I'm Jumping In

I don't have a bad mortgage - 5.5%. But I've long said for the five and a half years since I got it that if I could ever refinance for a full percentage point less, or 4.5%, I would pull the trigger. That day has come.

Now, it is possible that if I had held out longer, I may have been able to get a slightly better rate. However, I'm willing to hedge that risk with the money I'll be able to save immediately. And I'll tell you why I don't think it likely that a significantly better deal is just around the next bend.

1. Lenders are never going to offer 0% APR mortgages. There is some invisible lower limit on interest rates. Is it 4.5%? 4%? There is no way to know for sure until it is too late.
2. An article in American Banker yesterday ran an article titled "Using Rates to Fend Off Refi Volumes" by Kate Berry. I cannot provide a link because the site requires a subscription. However, one particularly poignant quote is worth mentioning. Said Mathew Pineda, president of a mortgage LLC in Salt Lake, "Why is Wells not afraid that B of A will roll out a rate of 4.5%? There are eight guys doing loans. Until one gives it up, they're all playing the game. The reason you don't give it up today is they'd have to work twice as hard for half the profit. Why would they give it up?" If all of the kids in your neighborhood are cutting lawns for $10 apiece and you start charging $7.50, you're going to pick up some new customers. But it will still take you just as much time per lawn and your gasoline costs will remain unchanged. Congratulations, you've just squeezed your margins, alienated your friends and enslaved your self to cutting grass non-stop for the rest of the Summer.
3. When speaking with the lender, I inquired about several different loan structures, changing things like points and closing costs. I had an offer of 4.5%, no points, with some closing costs. I asked if they offered any "no fee" loans. He said they did, but that the interest rate would be higher. He put me on hold to check on the program. He came back to me and said the no fee loans were also at 4.5%. That tells me that, for this lender at this point in time, 4.5% is the floor. It was a no-brainer.

So what exactly does this 1% rate improvement mean? Here's the real world proof: The payment on my refi will be a full 21.5% lower than the payment on my original loan, saving me hundreds of dollars a month. However, I have no intention of lowering the amount of my payments. I will continue to pay the same amount and the difference will be applied to the principal, helping me pay off the mortgage early. A lot early.

I have been paying a little extra on my original loan since inception. Continuing that same payment over the life of the loan would have allowed me to shave off nearly three years worth of payments. Not too bad. However, by continuing to make that SAME payment my family is accustomed to, but towards the new loan with a 1% lower interest rate, the new loan will be paid off more than 11 years early. The net effect, considering the 5 1/2 years of payments we're losing plus the differences between early payoff of the two loans, is that both Sara and I will be three years younger when the new loan is paid off compared to the original.

Assume hypothetically that my original mortgage was for $100,000. The table below illustrates the differences between my original loan and my refi. The relationships between the two principal amounts and the relative value of the extra payment amounts all mirror my actual loans.

From this example we can learn several important things.

1. The pure interest savings alone is worth doing the refi: without making any extra payments, total interest for the original loan would be $104,403 compared to $72,519, for a difference of nearly $32k.
2. Without changing anything except for the interest rate (read: keep paying the same amount each month), I will end up paying less than half as much interest over the life of the loan. 
3. The refi is an asset that can be held, bought and sold in the financial world. Lenders want to lure customers from the competition. In my case, I am refinancing through the same lender - so they are knowingly giving up pure interest income in exchange for a) retaining my business, and b) capturing the asset of a new 30-year loan, albeit less valuable.

Only time will tell if I should have held out for a better deal. For now, I feel really good about what I'm getting and the flexibility this provides me now and in the future. And if rates drop another 1%, I'll do it again.

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Some mortgage advice:

• Shop around. Start with your bank. They know you and want to earn more of your business. I believe this is likely to be one of your best offers. This will give you a trusted baseline by which to compare all other offers.
• I believe it is generally better to take the 30-year fixed option as opposed to the 15-year fixed. Yes, the APR is a bit higher, but you have a LOT more financial flexibility for repayment. You can still pay the loan off in 15 years if you wish by paying something extra each month.
  
• Avoid ARMs (Adjustable Rate Mortgages) like the plague - especially now during this period of exceptionally low interest rates.
  
• Pay attention to points, fees, closing costs, etc. These all factor in to the overall cost of the loan. ASK QUESTIONS of your loan officer until you are sure you understand everything. They are the expert and it is their job sell you the loan. You are not obligated to buy anything from them. You do not want any surprises, so don't sign until all of your concerns have been addressed.