Author Topic: Help me figure out refinancing math, maybe!  (Read 5367 times)

whitedragon

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Help me figure out refinancing math, maybe!
« on: May 02, 2016, 02:04:09 PM »
Ok folks, here's my situation.  I have a million ideas running through my head right now, and I'm probably not going to do a good job of putting it all on "paper", so I'm hoping for a few face-punches to keep me honest.

Basically, I have a 30 year mortgage right now, at 4% interest for 120k.  I'm 4 years into the loan, and paid down aggressively for the first couple years, so my balance is now about 97k.  I also get a bajillion offers in the mail for refinancing, and my bank/credit union rate page on their website shows that rates are anywhere from 2.75ish to 3 on 15 year or 30 year refinances.

Doing some back of the napkin math, my current principle + interest (so we're not confusing escrow for taxes and insurance) is about 650ish, and going to a 15 year at 3% on the remaining 97k looks to keep the payments exactly the same?!!??!  Am I crazy, or is this legit?  Should I be signing a refinance agreement yesterday?

Conversely, a 30 year at 3% looks to drop my principle + interest to about 450 a month!  This looks like legitimate madness.  Should I do that instead and start dumping the extra 200 bucks into VTSAX???

Additionally, I'm forecasting FIRE by 2020ish.

So my questions are:
1) Is my math even close to correct? (And if not, where am I messing up?)
2) If my math is correct, or some facsimile there-of, how should I compare the differences between the 15 year and 30 year mortgage scenarios in terms of how it affects my stash?  (FIRE date unchanging at this point).
3) What did I miss? (Because I'm sure I missed something.)

Learn me....

nereo

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Re: Help me figure out refinancing math, maybe!
« Reply #1 on: May 02, 2016, 03:29:50 PM »
Ok... hopefully this will help

You aggressively paid down your mortgage, which is part of the reason why the new rates are so much lower (that and the lower interest rate).  You may be 4 years into your loan, but due to your over payments I estimate you have just over 20 years remaining instead of 26.  You will pay (all told ~$178k) if you stop making over payments now.

Ignoring refinancing costs for a moment
$97,000 15y fixed at 3.00% = $670/mo ($23,500 interest)
$97,000 15y fixed at 2.75% = $658 ($21,500 interest)
$97,000 30y fixed at 3.00% = $408 (note: I doubt you can get a rate this low on a 30y)
$97,000 30y fixed at 3.675%= $445 (note: this is about Prime right now - $63,250 interest)

Now on to your second question: "Should I [stop overpaying] and start dumping the extra money into VTSAX."  Well, this is a hot topic here.  Personally, at rates as low as yours I would put every extra cent first into tax-advantaged accounts (IRAs, 401(k)s, HSAs) before I would ever over-pay the mortgage.  Even then I would likely put the rest in taxable accounts.  The idea is the market returns will far outstrip a <4% fixed debt. But, some people just want to kill a mortgage as fast as possible.  You need to make that decision for yourself.

ETA:  This also may be useful to see how much you "save".  As I said above, the main reason these rates seem so much lower than what you are paying now is because you have overpaid and you would be stretching out your term.  If you "refinanced" and got the exact same 4% rate on your remaining $97,000, it would be
30 year @ 4.00% = $463
15 year @ 4.00% = $718
Again - this is not including insurance or refinancing costs that might be rolled into your current loan.
« Last Edit: May 02, 2016, 03:35:38 PM by nereo »

dandarc

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Re: Help me figure out refinancing math, maybe!
« Reply #2 on: May 02, 2016, 03:38:05 PM »
If you want a lower payment without the closing-costs involved in a refinance, you could also ask your bank about a recast - basically stretch your 20 year payoff out over the original 26 years as nereo points out.

Drifterrider

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Re: Help me figure out refinancing math, maybe!
« Reply #3 on: May 03, 2016, 06:14:33 AM »
Are you guys in Canada (for all posters thus far)?

nereo

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Re: Help me figure out refinancing math, maybe!
« Reply #4 on: May 03, 2016, 06:17:58 AM »
Are you guys in Canada (for all posters thus far)?
The OP talked about a 30y mortgage, which is pretty exclusive to the US.
I am currently in Canada but I am a US citizen.

whitedragon

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Re: Help me figure out refinancing math, maybe!
« Reply #5 on: May 03, 2016, 07:48:43 AM »
I'm definitely in the US.

And for all the ancillary data, I'm already maxing out all tax advantaged accounts, 401k, tIRA's and HSA.  The extra money saved by going to a new 30 year would go into my taxable account into VTSAX.

I agressively paid down my mortage for the first couple years because I mistakenly thought it would help me out more in the long run then investing and all that.  Now I'm more of the opinion that I should let the mortgage ride and dump my extra savings into my investments to grow my stash.

