. I’ve calculated a break even of 24.5 months. I’m not gonna lie tho, the 4.0% rate and $3300closing cost make me just want to pay the thing off ASAP...

[Another Reader]

Mortgages should always be shopped.  A competent mortgage broker shops the wholesale market to find the best deal for your situation.  The bank sells you what's on their shelf.  There is a hit for being a condo, but you can probably cut a better deal if you shop.

[secondcor521]

You should shop around.  I'd also consider other fixed mortgages besides 30 year.  You could probably get lower rates on 20 year fixed, 15 year fixed, and even a 7/1 balloon.

Depending on your balance and what is typical in your state, $3300 doesn't sound necessarily out of line.

I've had some good luck with credit unions when I was mortgage shopping.

[ZMonet]

Check out a site like Aimloan for a point of comparison.  I just ran the numbers on their website on a 15-year loan for a condo and they are showing 3.125%.  A 30-year is 3.625%.

[ChpBstrd]

I refinanced my 9 month old 30y mortgage at 4.875% to a new 15y mortgage at 3.25% at a cost of about $2500 even though I plan to probably pay off the house in 5 years (and not if, for example, bank CDs are yielding higher than the interest rate). Those closing costs were perhaps the best risk free investment of my life. Do the math on that IRR and NPV for 5 years, and compare it to the return I would get by putting those $2500 into principal instead of a refi!

[talltexan]

I will add my voice as a member of the DPOYM crowd.

However, if being mortgage free is your goal, you can probably still gain by refinancing the 5 1/8 rate down to something in the low 3's via a 15-year fixed.

[ysette9]

If you are selling in 5 years then there is no reason to go with the higher interest rate of a fixed-rate mortgage.

Get a 5/1 or 7/1 ARM, save money on lower intérêts, bank the difference, and have a pile of cash waiting for you when you do sell.

We are in the process of a refi to a 7/1 ARM for 2.875% with around $4k closing costs. Definitely shop around and play the banks off of each other to get the rate as low as possible.

[TomTX]

Yes that is what I mean by inflection point, more of your monthly payment going to principal than interest. The current rate is 5.125%.
The thinking behind this is the majority of the interest is front loaded, if you get to the inflection point as fast as possible, you pay less interest total.

That thinking is wrong.

[TomTX]

You may be best refinancing to a 5/1 ARM, those often have low upfront costs, but do the math, probably with an online calculator.

5.125% is actually a pretty high interest rate. If you are sure refinancing doesn't make sense, it may actually make sense to pay it off, most especially as a lump sum but maybe as a series of smaller payments if your income is secure, provided you are comfortable with having the money locked away until you sell.

My local CU is letting me do a 30 year "Home Equity Refi" (cashout) with total costs of $32 (no costs rolled into the loan) and a rate of 3.95%.

OP can do a lot better than 5% even with zero closing costs.   Many, many options.

Also, OP can get past the whole "inflection point" bull by going with a 15 year loan at an even lower rate, right? ;)

[Sandi_k]

Refi for a 20 year. More going to principal, but keeps your cash stash liquid in case of another meltdown.

You may "plan" to move in 5 years, but you don't know. We planned to move from our starter house around Year 7. We stayed 19 years.