Monday, September 8, 2014

Refinance after one year

Mortgage interest rates are still at very low levels. Does it makes sense to refinance now ?  What will rates do in the near term ? I plan to refinance within the next two months, here's why.

People refinance for different reasons. Some simply want a lower monthly payment, which may seem nice, but you end up paying more interest in the long run. Most of the time you refinance for the same term, e.g. another 30 years. Even if you're 3 or five years into your old mortgage. Use mortgage calculators to do the math -- in some cases it may be worth the lower monthly costs now, even if it means more interest paid in the long run.

In our case, we bought our house when the rates were at a temporary peak. We picked a lender that offered a nice cash incentive, with a rate that was the same as other lenders. A year in, we have seen rates drop, now close to one percent lower than our current rate. A one percent different is huge, and would free up several hundred dollars of cash each month.

To follow the mortgage news, and mortgage backed securities, check out Mortgage News Daily. They have a nice overview of the events surrounding the bond market, interest rates, and economic data that influences mortgages. When refinancing is a near term option, it's useful to gauge the financial climate and whether or not to wait a bit. Waiting may be useful if you recently opened new credit lines and want to age them a bit so they don't affect your credit rating negatively.

In researching refinancing options, look for different terms. I believe rates will stay low for the next year or so, before they will start to climb. I like the predictability of fixed rates. Most mortgages allow penalty-free pre-payment. This means if you have extra cash and don't have a better place to put it, you can use it towards your mortgage. Try it in the calculators, it's amazing how much you can shave of your loan. The power of compound interest!

Some examples for my options:

  1. Refinance 30 year : save about $120k in interest over the term of the loan
  2. Refinance 30 year; pay same monthly: save about $192k
  3. Refinance 15 year: save about $371k, but much higher monthly costs
There are many other options, including making one extra payment per year, paying half the monthly savings extra, or making payments when selling an under-performing stock. It's possible to get a 20-year term, and 'force' to make the payments faster. I like the flexibility of a 30-year with extra payments when I want. That way I can dial it back if needed or if better investment options present themselves. And the rate difference is not that significant.

Why not refinance now ? We took out a (0%) loan to finance a new car when the old one died. This of course put a dent in our credit score. I want to age the loan a bit to improve the credit score. The other reason for not refinancing is cost. If there are closing costs, or rate points (meaning pre-paid interest), then it may take several years before the lower interest covers those costs. Only when the interest is sufficiently lower than the current interest does it make sense to refinance.

Generating Passive income includes actively managing debt. Simply put, when the interest on debt is higher than the expected income from an investment (say dividend that a stock generates), then it may make sense to pay off some of that debt. It's not that simple, as there are tax considerations, and having no debt but also no income is undesirable as well. And when making investment in dividend growth stocks, the income may surpass the interest rate within a few years (yield on cost).

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