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.
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take the biggest fixed rate mortgage, longest term possible, as high a balance as is allowed, and as long as the payment is not unaffordable.
Put the cash proceeds to use with proper financial planning, retirement savings should be a priority before paying off your mortgage. otherwise, you’re going to retire with a free and clear house, and have low income/assets. which means… you sell, refinance, or do a reverse mortgage. all equate to failure to plan adequately for retirement.
to pass over the rates at these levels is a mistake. don’t over-burden, but maximize the opportunity. 4% interest, which after taxes is a cost of ~3%.
just dont blow the money on consumption
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If you can refinance at a lower rate for 30 years, plan to stay in your home and continue to pay based upon the amortization of the current loan (so you pay it off in 30 years since original purchase date, not refinance) you can reduce min required payment (in case of emergencies), not extend the loan and yet still free up some cash flow.
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We refinanced 08/2009 for the extra monthly cash and rate drop to around 4.% on a 30 yr fixed (love my Credit Union). First on this list was braces for two kids – started that Jan 2009. Going through the HSA, I was able to spread the paymments over 3 years (Jan 10, 11 and 12).
Then, Life stepped in, and spouse got unexpectently laid-off Feb 2009 and is now a FT college student. So glad we refinanced when we did even though now we don’t qualify for any mortgage assistance programs since the loan is too new.
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In my opinion the best reason to refinance is to save on interest and lower payments. But, that being said, it is a big temptation to let the savings be absorbed in other areas and not accomplish the original goals. If you have your own weak spots build in some boundries to insure you come out ahead. Truely the best way to save interest is to pay off the debt as quickly as possible.
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We debated refinancing our loan recently, but I decided the closing costs were not a good idea. We don’t know how long we will be staying in the house, and it would take us several years to even break even on the closing costs. Why do that when we could just put extra money towards the principal every month and get the same result? It is much less hassle than filling out all the paperwork and going through the appraisal. I didn’t want to be in the hole and feel pressure to “make back” the sunk costs.
A question to people – why are closing costs so outrageous?
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When we refinanced, we took the lower payment and had the loan written for the remainder of the term of the first loan. That way our payments went down and our payoff date did not change.
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As with most finance matters, the answer is that it depends on your personal situation. Beyond that it is merely a mathematical exercise to determine the alternatives considering the following variables: principal, interest rate, monthly payment, amortization period, and payoff date. Your personal situation will then determine if the outcome is desirable.
Your current situation is known: 30-yr mortgage, outstanding principal of $141,859, interest rate of 5.375%, a monthly payment $902 and 273 months remaining.
If you refinance, your monthly payment will decrease for two reasonons. You are extending the remaining period of the loan (i.e. over the 87 months you have already paid), extending your mortgage payoff date. Assuming you refi at the same interest rate, this alone would cause your monthly payment to decrease by $107.
If you also refinance at a lower rate, you will reduce your monthly payment by approximately $44 for every 0.5%.
If you refi at the same rate, your total interest cost will increase by $39,849. However, if you refi at 0.5% lower, the incremental interest cost is $24,138 and 1% lower increases total interest cost by only $8,857. An interest rate of 4.078% yields a breakeven interest cost. This analysis ignores the opportunity cost of investing the cash for the additional 87 months after payoff in your current mortgage.
If you refi at a rate 1% lower, you will lower your monthly payment by $193 pm, however if you make an additional payment of $113 pm you would payoff the mortgage in 273 months (same as existing mortgage), save $21,908 in interest and have the flexibility to reduce monthly payments if necessary.
Just some data points to consider, and a chance for me to play with some spreadsheets.
Overall, with rates where they are, I think you have an excellemnt opportunity to lower your total interest cost, while also lowering your monthly payment and giving yourself the flexibility to reduce your payment if the cash is needed elsewhere.
Good Luck
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How about refinancing to a shorter-term loan, say 15 years? Pay down the debt quicker and at a lower rate if you can.
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I currently have a 30 year mortgage of $416K @ 5.75% with 26 years remaining. I am planning to refinance to either a 15 or 30 year mortgage. I can’t decide which option makes the best sense financially. I realize the advantages of each (early payoff / extra $), however I am having trouble figuring out whether or not it makes more sense to take the $550 I would be saving (30 yr) and apply it to max out our 401ks OR reduce 401k contributions to around 5% and still take advantage of employee matches, etc. The extra $ would then go into the house. We are not planning on moving anytime soon and I figure if something happend and we did have to move in 5 years we would have an extra $75K in princiipal paid. Another opotion to consider is the reduced interest write-off on my taxes with a 15 year mortgage. Perhpas I should seek advice from a tax advisor? Any assistance would be greatly appreciated.
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