4

This is a VA refinance (IRRRL). The fees are the same no matter which choice.

yr     apr        p+i
15     3.875%     $869  
20     4.000%     $718  
30     4.000%     $566
  • IRRRL does not include possibility of taking out equity
  • Almost all other debts are paid
  • emergency fund is being rebuilt
  • Current term: 20+ years remaining
  • Current rate: 6.5%
  • Current amount: $115k
  • Current equity: $20k (would cost 10k in fees and closing costs to access this, so not really much here)
  • Current p+i: $881

I am 48 years old. Bringing in $80k. Wife is stay at home mom to 2 kids. Retirement savings is woefully underfunded - to the point where we'll just call it barely begun. Saving for retirement is the focus at this point. Due to this, I am leaning toward the 30 year mortgage and putting the 320 savings directly into 401(k). Edit: 401(k) matches first 4%. In 2 years this increases to 5% (age based).

  1. I want to find out the current value of the 15 year mortgage and the 30 year mortgage.
  2. I want to estimate the value of the cash flow freed up if I choose the 30 year term.
  3. I want to compare the cost difference between the two mortgages with the estimate of what the cash flow could be worth.

My instinct is that the 30 year mortgage gives me flexibility to use the cash flow to build savings. Then once that is done, I can focus on paying down the mortgage, or sell the house to recover that equity. Have I gotten it completely wrong in some way?

  • Can you edit in the term of the 401(k), specific to matching, vesting, etc? – JoeTaxpayer Mar 1 '17 at 15:57
  • Have you shopped around on the IRRRL loan, just to make sure you're getting the best rate? 3.875% seems a bit high on a 15 year. (4 seems okay on 30, though.) I'd expect more like 3.75. Just looking at rates, for example, I see 3.75/4.125 or 3.625/4.0 at a few sites (so I'd expect 3/8 points difference, not 1/8). Also - is "APR" the true APR, or is it the quoted rate? ("APR" usually should include fees, so it shouldn't be a neat percentage like this.) See this site for one example (no affiliation, first google result) – Joe Mar 1 '17 at 17:42
  • I can't afford a straight refi (630 score). IRRRL includes no qualification. Credit score determines interest rate. And, if I refi with the lienholder, there's no appraisal required. That's important because the house was a rental for 8 years and we're still digging out from that financial disaster. My credit score is UP to 630 after almost losing the house even while I had it rented. Expensive lesson and we're approaching 'debt free' (aside from the mortgage). Short version is, appraisal would cancel a deal, and I can't qualify for an alternative. – Xalorous Mar 1 '17 at 18:01
  • Update: I procrastinated and delayed and only just now closed on a refi deal. We kept the term the same (19 years left) and lowered the rates. I've already upped my 401k contribution from 10% to 15% and intend to increase that next year. I am changing jobs in the next 6 months, and I am hopeful that the new position will bring in more income. 70 to 80% of the increase will go to retirement savings, though I'm considering starting a Roth IRA to balance the 401k (contributions up to matching with 401k, then Roth to max, then any remainder into 401k). Credit still improving. – Xalorous Nov 29 '17 at 16:30
4

One thing you didn't mention is whether the 401(k) offers a match. If it does, this is a slam-dunk. The $303 ($303, right?) is $3636/yr that will be doubled on deposit. It's typical for the first 5% of one's salary to capture the match, so this is right there.

In 15 years, you'll still owe $76,519. But 15 * $7272 is $109,080 in your 401(k) even without taking any growth into account. The likely value of that 401(k) is closer to $210K, using 8% over that 15 years, (At 6%, it drops to 'only' $176K, but as I stated, the value of the match is so great that I'd jump right on that.)

If you don't get a match of any kind, I need to edit / completely rip my answer. It morphs into whether you feel that 15 years (Really 30) the market will exceed the 4% cost of that money. Odds are, it will. The worst 15 year period this past century 2000-2014 still had a CAGR of 4.2%.

  • I got 315. The current payment is 881, and the future 30 year is 566, but he claims 320 so I used that. – Pete B. Mar 1 '17 at 14:53
  • Sorry, I was just subtracting the 30 year payment from the 15 year payment. My bad. – JoeTaxpayer Mar 1 '17 at 14:54
  • If your company offers a match on your 401(k) you absolutely should be contributing at a rate to maximize said match. Whether the 401(k) is the best investment venue beyond that level is open for debate, and will depend greatly on the details of the plan. – Rozwel Mar 1 '17 at 15:56
  • 1
    Capturing the matching is the element that I forgot. I'm going to take the 30 (mostly for the flexibility of the lower payment), increase savings rate for 401k, find ways to increase family income, and continue looking for wasteful spending to eliminate. As income increases, part of the increase will be used to increase payment rate on the mortgage, simply because I don't like paying interest. – Xalorous Mar 1 '17 at 17:38
  • Good plan. At 48, you have time to add prepayments later on, and perhaps aim for a payoff to coincide with retirement. – JoeTaxpayer Mar 1 '17 at 18:16
5

If the best they can do is 1/8th of a percent for a 15 year term, you are best served by taking the 30 year term.

Pay it down sooner if you can, but it's nice to have the flexibility if you have a month where things are tight.

  • I think you're right that the 15 isn't cheap enough, and that flexibility is what will allow me to start to boost my retirement savings. As family income increases, I can use part of it to increase the mortgage payback. – Xalorous Mar 1 '17 at 17:40
1

Have you looked at conventional financing rather than VA? VA loans are not a great deal. Conventional tends to be the best, and FHA being better than VA. While your rate looks very competitive, it looks like there will be a .5% fee for a refinance on top of other closing costs.