My thought process was, what is the effect on my expected expenses in ER on keeping the same payments out for 15 years vice 200 dollars less for 30 years from a "how big does my stash have to be" perspective.

Is it a "wash", or is one option really more advantageous than the other, and since I'm also ER'ing in 4 years, is 10k "extra" significant enough to warrant the extra 30 years of payments of 450ish dollars for my mortgage.

Does that make sense?

The previous replies are helpful but I'm not really sure of the best way to calculate this all myself so I can compare apples to apples.

nereo

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Re: Help me figure out refinancing math, maybe!
« Reply #6 on: May 03, 2016, 08:16:52 AM »

Is it a "wash", or is one option really more advantageous than the other, and since I'm also ER'ing in 4 years, is 10k "extra" significant enough to warrant the extra 30 years of payments of 450ish dollars for my mortgage.

Well, there are threads galore on this very topic, but to sum up: if you are planning on using the 4% rule (or anything close to it) - at today's fixed rates it almost always works out better to keep the mortgage and have other money on hand.

You've asked whether and "extra" $10k $12k (it will be more like $12k) is significant to warrant the extra 30 years of payments - well, consider this.  That $12k will pay your mortgage for over two years if it does nothing but sit under your mattress (which would be a silly place to put it).  At the same time, your mortgage will be fixed in 2016 dollars, but your annual payouts will increase with inflation (that's one of the givens behind the 4% WR method).  Currently inflation has been staying just below 2%.  Should this continue (unlikely) each year the percentage of your payouts that go towards your mortgage will shrink by 2% from the previous year.  If history is a good guide at some point it will rear its ugly head and rates will go up above 3% (maybe even above 5 or 6%, as they did in the 1980s).  If/when this happens the percentage of your annual budget that goes towards your mortgage will be even lower.  THis is what people mean when they say that a mortgage is a great inflation hedge.
Historically, high inflation rates have been the biggest threat to ER relying on investments.

whitedragon

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Re: Help me figure out refinancing math, maybe!
« Reply #7 on: May 03, 2016, 12:06:50 PM »
Nereo, I appreciate you helping me to break this down (although I'm still not quite sure how to set up the equation myself).

I have another question though, related to the 15 year vs 30 year refinance.  From an expense perspective, if I'm forecasting spending 30K in ER, and currently 650 a month for the next 20 years is going to that, then in 20 years my expenses should drop by 7800, so instead of 30k I only need 22.2K a year.  That means in 20 years my stash doesn't have to be nearly as big right?  (Not that it wouldn't be, just trying to understand.)

In the other scenarios (15 year vs 30 year), the expenses drop differently.  In 15 years, (with the 15 year refinance), my expenses drop to 22.2, so that's 5 years sooner that my stash can be "smaller".

For the 30 year, my immediate expenses go down today to 28.6K, (and I add 12K to my stash before FIRE) but expense doesn't drop off to 22.2K for 30 years.  That "delta" could affect how much money I actually need to accumulate in my stash right now.

How do I set up the equation to evaluate all these variables so I can put actual numbers to them?  (Hopefully that makes sense!)

nereo

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Re: Help me figure out refinancing math, maybe!
« Reply #8 on: May 03, 2016, 06:48:26 PM »
Nereo, I appreciate you helping me to break this down (although I'm still not quite sure how to set up the equation myself).

I have another question though, related to the 15 year vs 30 year refinance.  From an expense perspective, if I'm forecasting spending 30K in ER, and currently 650 a month for the next 20 years is going to that, then in 20 years my expenses should drop by 7800, so instead of 30k I only need 22.2K a year.  That means in 20 years my stash doesn't have to be nearly as big right?  (Not that it wouldn't be, just trying to understand.)

In the other scenarios (15 year vs 30 year), the expenses drop differently.  In 15 years, (with the 15 year refinance), my expenses drop to 22.2, so that's 5 years sooner that my stash can be "smaller".

For the 30 year, my immediate expenses go down today to 28.6K, (and I add 12K to my stash before FIRE) but expense doesn't drop off to 22.2K for 30 years.  That "delta" could affect how much money I actually need to accumulate in my stash right now.

How do I set up the equation to evaluate all these variables so I can put actual numbers to them?  (Hopefully that makes sense!)
Sure.
There's two things going on here that will affect your calculations.  #1) your debt will be held in 2016 dollars while #2) your WR will be adjusted upward for inflation each year.

