Sanity check on choosing the term for a mortgage refinance

Question

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?

Answer 1

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%.

Answer 2

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.

Answer 3

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.

Answer 4

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.