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Assumptions (using round numbers):

  • Two children start college in 12 and 15 years.
  • Currently saving $400/month in a college savings fund earning ~2%. (Some in a taxable account, some in a Coverdell.)
  • $150k mortgage at 4% with a $1k/mo payment and 18 years to payoff.
  • I can refi into a 10 year fixed-rate mortgage at 3% with a $1400/mo payment.
  • I'm never going to move out of this house.
  • Retirement and other savings/debt are taken care of and are outside the scope of this decision.

Staying with the current mortgage/savings scheme would mean $53k in the savings fund after 12 years, but a ~$80k balance on the mortgage at that time, and only the $5k/year of cash from the monthly savings deposit to add to it. This is $35k of cash flow during the 7 years of college attendance for both kids. Net cash available for college is $88k (53 + 35).

After the mortgage is paid off, I'd have two years to put that $1400/mo into a savings account -- $34k. A paid-off mortgage also means ~$17k/year of cash (from the former mortgage payment) during college years. Over 7 years of college attendance, this is ~$117k in cash flow. So it looks like this nets $151k (34 + 117) through the end of college attendance.

The 10y mortgage option looks really attractive.

Is there anything I'm missing in this analysis that makes the 10y refi a bad idea?

  • Waiting for a spreadsheet wizard, but rising interest rates help both scenarios right? – MrChrister Sep 30 '11 at 17:00
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    The one factor you seem to be leaving out is the time value of money. That is, I assume you plan to invest the money you are saving. If so, the first scenario would give the money more time to grow than the second and might even it out some, depending on what rate of return you think you can get. – JohnFx Sep 30 '11 at 17:02
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    Also, it is great you are paying for college, but for anybody else reading this, make sure your retirement is fully funded and on track first. (I know from past experience that bstpierre is already set up for his retirement). Your kids can get loans for school, but there is no loan for retirement. – MrChrister Sep 30 '11 at 17:03
  • I know a family who did it this way, but they also added in extra income while their kids were in high school by having the stay-at-home parent go back to work part time in order to accelerate the earnings rate. It worked for them mostly due to the whole combination of their circumstances. Also remember how tuition is supposed to bubble over the next several years unless costs are controlled somehow. – justkt Sep 30 '11 at 17:20
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    @btspierre - Another thing to factor in is that you need to reduce the rate of return near the end because you should be moving the money to more conservative investments as the time you need the money gets closer. – JohnFx Sep 30 '11 at 18:52
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This is a great question! Just a couple of days ago I put together a spreadsheet to analyze two mortgage scenarios in response to this question about 15 year mortgages. I ended up not answering that question because there weren't enough solid numbers to provide advice one way or the other.

However, your question makes this spreadsheet really interesting.

I put these facts into the spreadsheet:

  • $150k mortgage balance
  • 18 years vs. 10 years
  • 4% current rate vs. 3% 10 year mortgage rate
  • 2% savings rate
  • The spreadsheet upped your savings on the 18 year scenario to $473 per month since that was the actual difference in mortgage payments.

Here's what I show: (Check out the full spreadsheet for more data)

Spreadsheet screenshot

  • As you can see, your calculation of how quickly you can save after the 10 year mortgage is paid off is correct: $35k in 2 years.
  • In a fair comparison (equity + savings) the 10 year scenario is better at the end of every year. This is because the interest rate is better in the 10 year and your savings interest rate (2%) is lower than your mortgage rate.
  • You end year 10 with 17k more in net worth
  • In fact, by year 16 you would catch up in savings (and still have greater equity).

Limitations:

  • My spreadsheet doesn't calculate spending (after year 12), but based on year 12 balances you should be able to extrapolate that.
  • The spreadsheet is based on round years.

Conclusion

You are exactly right, the 10 year refi is better (much better). The only thing to be cautious of is your reduced liquidity from years 1-12.

I'm sure you are aware of Dave Ramsey's baby steps, where he suggests saving for college before paying off the home early. This is partly because many people don't have the ability that you do to pay off the home and then save for college, and partly because he likes a more balanced (and generalized) monthly saving scenario (15% of income to retirement, some for college, the rest to the house).

If you are confident that the illiquidity is not going to hurt you, and that you have a backup-plan should your income be cut, then I think you are ok to go with the plan you've put together.


Just to play devil's advocate, if you put the money in a (theoretical) 8-10% investment vehicle, your year 12 looks like this:

enter image description here

You are much better off with the longer mortgage in that case. Just something to be aware of.

  • 2
    +1 Thanks for the analysis & spreadsheet. I've considered the illiquidity -- it's the biggest thing keeping me from pulling the trigger. Re: devil's advocate, yes, with all else equal if I can earn more on an investment than I'm paying in interest, it makes sense to keep the loan. However, I can't get 8-10% without taking on a lot of extra risk. In comparison, the "earnings" from paying down the mortgage is risk free (ignoring illiquidity). I can get 2% nearly risk-free with a conservative combination of HY savings, bond fund, and equity fund. – bstpierre Sep 30 '11 at 18:18

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