Ask the Readers: Is It Okay to Refinance a Mortgage to Get Cash for Other Goals?
Published on - October 29th, 2010 (by J.D. Roth) I have a backlog of “ask the readers” questions since I didn’t publish any while I was vacationing over the past month. As soon as possible, I’ll get to those I’ve promised to post. Today, however, I wanted to share a question from Kristine, who wrote to me earlier this week.
Kristine is trying to decide whether she should refinance her mortgage. Here’s what she has to say:
I’m trying to decide if refinancing is the right choice for are family. We’re living pretty tight right now and the idea of reducing our monthly payment is very tempting. I would love to be able to take the savings and put it towards retirement and possibly some other future goals. However, if we do that then we’ll be paying thousands of dollars extra in interest over the life of our mortgage.
Is it better to take the monthly savings and put it away anyway, or wait another 23 years until the mortgage is gone? (Hopefully our finances will change before that time and we will have extra money to start saving before then!)
I’ve been playing with all of the calculators, but am still overwhelmed by the decision and am not 100% sure that I’m realizing all of the pros and cons. What do you and your readers think? I realize no one can make the decision for me, but input is helpful!
Kristine supplied some additional information with her question. Her original mortgage was for $161,000 in June 2003. It’s a 30-year mortgage with a fixed rate of 5.375%. Her family does not make extra payments, and they do not have PMI (private mortgage insurance). The mortgage has a balance of $141,850.
Her family’s only other debt is a small balance on an auto loan that they hope to have repaid by the end of the year. They’ll then take the amount from the car payment to start saving for another car when the current one bites the dust. (Awesome method, by the way! That’s what I’ve been doing — until I routed the money to my upcoming Africa trip, anyhow — and it’s an idea popularized by Dave Ramsey and others.) Kristine says she might be willing to take a portion of that that money to apply to a different savings goal.
No right answer
As with all questions of this nature, there’s no one right answer. Kristine’s decision needs to be based on her goals and values, and on what brings her peace of mind.
When my wife and I were faced with a similar decision two years ago, we opted to refinance. We dropped our interest rate from 6.25% to 4.96%. We chose to stick with a 30-year loan instead of moving to 15 years because we liked the idea of having lower payments in case we needed the cash flow for something else. (However, we decided to keep paying what we’d always been paying in the meantime.)
For us, peace of mind meant paying aggressively now, while we can, but leaving open the option to use the money for other purposes in the future.
So, obviously I think that refinancing can be a good idea. The trap, however, is refinancing to free up cash flow, but then frittering away that cash flow on Stuff. Using it to keep paying down the mortgage? Great. Using it to pay off high-interest debt or to fund retirement? There are arguments for and against, but if that’s what will help you sleep at night, I say do it. Using the extra cash flow to fund a trip to Tahiti? Probably not a good idea. And I wouldn’t recommend buying new books or boats or computers with the money, either.
Exploring options
Since Kristine wants to hear what you would do in her situation, I’ve pasted a mortgage calculator below so that you can run various scenarios. (I used mortgage rates from HSH and other sites to run what-if scenarios.)
So, based on the information Kristin has provided, and based on your own experience, what would you do in her situation? Would you refinance your mortgage to free up cash flow for other goals? If you’ve done something like this already, how has it worked out? Would you do it again?
Further reading
We’ve covered variations on this theme several times in the past at Get Rich Slowly. Here are three related articles from last year:
- Ask the Readers: When Does it Make Sense to Refinance a Mortgage?
- Refinancing Made Easy: Our Story (in which I describe how Kris and I refinanced our mortgage)
- Does it Still Make Sense to Refinance in Today’s Market (advice from an actual mortgage expert)
For a more in-depth look at refinancing, check out the HSH.com article “Refinance: Is It Right for You?” You also can see different lenders’ lowest mortgage rates or request mortgage quotes from reputable lenders via GRS.
Finally, here’s an old post in which my pal Nickel shares his thoughts about how to decide when to refinance your mortgage.
This article is about Ask the Readers, Choices, Debt, House and Home
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I think that so long as the rate is good, and you know that you can keep up the self-discipline, it sounds like a good idea. I think this might be the minority view though.