If I have the numbers correct, you are looking to finance about 120K, and the house is worth about 140K. Given your salary and equity, you should have no problem getting a conventional loan assuming good enough credit.

While the 30 year is tempting, the thing I hate about it is that you will be 78 when the home is paid off. Are you intending on working that long? Also you are restarting the clock on your mortgage. Presumably you have paid on it for a number of years, and now you will start that long journey over.

If you were to take the 15 year how much would go to retirement? You claim that the $320 in savings will go toward retirement if you take the 30 year, but could you save any if you took the 15 year?

All in all I would rate your plan a B-. It is a plan that will allow you to retire with dignity, and is not based on crazy assumptions. Your success comes in the execution. Will you actually put the $320 into retirement, or will the needs of the kids come before that? A strict budget is really a key component with a stay at home spouse.

The A+ plan would be to get the 15 year, and put about $650 toward retirement each month. Its tough to do, but what sacrifices can you make to get there? Can you move your plan a bit closer to the ideal plan?

One thing you have not addressed is how you will handle college for the kids. While in the process of long term planning, you might want to get on the same page with your wife on what you will offer the kids for help with college. A viable plan is to pay their room and board, have them work, and for them to pay their own tuition to community college. They are responsible for their own spending money and transportation.

Thank you for your service.

  • I'm already planning on recommending local 4 year university for the kids and supporting them with room and board. The wife is interested in entering the workforce. I am eligible for a promotion at work with an increased certification. I feel an urgency about increasing retirement savings. I think I will take the 30, increase savings, then increase payoff rate on the mortgage as family income increases. – Xalorous Mar 1 '17 at 17:28
  • Also, in another comment, I related some extenuating circumstances. The value of the house I gave is assuming I could get the appraised value of the house (155k) after significant repairs (plumbing, roofing, hvac, maybe 10k, but probably more like 15k). However, if I tried to sell now, I'd probably be lucky to break even, after closing costs. And any appraisal would probably nix any deal due to water damage. I'm a bit stuck in the house. One cost saving effort is going to be to train myself up in sheetrock and roofing working with Habitat. I will do some of my repair work. – Xalorous Mar 1 '17 at 18:07
-1

So I will attempt to answer the other half of the question since people have given good feedback on the mortgage costs of your various options.

Assumptions:

  • You have a total of $1000 available in your budget to split between mortgage payment and savings. (you didn't give a number, so I picked one.)
  • You are refinancing just the $115k balance, closing costs are being covered out of pocket.
  • I am using your payment and interest numbers. (which do not match a 115k starting balance)
  • You have a savings venue that is earning 5% annually. (conservative for most investment funds, better than you usually find at a bank.)
  • You will continue on this plan for 30 years.
  • You are on your own in terms of savings, no matching funds etc are available.

It is certain that I am off on some (or all) of these assumptions, but they are still useful for drawing a comparison.

If you were to make your mortgage payment, then contribute whatever you have left over to savings, this is where you would be at the end of 30 years.

option    TtlMrtgPmt   TtlSavCont   SavBal
NoChange  $200233      $159766      $254757
15yrMrtg  $150258      $209741      $354490
20yrMrtg  $164696      $195303      $359000
30yrMrtg  $192352      $167647      $373075

Wait, so the 30 year mortgage has me contributing $40k less to savings over the life of the loan, but comes out with a $20k higher balance? Yes, because of the way compounding interest works getting more money in there faster plays in your favor, but only as long as your savings venue is earning at a higher rate than the cost of the debt your are contrasting it with.

If we were to drop the yield on your savings to 3%, then the 30yr would net you $264593, while the 15yr ends up with $283309 in the bank. Similarly, if we were to increase the savings yield to 10% (not unheard of for a strong mutual fund), the 30yr nets $993418, while the 15yr comes out at $684448.

Yes in all cases, you pay more to the bank on a 30yr mortgage, but as long as you have a decent investment portfolio, and are making the associated contributions, your end savings come out ahead over the time period. Which sounds like it is the more important item in your overall picture.

However, just to reiterate, the key to making this work is that you have an investment portfolio that out performs the interest on the loan. Rule of thumb is if the debt is costing you more than the investment will reliably earn, pay the debt off first. In reality, you need your investments to out perform the interest on your debt + inflation to stay ahead overall. Personally, I would be looking for at least an 8% annual return on your investments, and go with the 30 year option.

DISCLAIMER: All investments involve risk and there is no guarantee of making any given earnings target.

  • Thanks. My thoughts are along the same lines with investments adjusted for inflation needing to beat the mortgage rate. The important number is the savings balance. I'm going to have to work extra hard at saving and cutting costs, because my goal for retirement is 60 - 65. – Xalorous Mar 1 '17 at 18:12
  • The answer is well thought out and I was nodding my head right till you said inflation. Say I borrow at 3%, and invest at 6%. But inflation gets crazy, 8%. That doesn't change the fact that the 6 beat the 3. It was still better regardless of inflation. An IRR calculation or NPV calculation doesn't take inflation into account, only that the net return is positive. – JoeTaxpayer Mar 1 '17 at 20:54
  • @JoeTaxpayer Agree that the main point is for the investment to beat the debt. However, if I borrow 100k at 5%, it doesn't matter whether inflation is 1% or 20%, my obligation will be the same. How well I can live on my savings however IS impacted by inflation, and it should be kept in mind when considering which investments you are going to put your money into. My point was look at the rate of your debt, add on the inflation rate, pad it a bit more, and use that as your minimum target for your ROI when considering where to put your money. – Rozwel Mar 1 '17 at 21:40
  • Curious why someone thinks this was worth a down vote? – Rozwel Mar 2 '17 at 2:56

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