Above, you've said that your mortgage costs $7,800/yr ($650/mo) and concluded that in 20 years your necessary expenses will drop down to $22.2k (you subtracted $7800 from $30,000 to get $22,200).  However, the math doesn't work out that way because of inflation.  We can't predict what inflation will be, but for the moment let's assume that it's 2% per year.  Following a normal 4% WR you will adjust your withdraws each year to match inflation.
HEre's what it what that will look like in non-adjusted terms:
Year 01: $30.0k - $7800.  Mortgage = 26.0% of expenses
Year 02: $30.6k - $7800.  Mortgage = 25.5% of expenses
Year 05: $32.5k - $7800.  Mortgage = 24.0% of expenses
Year 10: $35.9k - $7800.  Mortgage = 21.8% of expenses
Year 15: $39.6k - $7800.  Mortgage = 19.7% of expenses
Year 20: $43.7k - $7800.  Mortgage = 17.8% of expenses
Year 21: $44.6k - $0000.  Mortgage paid off. Note: in real adjusted terms this is exactly the same as having $30,000 in 2016.

Now this is a pretty rosy picture where inflation never rises its ugly head.  Historically, the mean inflation rate has been closer to 3%, with occasional multi-year sorties into 5%+.  If we create a scenario where inflation is higher things are even more dramatic.  Your ability to pay off debt becomes easier each year, because it's a lower percentage of your total budget.  If you take the 30 year term with moderate inflation estimates (~3%) the portion of your mortgage will be just ~11% of your budget towards the end of your term.

To get to your other question - you are correct that once that debt is gone, you can survive on a smaller stache.  However, there's no good formula for calculating this because the returns over 20 years will be far from uniform.  A much better idea is to use FireSim to see how your success rate would change after x# of years when your debt goes away.

I haven't touched on the added $12,000 in your portfolio from increasing your savings over hte next four years because of the refinance (and since I'm on a tablet I'm not likely to do it right now). But suffice to say it adds a healthy chunk to your overall bottom line.
A single caveat: Having a mortgage assumes we don't suffer the economy-crushing deflation. I haven't tried to model this because I honestly don't know how market returns would fare over such a period (there's little historical evidence to go by for an extended period of deflation).

Drifterrider

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Re: Help me figure out refinancing math, maybe!
« Reply #9 on: May 04, 2016, 05:59:34 AM »
Are you guys in Canada (for all posters thus far)?
The OP talked about a 30y mortgage, which is pretty exclusive to the US.
I am currently in Canada but I am a US citizen.

I was curious because the term "recast" was used and I've never heard that term in conjunction with a US Mortgage.

FrugalFan

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Re: Help me figure out refinancing math, maybe!
« Reply #10 on: May 04, 2016, 06:21:21 AM »
Nereo, I appreciate you helping me to break this down (although I'm still not quite sure how to set up the equation myself).

I have another question though, related to the 15 year vs 30 year refinance.  From an expense perspective, if I'm forecasting spending 30K in ER, and currently 650 a month for the next 20 years is going to that, then in 20 years my expenses should drop by 7800, so instead of 30k I only need 22.2K a year.  That means in 20 years my stash doesn't have to be nearly as big right?  (Not that it wouldn't be, just trying to understand.)

In the other scenarios (15 year vs 30 year), the expenses drop differently.  In 15 years, (with the 15 year refinance), my expenses drop to 22.2, so that's 5 years sooner that my stash can be "smaller".

For the 30 year, my immediate expenses go down today to 28.6K, (and I add 12K to my stash before FIRE) but expense doesn't drop off to 22.2K for 30 years.  That "delta" could affect how much money I actually need to accumulate in my stash right now.

How do I set up the equation to evaluate all these variables so I can put actual numbers to them?  (Hopefully that makes sense!)

You could use cFIREsim. Add the mortgage as a "extra expense" for x number of years, and subtract the amount of mortgage you would pay from your regular expenses. Then you can compare multiple scenarios.

Arebelspy said something on another post that makes sense to me to. When you have an expense that will disappear after some time, you can take that into account in terms of the size of stash you need. You don't need your stash to be big enough to cover your mortgage each year forever because your mortgage will end eventually. You need to save up a stash that covers all your expenses minus your mortgage PLUS the principal amount remaining on your mortgage upon retirement. If interest rates went up dramatically this would not be a good idea, but at today's rates, it should work well.

whitedragon

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Re: Help me figure out refinancing math, maybe!
« Reply #11 on: June 14, 2016, 01:15:35 PM »
By the way, I never replied back because I forgot.  Turns out, I did some math wrong.  My mortgage is not quite $600 right now, so the 15 Year increases my mortgage by about 100ish dollars, the 30 year only reduces it by about 100 dollars, and recasting only saves me about 75 bucks.  That and none of the banks wanted to give me any breaks on closing costs or anything for a zero down re-finance, so I just am going to ride out what I have!

However, having you guys help me check my own figures was a big help!