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I performed the calculation with the calculator that was provided. Assuming you could get a rate of 4% and had closing costs of about $2,000 (which I think is completely doable right now), even if you extend the mortgage loan back to 30 years, you will have an overall savings of $3,000. Since there is a savings AND you’ll have about $200 freed up every month, I think it’s a good idea to refinance.
I’m sure that you all know moving to a 15 year loan will insure further savings in the long run, but to J.D.’s point, it’s always good to have some cash freed up for unexpected emergencies.
Check out my savings tips and investment ideas at http://www.lifeandmyfinances.com
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We refinances to take advantage of the low interest rates. But instead of refinancing into a 30 year mortgage we went with a 25 year term. At the time we were about 5 years into our original 30 year term so we didn’t add any time (or more interest payments) to our amortization schedule.
We could have refinanced at the same rate into a 20, 25 or 30 year term. 15 year term was a different product.
Sounds like the reader is 8 years into a 30 year term so if you are going to refi, maybe try to get into a 20 year term which with a lower rate could still free up money. If that is too aggressive, maybe go with a 25 year term. it would be better to tack on 3 years vs. 8 years to your schedule.
Our plan was to put all of the extra money we saved via the refi towards principal prepayment on the mortgage. And guess what, it didn’t happen. We are putting $100 a month extra towards principal, but the rest of the savings is going towards other goals or is going towards life. We plan to up our principal prepay in 2011. But I was surprised that life got in the way and we, who are quite disciplined with our personal finances, have not stuck with our original plan.
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I would refinance, but do not take any cash out. Refinance for $141,850 + expense, let’s say $143,000. I punched the number in at 4% and they will save about $220 a month.
Now what she needs to do is roll that $220 a month back into the principle every month. If she does this, the loan will be paid off in 19 years. It will be difficult to make extra payment every month for 19 years though.
Or she can use part of the money to pay down the principle and invest the rest.
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I agree with number 4.
If you don’t need the money now, roll it back into the principle. If you do need the money, then use it. the lower monthly payments gives you more flexibility, more flexibility is more fiscal power.
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We refinanced a little over a year ago and pulled out as much money as we could, which ended up being about 100K. I had a few reasons for pulling the money out. First, I knew house values were still dropping, so I wanted to get the equity out of the house then, while I could still do so. I didn’t want to count on it being available in the future for a home equity loan. Second, we knew we were going to have to replace the roof and while we had an emergency fund which would have covered most of it, we would have been wiped out on the savings front.
I put all the money into high(ish) yield accounts and waited. The next summer we replaced our roof and decided to get a “lifetime” roof, which cost a bit more, but will reduce the hassle and expense of the roof in the future. And we did end up having another family emergency around that time as well.
Most of the money is still sitting out there, but it has brought a lot of freedom and peace of mind. We are actively working to “pay back” the money from the emergency to that account.
The thing that makes this work is that A. our increased mortgage payment was minimal and we can afford it. We are also disciplined enough that we are not going to spend it on luxury items. But with both my husband and I in high tech, jobs come and go quite frequently. Having the cash brings us peace of mind in a big way.
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Assuming she can refinance (I know many people here cannot because they will not have 20 percent equity anymore because of the drop in housing prices), it would be a good idea. (You should NEVER give up free money.)
However, I don’t want that money going to frivolous spending. I hope that it either goes toward the mortgage every month, or they immediately increase their 401k percentage. Or, they could put the amount they saved right into a Roth IRA each month.
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We’ve refinanced twice so far to take advantage of lower rates. Right now we’re on a 20 year refinance. We’ve kept our modal payment the same with each refinance and with the changing escrow each year (because I like round numbers).
I would encourage them to look at their entire budget maybe with the balanced money formula, to get an idea if they’re going to be in this same situation with less flexibility down the road– if so, then other restructuring may be more important than the mortgage refi.
Personally, I would only do the refi if it made monetary sense in terms of the break-even point. Making any spending decision based on monthly payments alone rather than the bottom line, especially when interest rates in other savings vehicles are so low, is not a great idea.
