Should I Refinance?

Mortgage interest rates are at record lows, so we're getting this question a lot, and encouraging a lot of people to look into it!

Our main example is a 500K mortgage that you got 10 years ago. Is it worth the effort to refinance now, when you've paid a lot of the interest already? We go over the advantages and disadvantages of refinancing with another 30 year mortgage or refinancing with a 20 year mortgage.

Also check out this related post that covers--what to ask mortgage brokers when you're vetting them and figuring out who to work with.

TRANSCRIPT

Should I Refinance?

John: Is it worth it to refinance your mortgage? That's a question we've been getting from a lot of clients now with rates at all-time lows. We're going to answer that question in today's episode of Friends Talk Financial Planning.

I'm John Scherer. I run a fee-only financial planning business in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. We’ll also have a special guest star today, which is Matthew Barnard, and he is also a fee-only financial planner in my office in Chicago.

So, John, a lot of times we've been getting questions about: is it worth it to refinance? And generally, I want to talk big picture first.

So when we are financial planners and we go through our CFP or Certified Financial Planner training and take the test, we all immerse ourselves in all the numbers. And we find that we draw conclusions so that we can tell people the answer to their questions easily.

And so when we're going through that, we realize, “Okay, it's almost always worth it to refinance,” especially if you think you're going to be in your house for a while. You want to make sure you're paying off your closing cost. But it's almost always worth it to refinance. So we spout that advice.

And so for a lot of people that's worth it. They just hear what we say, and they go along with it. But a lot of people want to get more detailed. And so that's one of the reasons why we brought Matthew on today.

And John, what do you have to say about it? Is this a question that you're getting a lot?

John: Yeah, it certainly is. Especially with interest rates being where they are, again, down low. But one of the questions -- and you hit on it, Bridget – is… look at, refinance if it makes sense. Listen, my mortgage is 3.75, and now I can refinance at 3. Well, of course I want to pay less.

But then the question is: I'm 10 years into my mortgage, and I've already paid all these things. And then rather than having it paid off in 20 years or 15 years now, I'm going to be in for another 30 years. Like, how do you reconcile that math?

And so, Matthew, thanks for joining us here. I'm excited to hear… I know you put together the numbers and the data behind it. And as Bridget said, when we go through our CFP, we have to do all the numbers. I still like those, but I'm interested. I can't wait to see what you’ve put together.

So Let's look at some of the numbers. And then I'd like to talk a little bit about some of the non-numerical things, why I think it makes sense to refinance in general, too. But Matthew, can you share your screen? I know you've got some of the actual nitty gritty here behind it for us.

Matthew: Yeah, of course. And why don’t I go ahead and just start with a clear screen here?

So Let's start off with that 30 year mortgage that we've been talking about. And to have a round figure, we have a mortgage balance of $500,000. You buy a house, have a mortgage of $500,000 dollars. Let's say you bought it 10 years ago and you have an interest rate of 4%, which in the grand scheme isn't all that bad.

So they have a monthly payment of around $2,400. 30 years maturity. So with that loan if you were to pay for the 30 years, you have total interest paid of right around $360,000.

Now one of the scenarios that we were just talking about is: after 10 years, we get to this point and interest rates are incredibly low. What options do you have? So what if you're interested in really reducing your actual monthly payment?

What you can do then is to refinance. You take a new 30 year mortgage. So now interest rate’s right around 3, potentially, given different circumstances. So after 10 years with that original mortgage, you'd be right around $400,000 as far as the mortgage balance at that point in time.

If you were to refinance with this new interest rate of 3%, your monthly payments for those next 30 years would drop down to right around $1,700 per month.

Now do keep in mind you had a 30 year mortgage, paid for 10 years, and now you're opening a new mortgage. So overall payments are for 40 years. So including $3,000 refinance closing costs, and including the 10 years of interest you paid on the original loan, plus the interest you pay on the new refinanced 30 year mortgage, we'd be looking at total interest paid of right around $385,000, which is just over $26,000 dollars over the original amount, even though you're really reducing your monthly payment quite a lot, which is great.

Bridget: And it’s over 10 years, so that's like $2,500 a year extra.

Matthew: Yeah. And so if your goal was to maintain your overall amount of time paying down your mortgage, so keeping with that 30 years, not increasing it to the 40, you'd be refinancing with a new mortgage of 20 years.

So same scenario, same mortgage balance after the first 10 years, same interest rate of 3%. Your monthly payment would still drop. It wouldn't drop to that same level of $1,700 a month, but it would still drop from about $2,400 down to about $2,200.

You'd have 20 years again to be paying the rest of this refinanced mortgage down, but your overall total interest paid drops from that $360,000 originally down to $311,000 dollars. And again that includes all the interest you paid in the first 10 years of the original mortgage. And that includes all the interest you’d pay in the refinanced 20 years. And it drops about $50,000, which is great.

John: This is great, Matthew! I feel myself getting excited like, “Okay, I want to jump in and talk about a bunch of things here.” And thank you. I see you've got all the other tabs. There's a lot of math that goes into this, right?

Bridget: Right.

John: This is the Reader's Digest version. I love the “Tell us what time it is and not how the watch works” sort of thing.

But to make sure that I'm seeing that right and that viewers see it, the original 30 year mortgage, you don't do anything, you pay it off.

The last scenario that you showed, #3 over there, you're still paying it off in the same amount of time. But in the meantime, your monthly payments are a couple of hundred dollars less. And the total interest you pay is $40,000 or $50,000 less. So those are like, exactly apples to apples, if I see that right. Is that right?

