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Plan Well, Retire Well

Saving and investing your money

Refinancing: If it was just a simple yes/no question!


Home mortgage rates are AMAZINGLY low right now! According to Frank Nothaft, vice president and chief economist, Freddie Mac , "Fixed-rate mortgages continued to hover at 50-year lows, .... Compared to the recent peak in 30-year fixed interest rates 13 months ago (week of June 11, 2009), current rates are a full percentage point lower. With today's rates, homebuyers would save about $1,500 in payments each year on a $200,000 loan compared to rates last June."

So, how low is low? According to Bankrate.com's July 21, 2010 weekly national survey of large lenders the national average for a 30-year fixed rate home mortgage loan is 4.74%! (How many of you remember home loans for 18% in the early '80s?)

With rates like this many people may be thinking about refinancing their current home mortgage. If you're one of these, take time to read Looking for Cash? Have You Considered Refinancing? – a Plan Well, Retire Well Blog post from October. If you decide to refinance, is your decision-making done? No, why would life be that simple!

Let's look at an example. Suzie Q and her husband, John Doe, have a current home loan of $172,000 at 6.375%; they have 22 years left on the loan. Their options are shown in the Table below:

Years

Loan Interest Rate

Monthly Payment

Change in Payment

22 (current loan)

6.375%

$1213

---

30

4.625%

$884

- $329

20

4.5%

$1088

- $125

15

4.15

$1283

+ $70

From the Table, some things jump out. First, there's some money to be saved here! At first glance, it would seem to be a good idea to refinance for 30 years and gain $329 a month. Going to a 15 year loan would mean having to pay a higher monthly payment, but the loan would be paid off when Suzie & John plan to retire at 65 years old.

Mmmm, let's look at some more information, just to keep this interesting. Take a look at the two columns on the right.

Years

Loan Interest Rate

Monthly Payment

Change in Payment

Total Interest Paid

Interest Paid in Year 1

22 (current loan)

6.375%

$1213

---

$148,314

$10,858

30

4.625%

$884

- $329

$146,355

$7,898

20

4.5%

$1088

-$125

$89,158

$7,629

15

4.15

$1283

+$70

$58,952

$6,936

Wow! Look at how much Suzy & John will pay in total interest costs over the lifetime of the loan. For a given loan amount, the interest rate and the number of years of the loan both affect total interest costs – and small changes in either one can lead to dramatic changes in the total interest paid!

Look at the difference between the 30 year loan and the 20 year loan. With the 30 year loan, Suzy & John will pay over $57,000 more in interest to their lender than with the 20 year loan. That's a lot of hours worked! Dropping the loan term to 15 years lowers the interest paid even more.

So, which loan should Suzie & John take? What do you think? Questions that could help them decide include:

  • Do you need more cash now to pay expenses? Can you afford to pay more in monthly home payments now (for the 15 year loan)?
  • How important emotionally and/or financially to you is to have your home paid for by the time you retire?
  • If you had more cash now could you invest it and receive a better rate of return than 4.625%? Could you do this for 30 years?
  • Would you rather pay more now and pay less in interest charges over the lifetime of the loan?
  • Are there any tax disadvantages to having less home mortgage interest? Would reducing your home interest amount mean that you couldn't itemize your tax deductions – and would it matter?
  • If your goal is to increase your net worth at retirement, what would you want to do?

Let's get some conversation going on this! What would you suggest Suzie Q and John Doe do, and why? Click on my name below and send me a reply. I will share answers in next week's blog post.

Update: This blog post was shared on the Carnival of Personal Finance. Reading a variety of financial blogs provides different viewpoints and ideas to help you with your personal finances.



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