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If she needs more cash flow now and is looking at this as a hump to get over before putting more money at the mortgage later, then refinancing even if it risks costing you down the road is likely better for their current situation. Even if you can’t pay ahead later, those thousands in interest will be getting paid with inflation adjusted dollars, when you are hopefully in a better financial position and earning more. Worst case, you lose a job right after you refinance. Will it be easer to make a payment with $150-$200 less owed in a month?
I did much the same thing recently. In theory, if I saved the difference in payments and put that to the mortgage, I come out ahead by $4-6K. If I live on the money instead, I’m $20-30K in more at the back end of the loan (because what you’re typically doing is extending the loan out however many years you’ve been paying into it). But the real reason I did it is even $100 a month in extra cash flow is really helpful to me and mine right now and for the next five or six years. While you don’t want to overburden your future self, you have to take care of things now as well.
Big picture worst case, they reduce their mortgage by $150-200 or so a month, put more towards retirement and other savings goals or immediate needs (not wants), but end up not prepaying the mortgage, hence ending up making 7 more years in payments at significantly below likely rental costs for a nice two bedroom apartment in 20 years. I’m not seeing a killer downside here.
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Are you kidding? As a Canadian low income earner I can only say- have Americans learned nothing over this credit crisis? I was faced with the choice to pay it off or keep the cash. I saved tens of thousands of dollars by paying off the mortgage. Now I travel the world and do things no one else can do while they pay those minimum payments for decades. Debt free is the only way to go!
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If you’re going to refi, now is the time. I don’t think any of us will ever see rates this low again.
I didn’t see how old Kristine is, but that should enter the calculus. If she’s in her 30′s, she should think long and hard about a 30-year term. Who wants to be paying a mortgage in their 60′s?
In cases like these, I think that it’s wise to split the difference. If the monthly savings is $200, put a portion of that back to the principle each month and then use the balance for the retirement fund.
And I definitely agree with retirebyforty (#4) who warns against taking cash out. It’s hard to make progress if you’re going backwards.
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I was going to refinance but didn’t like being saddled with a 15 year payment and the fees associated with refinancing. So we kept the 30 year payment and decided to pay extra to reduce the mortgage to 15 years. This way if our budget explodes one month or something happens we aren’t obligated to make the higher payments. But it is truly an individual decision as everyone’s situation is different.
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I looked at this very recently. I am 7 years into a 30 year mortgage at 5.8%. But, I have been making extra payments all along so the mortgage would be paid off in 15 years or so.
When I looked at a refi, yes I could save money on the monthly payment, but the interest cost would be more (even at a 4.5% rate). Working it this way, I have had the option to make less of a payment on principle if an emergency came up and I needed cash for something else. So, ultimately, in my situation the higher interest rate is fine.
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If refinancing lowers the monthly payments (sorry, I’m too rushed to do the calculations), then do it (why throw that money away)? But don’t put it in a retirement fund. You’re guaranteed a great ‘return’ on your money by paying down your mortgage with it whereas investing isn’t likely to give you as much back. So keep putting that extra towards the mortgage (when possible). Also, take a look at your other monthly expenses and figure out where you can cut back. That’s the first place I’d look to see where to keep from being ‘tight’–not cutting monthly mortgage payments.
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Here is what I did. I originally had a fixed 8.5% 30 year mortgage, refinancing to 6.5% fixed and later at 4.9% fixed. Even though I had other debt I did not take on any more mortgage debt. I kept the payment the same each time. Result, the house was paid for in 19 years, even though I made no extra payments until I finally paid off the loan with $30,000 I had saved. That last payment cut 2.5 years off the repayment time.
So my advice is don’t add to your mortgage debt if you can help it.
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I agree that refinancing now makes sense. Take advantage of the lower rate while you can, you’ll be glad you did if you plan to stay in this home and pay it off early – which I hope you do.
Something does jump out at me though:
“We’re living pretty tight right now and the idea of reducing our monthly payment is very tempting.”
“…only other debt is a small balance on an auto loan…”
Why is money tight? There does not seem to be that much debt. Maybe it is legitimately a matter of income right now, possibly one of you is under-, or unemployed. Or maybe you just took on a little more mortgage than you should have. Totally understandable. My point is only this, make sure you have your spending under control no matter what other decision you come to. It will make saving and paying off debt easier. Good luck!