Bridget: Right.

Matthew: Exactly. That's what I was shooting for.

John: And so there's no reason why you wouldn't. And if a 30 year mortgage is at 3%, a 20 year is probably slightly less than that, even, right? So the advantage is probably even more?

Matthew: Exactly.

Bridget: Right.

John: And this really speaks to one of the things that I talk about with my clients when it comes to this. Listen, refinance, we have people refinance to a 30 year mortgage. So your middle scenario.

And then, hey, if you want to pay it off just in 20 years, you can still make those extra payments. You can pay $2,200 dollars a month. Now, because of the interest rate difference, you probably end up paying a little bit more in the way that I suggest folks do it. But then your minimum payment is only $1,600 or $1,700. Right?

So when things like oh, you know, a worldwide pandemic come. And maybe you've lost some income, that you're not locked into that higher payment. You've got flexibility should you choose to do that. And so one of the things I really believe in is having choices and flexibility.

And so this is really interesting. I've done the math years ago. But this math confirms that you can make the same payments. You can do the similar things but by changing it, by refinancing, you've got more control. And that's really critical for me. So that's what I see as I look at these numbers on this stuff.

Bridget: Yeah. What I see is this big opportunity. So if you're moving your monthly payment from roughly $2,400 a month to $1,700 a month. So if you do do the 30 year refinance, then similar to what John says, you've got more flexibility, but you could also invest that money, too. And you're going to get… your paying at 3% on it. And over the course of 30 years, you should be able to get a higher return than 3%. And historically, you would. So I like that opportunity, too.

John: One other thing talking about that. That's great, that investment for a component, right? It's significant. And we have a number of folks that might be in this situation and aren't maxing out their 401K plans for both working spouses, or aren't maxing out their Roth, or some place where you can say, “Listen, I can take that $700 difference, and I can put it into a tax-advantaged vehicle or a tax-deductible vehicle.”

Bridget: Or a 529, for that matter, too.

John: A 529, I mean those things.

Bridget: to save for college.

John: The other thing that I look at -- and I just recently did this myself, and I was 10 years in -- it's now at 3%, you've got a one way contract with the bank for the next 30 years that no matter what happens in the market and the economy and interest rates, they can never change their rate. They can never call the mortgage and make me pay it off.

I can pay more, like in the 20 year scenario. I can pay it all off if I choose to. I can let it drag out, and at some point back when I first started doing this 25 years ago, CDs were paying 6% and 7%.

Bridget: Right.

John: If in 20 years we get back to an environment where your checking account is paying 4%, and my mortgage is at 3%, I've got complete leverage over the bank, and there's some power in that side of it that, I think, is overlooked a lot, in addition to just the raw numbers that you put together here, Matthew. That's powerful, plus you get this leverage, plus what Bridget said about you have the investing advantage. Like I said, I look at this and go, “Yeah, this is why this makes sense economically, right?”

Bridget: Yeah. And so the only time that I would tell clients not to is if -- we see these $3,000 in closing costs -- if they're not going to be able to overcome that. So usually the savings takes a few years often to pay for itself. So in a year or two. So if you think you're going to move in a year, it's probably not worth it. That's when I would say it's not worth it.

The other time is it does take some time. So I tell people it’ll probably take 10 to 20 hours of your time. But as you can see, this is 10 to 20 hours that's well worth it. You don't get that much of a pay-off normally on your 10 to 20 hours of time.

John: Yeah, that's right. This is $50,000 over time in these scenarios. And that's really significant. Maybe this is a good place to wrap things up there.

Bridget: Yeah.

John: I've got a lot of other places that come in here. But we've really hit some of the big things here, I think. And as we try to wrap things up at every episode, what are the big takeaways?

I take that as, well, the bottom line is: refinancing makes economic sense when you have some of the numbers. And as you said in the beginning, Bridget, we kind of look at, like, hey, if it's a half a percent or more, it's sort of a no-brainer. If you think you're going to stay in your house for a while, you can save half a percent. Go through the refinancing process.

And then the other takeaway I get is: it's not just about how much interest I pay. Or it's not just about what my monthly mortgage payment is. There are a lot of different factors. It gives you options. It gives you choices. It gives you leverage over the bank. Those are sort of my takeaways as I have this conversation. What about you, Bridget?

Bridget: My other thing is that it's almost always worth it. Even if we put these numbers out to 20 years, they wouldn't be as dramatic. So if you had only 10 years to go in your mortgage, the numbers would not be as dramatic, but they'd still be there if you're lowering your rate by half percent. So it's almost always worth it to do it.

John: Matthew, you're the one I did all the math and did all the work on this. Do you have any other takeaways from these things that you wanted to share with folks?

Matthew: I think in my view, the most important piece here is just that flexibility that you're talking about. Just being able to have so much flexibility. If you want to pay it down faster, you can. If you want to keep your payments lower and invest more money on the side through retirement accounts or otherwise, that's great, too. It just affords you a ton of flexibility. It's incredibly helpful.

John: That's great.

Bridget: Well, thank you so much!

John: Yeah.

Bridget: We'll wrap it up.

And the other thing we like to do at the end of the episode is talk about ACP, which is the Alliance Comprehensive Planners. I have to remember that! This is a group that both John and I are members of. It's a not-for-profit group, and we all offer comprehensive financial planning. And so if you like the type of approach that we're taking, you can check out acplanners.org and find out more information.

John: That's great. Thanks so much for joining us today, Matthew. I appreciate it.

Matthew: Of course!

John: And we'll talk to you next time, Bridget.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.