Author Topic: How I earned 14% per year risk-free  (Read 2904 times)

ChpBstrd

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How I earned 14% per year risk-free
« on: November 04, 2019, 09:14:21 PM »
Old mortgage:
4.875%
30y
$157.50/mo principal
$498.72/mo interest

New mortgage (established just 9 months later):
3.25%
15y
532.59/mo principal
$331.69/mo interest
$178.90/mo higher payment
$3,612 closing costs

Savings:
$375.09 additional principal paid
$167.03 less interest paid
$(178.90) higher payment
----------
$363.22 monthly increase in NW compared to old mortgage

Annual return:
((363.22 * 12)-(3612/15))/3612 = 114%
Note that I flat-line depreciated the closing costs in the numerator. No cheating!

NPV of closing costs and savings, per Excel:
$45,997.71

I will happily hand over another $3,612 if interest rates get down to about 2.5%. Also, it's astonishing how the mortgage balance goes down over 3X faster, initially, with a 15y loan instead of a 30y. Do I wish I had just waited 9 more months before buying? Of course, but thinking that way is the sunk cost fallacy. Bottom line is I saw an opportunity to earn 14% risk-free and grabbed it.

moneypitfeeder

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Re: How I earned 14% per year risk-free
« Reply #1 on: January 15, 2020, 03:48:47 PM »
Awesome reduction! We waited even longer than you to refi, but the reduction was still well worth it. Such a conundrum, if you wait for the right rates, you might not find the house you want--when you find the house you want, the rates might not be what want. I think you went about it the right way.

Simpli-Fi

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Re: How I earned 14% per year risk-free
« Reply #2 on: January 16, 2020, 04:34:21 PM »
I refi'd an investment property last year...one tactic I used to bring less to closing (not everyone's cup of tea) was to eliminate escrow.  We are all responsible mustachians and we pay our bills and budget and saving appropriately...instead of a quoted needing approx $8k for closing and front loading insurance/tax.  I ended up ultimately getting a couple thousand back as they overpaid my mortgage off (they even tried to increase my loan amount by $3k and that's when I told them I was ready to walk)...they didn't believe my estimate of principal going down by over $1k per month (ordeal took about two months) and lender gave me $1400 credit; they originally told me they couldn't give the credit if I didn't use escrow for some reason...then I told them their product wasn't for me.

It's great to be able to not rely on a lender to make financial decisions for me...knuckleheads.


ChpBstrd

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Re: How I earned 14% per year risk-free
« Reply #3 on: January 16, 2020, 06:47:33 PM »
Awesome reduction! We waited even longer than you to refi, but the reduction was still well worth it. Such a conundrum, if you wait for the right rates, you might not find the house you want--when you find the house you want, the rates might not be what want. I think you went about it the right way.

This is why I tried to break it down as a ROI thing. If rates continue to fall, I have a way of determining if yet another refi is a good investment. No thoughts allowed about sunk costs!

AMandM

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Re: How I earned 14% per year risk-free
« Reply #4 on: January 17, 2020, 09:00:20 AM »
I think you've over-counted your savings.
Each payment decreases your NW by the amount of interest paid, because you lose cash equal to (principal + interest) and you gain equity equal to the principal. So the benefit from the new mortgage is just the difference in interest paid, $167.03 rather than $363.22. Each payment will have a different split between principal and interest, so it's not quite accurate to take this month's savings and multiply by 12 to get the annual return.

Still a great deal, though! Over the 30 year life of the original mortgage, you're saving close to $80k of interest for a total ROI around 2100%.

robartsd

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Re: How I earned 14% per year risk-free
« Reply #5 on: January 17, 2020, 10:48:39 AM »
Your numbers show a difference of $208.06/mo in PI payments. If your the total payment change you used in your calculation included the change due to dropping TI escrow payments, you failed to account for making those payments in your calculated return. Using cash flow analysis, I don't see an actual gain. You spent an extra $3612 at the start followed by 180 months of $208.06 to save $656.22 for the 170 months at the end of the cash flow. The IRR function returns an error for this cash flow.

ChpBstrd

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Re: How I earned 14% per year risk-free
« Reply #6 on: January 17, 2020, 12:09:48 PM »
I think you've over-counted your savings.
Each payment decreases your NW by the amount of interest paid, because you lose cash equal to (principal + interest) and you gain equity equal to the principal. So the benefit from the new mortgage is just the difference in interest paid, $167.03 rather than $363.22. Each payment will have a different split between principal and interest, so it's not quite accurate to take this month's savings and multiply by 12 to get the annual return.

Still a great deal, though! Over the 30 year life of the original mortgage, you're saving close to $80k of interest for a total ROI around 2100%.

Because I refi’ed from a 30y loan to a 15y loan, the principal adds up at a faster pace. Therefore I counted it as a relevant flow of wealth.

ChpBstrd

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Re: How I earned 14% per year risk-free
« Reply #7 on: January 17, 2020, 12:59:46 PM »
Your numbers show a difference of $208.06/mo in PI payments. If your the total payment change you used in your calculation included the change due to dropping TI escrow payments, you failed to account for making those payments in your calculated return. Using cash flow analysis, I don't see an actual gain. You spent an extra $3612 at the start followed by 180 months of $208.06 to save $656.22 for the 170 months at the end of the cash flow. The IRR function returns an error for this cash flow.

You’re only looking at cash. On the equity side, I went from gaining $157.50 equity per month to gaining $532.59/mo and this difference will only widen as the loan amortizes. This is why the loan will be paid off in 15y instead of 30. The refi does involve a higher payment, a transfer of wealth from my cash account to my equity account, but I’m good with that because I’m mostly interested in net worth.
The increased payment size only partially offsets the increased rate of principal gain as shown under the “Savings” heading.

I suppose to be extra fair, I could have deducted from cash flows the implied interest I could have earned in similarly risk-free investments with the extra $178.90 per month and $3612 closing costs. At a 2% “cost of capital” this drops ROI to about 10.8%. This is still a very respectable return for a zero risk investment. If I were comparing this investment to, for example, the alternative of a junk bond, I would have to use the originally calculated return of 14% because I would need nominally that much return from the bond to end up with the same amount of money in the end.

One could go further down the rabbit hole with inflation adjustments, yearly amortization charts, compounding, and taxes, but most of these factors lean in favor of the refi anyway.

I excluded any escrow info from all numbers, because that doesn’t change anyway.

robartsd

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Re: How I earned 14% per year risk-free
« Reply #8 on: January 17, 2020, 02:46:10 PM »
You’re only looking at cash.
I didn't miss the equity, I just ignored it by taking the cash flow out to where the equity was the same (you own the property with no mortgage 30 years after initial purchase).

I figured out the error. I had not supplied Excel with a guess in the IRR function and the default assumption was high enough (typically this function is used on annual cash flows) that the calculation hit a rounding error. Providing a guess of 0.1% return per month resulted in a calculated value of 0.61% per month which compounds to 7.61% annually. If I adjust the cash flow for constant 2% annual inflation, the compounded result is a 5.49% inflation adjusted annual return.

Retireatee1

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Re: How I earned 14% per year risk-free
« Reply #9 on: January 18, 2020, 03:46:12 AM »
Seems like a good move, however I would assert that there is some risk in having to move and sell the house before the closing costs pay for themselves.

The "risk free" assertion is perhaps a bit strong.