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If not handled properly, with all the pros and cons and calculations involved, and if implemented without a disciplined plan, refinancing can be the worst thing you can do for your finances. You are basically paying expenses to the lender to incur more debt, often over a longer period of time. In other words, nine times out of ten you are taking a giant step backward. When people need to refinance, it generally means that they cannot afford the house. The mortgage payment is too high and it’s sucking away income. Based on my own personal experience, I would never refinance again. The ultimate goal should be to have a mortgage payment that takes away no more than 30% of your monthly income MAX on a house that reflects CURRENT market value. That’s going to be impossible to achieve if you’re upside down in the mortgage to begin with. If you’re not upside down, it may be time to consider selling the house and buying something more affordable (lots of bargains around right now) or even renting. Whenever someone suggest refinancing to me personally, I make the sign of the cross. It’s just more money out the window ultimately.
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I am surprised that no one has mentioned the PMI. If she refinances, she will be borrowing more than 80% of the value of the house, assuming the house appraises at $161,000, which might be optimistic depending on where Kristine lives. As a result, won’t she have to pay PMI on the new mortgage? Currently she says she is not paying PMI. That needs to be factored into the new monthly payment and the time required to break even.
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I am going to throw out two scenarios here:
1. existing loan of $141,850 @ 5.375% over the next 22 years
2. refi loan of $141,850 @ 4.000% over the next 30 years
In both scenarios you will pay nearly the exact same interest over the course of the loan (around 100k). However, if you refi you get to hold onto an extra $240 a month of it for the first 22 years. Then you’ll have to pay the total amount amassed back over the last 8 years. So, if you get 0% return on that money over that time frame you lose nothing. If that money gets you any return back you are ahead of the game.
I also ran a 3rd scenario:
3. refi loan of $141,850 @ 4.500% over the next 30 years
In this case (assuming 25% income tax, 18% capital gain tax) the extra monthly savings from the refi would need to get you a return of at least 2% to break even.
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Something does jump out at me though:
“We’re living pretty tight right now and the idea of reducing our monthly payment is very tempting.”
“…only other debt is a small balance on an auto loan…”
This jumped out at me, too. If $200 a month is make or break for you, then refinancing isn’t a long term solution. Overall, I would refinance – having breathing room in the budget for when you need new brakes on the car or the cat has to go to the vet – that’s worth more to me than money that my “future self” 22 year in the future will save. I would also take the extra $200 a month to start saving for retirement and an EF, if they don’t have those savings already going.
But I would also examine why money is so tight if you don’t have much debt, and the car loan will be gone by the end of the year.
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This is a good question. I had been comtemplating a refinance for months and finally just pulled the trigger Tuesday because it seems like rates won’t go any lower. I went from a 5.875% to 4.375% .
Anyway, with closing costs its surprising how little one really saves. I found that if I pay the same payment every month as I do now, I will pay off this new mortgage in 19.5 years instead of 23.5. The way I see it, I will break even in 3 years. That’s based on when my loan amount will actually be less than it would have been had I not refinanced (assuming the same monthly payments).
I think part of the answer lies in your age – if you’re very young and the 30-year will still allow you to pay off your mortgage before retirement and you think you’ll stay in your house for quite a while, then the 30 year might make sense. However, pushing out the length of your mortgage can be a risky precedence. You would essentially be giving back nearly all of the gains you’ve made in the time you’ve been paying down your mortgage thus far. Plus, you have to be really certain that the savings will go towards retirement and will not go to “transmissions and prom dresses” as Dave Ramsey would say.
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You should refinance with a 15 year mortgage if you can afford the payment. As you make your monthly payments you will see a significant improvement in the amount going towards principal. Especially in the current interest rate environment it makes sense since your freed up cash flow wouldn’t earn much interest at a bank. Wouldn’t it be nice to have a mortgage paid off in significantly less time thereby helping you reach financial independence much faster?
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1. if you need money for other parts of the budget, then refinance for rate if you can but don’t take money out and don’t extend the term back to 30 years.
2. if you don’t need money for other parts of the budget, then refinance for rate if you can, don’t take money out, but shorten the term of the loan so that your monthly payment is about the same. This option cuts thousands of dollars off of the total interest paid for the mortgage.
No one ever hit themselves over the head for getting their house paid off as soon as possible.
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1. Unless you truly NEED the money, do not take cash out. That said, if you don’t put money in retirement accounts each year, you lose that opportunity.
You should refinance to a lower interest rate, so long as you will be in the house long enough to amortize the closing costs. Then, you should make sure you have funded your emergency account(s) and are taking advantage of any employer retirement match. If at all possible, you should contribute the maximum possible each year into your 401(k)/403(b).
Unless there are extraordinary, one-time needs, do not take cash out for current expenses. Figure out how to truly live within your means!
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Not enough info here, at minimum I’d ask:
1) what are the other goals? Like JD said, if they take the savings and blow it on Crap/Stuff what’s the benfit.
2) what is the new rate? I’m a CPA, I need numbers. Are we talking a drop of $75 or $300 per month. What’s the payback period on the closing costs they’ll have to fork over?
Also, if they’re already living “pretty tight”, I’d question whether they have too much house to begin with. Not trying to criticize here, just offer my advice because I’ve been there. In 2001 my ex and I bought a house that stretched us, we refinanced a year or so later, but it was still a huge burden.
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Assuming you aren’t going to move and won’t take out any equity, I think refi makes sense in your case. Your rates will drop by about 1%. We’re in historically low rates right now. They won’t be around forever.
If you work with your current lender, sometimes you can lower your interest rate and keep your current term (23 years). We did this once after my son was born, which lowered our payments by about $75/month. Not a lot, but enough to give us a little more wiggle room. By working with your current lender, you save some of the refi fees too.
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As a mortgage broker, I always advise my customer to do a refinance contingent on their goals. If you want to pay your mortgage off sooner rather then later, try to refinance to a shorter amortization period(what #3 said above). If you want to lower your payments, you can do the 30yr as long as you recoup. the refi. costs within a two year period.
The best tool is to use Excel’s Loan Amortization Template. Save one as Current Mortgage and the other as Refinance Option. Then play with the numbers, it’s the best mortgage calculator available! Especially when you start putting numbers in the extra payment field.
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I’m currently looking into ways in which I can refinance my townhouse, take money out and pay off some school loans. It’s a no brainer for me since the school loans are at a higher interest rate and not tax deductible. I think like the “own versus rent” debate, there’s no real right answer. Just do the math and pick the option that works out the best.
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I’m part of a two-man company that develops apps for iPhone and iPad, and our most recent app is a financial calculator based upon HP’s 10bII financial calculator. One of the features we included in the app is a set of Easy Modes, which are kind of like wizards that ask simple questions in plain language and then come back with some insight into your question and its answer.
The reason I bring this up is that our Refi Helper Easy Mode was conceived by a friend of mine and we wrote it specifically to answer this kind of question. In addition to telling you your total savings over time and your savings per month, it will also tell you how much you’ll save per month if you want to make extra payments so that you keep the same end date (which seems to be a concern for the lady asking the question), and also how fast you’ll pay off the loan (and how much you’ll save overall) if you take your current payment and apply it to the new loan. I’ve found this to be one of the most enjoyable aspects of the app, not to toot my own horn, because it really helps when making the kind of decision that Kristine’s struggling with.
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I don’t have a mortgage (and I enjoy this), but I’m a big believer in the fundamental evil of debt. Call me a fanatic if you want, but thanks to this mindset I’m finally not completely broke. I live with a very tight budget, but I am not broke. Isn’t that great?
From this recovering debtaholic, then, some thoughts: If you free up cash flow, do it to build an emergency fund that will keep you from dipping into credit cards (say, 12 months of living expenses), do it to pay off your car loan quickly, do it to put more money away for retirement, and do it to shorten the term of your mortgage because you will pay a lot less in the long run. (I understand some of these goals might be mutually exclusive, but what I’m saying is, don’t refinance to buy stupid stuff, like new furniture, or a big TV).
While Dave Ramsey’s religiosity gives me hives, I find his behavioral advice with regards to money to be sound. Please check out his books while you think about tweaking your mortgage. Because ultimately money is not about numbers, it’s about how we relate to it. If you relate to money poorly, if you gamble on hopes that “in the future your finances will get better” you’ll get into trouble down the line even if your refinancing is numerically advantageous.
I used to think “oh, I’ll pay off these credit cards easily in the future when I make more money”. Didn’t quite work out that way. Please don’t do what I did. The future is unpredictable. Make compound interest work for you, not against you.
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No, no, no. I have a friend who has done this a time or two. They got their original mortgage about fifteen years ago or so….arond $50,000 (this is the midwest). After several refinanes to get their hands on more cash, they now owe over $90,0000. Don’t forget, over 15 years have gone by in this house and they owe almost double, when they should be getting this paid off. Now they want to move and sell the house for a fancier, newer (and much more expensive) one.
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My husband and I closed on our refinance last night. We had a 30 year (with 29 years left) at 5.5% and switched to a 25 year at 4.25%. Our payments are only about $20 less per month, but the savings over the course of the loan are near $60K. If we had chosen the 30 year, our payment would’ve been a $100 less per month. The loan company integrated all of the closing costs into the loan, which was a relief, considering we still come out ahead. Of course, if someone doesn’t plan on staying in their home for a certain period of time, refinancing doesn’t make much sense.
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We are seriously considering it. We could refinance and take out enough to go most of the way towards a attic remodel and can comfortably handle the increase in monthly payments. But I don’t know if I want to. The idea of an earlier paid off house is also very attractive in my mind. I can’t decide which I value more so we are going to try to wait a year to decide.
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Key information is missing, like their credit score and the current value of their home. This will determine if they can refinance at all, and what their % mortgage rate might be if they could refinance for either 15 or 30 years. I’d check with a bank first about this.
That said, it’s hard to imagine how money put into a retirement account could possibly earn more interest in the next 5 years than the 5% guaranteed return they currently get by paying down their current mortgage. Even if they could put all the money “saved” by a refi into a retirement account which, since money is apparently “tight”, would probably not happen.
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I’d refinance, because I hate the feeling of not quite having enough money. However, I agree with those who said that if you do refinance, don’t take any extra money out.
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I would refinance and lock in the lower interest rate now. The reduced payments will give breathing space – set the money aside for emergencies and then at the end of year make an additional capital repayment.
I just recently refinanced and reduced my mortgage payment by about $100 a month. I’ve just committed to new windows and will pay for those through a home equity loan and will be using the money from the reduced mortgage payment to cover the interest and debt payments on the home equity.
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We went from 5 months into a 30 year at 5% to a new 30 year at 4.5% last month. We’re taking the extra $150/mo and rolling it into our already doubled monthly payments, so we’ll pay it off even earlier. That’s the only thing that made sense to us.
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To answer some of your questions:
Yes, money is tight, but we are paying our bills and are not in danger of falling behind. We aren’t looking to reduce our payment to meet regular monthly bills, and we aren’t looking to take any cash out with the refinance. We really got serious about our spending about 2 years ago so we do have our spending in check (although, like most people, we could go a little more extreme in the cuts if we HAD too). We have no cable, use cash envelopes, etc. We are keeping afloat, but aren’t really gaining much ground either. We don’t have a lot left for saving after the regular bills are paid. We would like to increase our savings – retirement or other.
We do have an emergency fund of about 3 months. 5 months if we took all of our savings. I admit I would like a little more in there.
I am 32 and hubby is 34. We bought the house when we were both working full time. I am now a stay at home mom of twins because 1) I want to be for a myriad of reasons and 2) we would’ve been paying almost my entire salary for daycare expenses. We both have excellent credit (in the 800′s last time we checked).
We are not upside down. I think our home would be valued around 220,000 or so.
Hubby works full time and part time as well. I do some per diem work from home for my former employer which helps some, but is not steady income.
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I am surprised there is no information what the house appraisal value is. Now that we know that house values do indeed go down, it is a key piece of information.
In general, usually when things are “pretty tight right now,” the first place new money goes is not to retirement or even savings. If it were me, I would look to other places in the budget to cut costs or try to find additional income streams. Also, retirement should really be part of your current budget, not tomorrow’s budget. I’m not saying you should or shouldn’t refinance, but your current budget does not appear to be working — you may want to consider making a number of changes (not just one).
What if mortgage rates go up in the future and you need to move? What if housing costs are more expensive in the new place? What if your net income goes down or taxes go up?
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I think for your situation the longest term guaranteed rate is best (probably a 30-yr fixed).
I am a little wary of claims that “rates will never be this low again”. How many times have we heard this? Also, the rates are relative to what you can get for your money. 4.375% for a 30yr mortgage only looks good until you see you are getting 2.5% for a 5 year CD. Sure, the stock market could get you a better return, but….
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I’m the other guy in Kyle H’s two-man company (comment #29) who develop iPhone and iPad apps. Our 10bii Cash Calculator app’s Refi Helper Easy Mode can answer this problem for Kristine!
If we assume Kristine’s new loan is at 4%, her new payment is going to be $677.21 which is $224.34 _less_ than her current payment.
If we assume she is going to have to pay $1200 is refinance/closing costs, the monthly savings on her payment means she’ll have recoup’ed her refi costs in 5 months.
The total loan payments over the life of the current loan are going to be $246,093 and the total for the new loan payments will be $243,796. That’s only a total difference of $2,297. So, even if you just do the refi (with the above assumptions) you’ll save each month, but you’ll pay almost exactly the same amount once you’ve paid all the interest.
So, Kristine’s worries about her savings being chewed up by the extra years of paying interest are well founded! However, our Refi Helper provides some extra info. If Kristine wants to avoid those extra years of interest, the situation gets better! Her original loan is scheduled to be paid off in July 2033. If she wants to avoid extra years of interest, she can pay $792 each month ($115 more than the new loan payment, but still $109 less than her old payment!). Paying $792/month means she’ll save $29,835 in interest over the course of the loan!
Now, Kristine could use the monthly savings to invest in a savings/investment account somewhere else, but unless she can get more than a 4% return on her money (or whatever the rate on the new loan is) then she’s better off investing that money into principal paydown on her new loan. Not having to spend money paying interest is just like earning money from an investment! So, if Kristine did the Refi, but decided to continue paying her extra monthly savings into principal paydown ($901.55 being paid monthly instead of $677.21 on her new loan), then the 30 year loan would be paid off in about 18 and a half years. Over the shorter life of the new loan her total payments would add up to $201,376 and that would be a savings of $44,717 in interest!
However, if the new loan interest rate is 4.5%… the new monthly payment would be $718 which means that if she paid $718 for 30 years she would end up paying $12,650 _more_ in interest. So, the answer to Kristine’s dilemma is definitely a tricky one and dependant on what kind of interest rate she’s going to get on the new loan! Keep in mind though, if Kristine gets a 4.5% interest rate on the new loan, but decides to spend part of her monthly savings on extra principal paydown that she can still save money ($19,224 if she wants to keep the same end day and $31,325 if she keeps paying $901 on the new loan).
It’s a very complex and tricky question, one which many people have but can’t find the answer to! I did all of the calculations above with our Refi Helper Easy Mode in our 10bii Cash Calculator app for iPhone and iPad. Check it out if you are interested!
http://www.inadaydevelopment.com/app-CashCalculator.php
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I’m a former banker with two personal finance books to my name, so I would like to weigh in on this from the financial perspective. In today’s economy it is likely that you couldn’t qualify for a refinance, Kristine, because you aren’t working … or should I say, you aren’t getting paid for your work. By your own admission, money is tight, and as the old saying goes, banks only lend you an umbrella when the sun is shining. Also, you may think your house is worth $220,000 but the appraiser will probably have a different opinion, so PMI is a real possibility as are a myriad of fees that will jack up your closing costs. Finally, the average life of a mortgage in the US is something like seven years, so why assume you will have this mortgage for thirty years. More likely you’ll want a bigger house when the twins grow or want a house in a neighborhood with a better school system or your husband will get a transfer to another city and the closing costs you rolled into the refinance will end up costing you money. Tough it out until the twins are in school and you can get a job outside of the home and start socking away the dough for retirement and their college funds.
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If you want to lower your monthly payment, I think it’s OK to refinance, but not to take equity out. I agree with a PP who wondered if you might have taken on too much house if your finances are tight.
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Look at refinancing into a 20 year fixed loan with a rate of 4.0%. This is absolutely available today. Not only will it save you $40 a month, but it will pay off your home in 3 less years. Take your first two months off your mortgage payments to get caught up on your bills.
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I wouldn’t do it if you can avoid it! The fact that the reader says that money is tight which makes this option tempting tells me that it is not as likely that the money saved will all go into savings/retirement. From the e-mail, it feels that the reader is not being honest with herself. In order to convince herself that this is a good option, she’s promising herself that she’ll be using the money on another good goal: retirement. But the way that she phrases it makes it feel like she is really looking for relief and have more money to spend on other areas. If money is really that tight and you NEED it to live, be honest with yourself. But don’t go into this decision with promises that it will be for retirement when deep down, you’re wanting something else (perhaps wiggle room in the budget)
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My husband and I refinanced a couple of years ago to a 15-year mortgage to get our last debt (mortgage) paid off as quickly as possible. We both had good-paying steady jobs and life was good. Shortly afterwards my husband got very sick with something doctors were having a hard time diagnosing. Two years later we’re still dealing with a ton of out-of-pocket health expenses, his lower income due to illness, and we made the decision for me to quit my job to help take care of the many things at home that were falling apart. My suggestion is always refinance to a 30-year and pay aggressively so that if something bad happens, you can revert back to only paying the lower monthly amount. On another note, we just refinanced to get our payment as low as we can which is helping to keep us afloat and things are looking up. Good luck with the decision!
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Great discussion. My wife and I have been in our house for 12 years, and are about to refinance for the fourth time. 6.875/30 yrs to 5.99/20 yrs, to 4.99 15 yrs, and now 4.49 for 10 years. We started out putting down 20%, so our mortgage has always been below 80% of the home value.
What we have done is take out a home equity loan to avoid paying ANY closing costs. The rate was a little higher than a traditional refi, but I don’t care because I am lowering our total interest payments without paying $$ up front.
Normally we didn’t take out extra money, but this time we are taking out a little extra ($3K) to replace a badly needed back yard fence. If you have the opportunity to take some $$ out to beef up your emergency account, I say do it. You’ll sleep better knowing that you have the basics covered for 6 months or longer.
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I would advise NOT to refinance. That’s a relatively small mortgage. If cash flow is tight, it’s an income problem, not a debt/obligation problem, and a low income is not going to generate the best terms.
Very likely, any refi is going to cost money out of pocket (closing costs) which it will take quite some time to “earn” back through lower monthly payments. Plus there’s the potential PMI to consider. It doesn’t sound as if the LW has thousands of dollars saved.
Finishing off the car payment will help with the cash flow. My advice would be to look for other expenses to cut, and/or other possible sources of income, and keep setting aside the amount of the car payment in an emergency fund.
Kristine can revisit refinancing next year.
I seriously doubt there will be major rate inflation within the next twelve months.
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If the goals are income generating goals, or if the interest you’ll pay on the refi is less than what you’re paying on the “goal” you want to achieve, then sure.
I think you have to look at it purely from a financial viewpoint.
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We refinanced our home twice between 1995 and 2005 and on both occasions took the lower payments as well as shortening the mortgage term to 15 years. If you plan to stay in the house for the term of the mortgage, this IS the time to refinance. That extra $200 is money you are paying in interest right now.
So I think this is actually a simpler question than it appears. If you were taking money out you have to decide if ou want to borrow money for the purposes it will be used for? Yes, the interest rate is low if you put your home up as collateral. But you are still just borrowing money.
When we refinanced, lots of people were “taking money” out of their house, but the fact was a lot of that money was imaginary as they found out when the bubble burst. They ended up over-leveraged and when prices dropped by 20% or more, they were under water. But refinancing with a lower interest rate is a no-brainer if you are going to stay in the house long enough to cover the costs.
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