16 Mar Mortgage Refinance Round 2

Refinances can be a sneaky subject where you kick your mortgage down the road, in exchange for a lower payment.  In full disclosure, the first refinance I did on my home, I didn’t realize I wasn’t actually saving money unless I continued to make my original payment while assuming the new, lower interest rate.  If your goal is to simply lower your monthly payment, then sure a lower interest rate may help you achieve that even when you roll closing costs into the new note. If you are trying to pay your house off on time, or early, however, it takes a little more math and planning than simply making the new lower minimum payment.

Always remember its your job to protect your money and ensure you are making the most appropriate decisions for your personal situation.  Your mortgage broker might be a good guy or gal, and they may be able to save you on that monthly payment, but they aren’t likely going to help you fully digest that you are simply starting a new 30 year note that will take you a fresh and new 30 years to pay off.  For example, you’ve been in your house for 4 years and rates drop by .75%.  Your broker gives you a call and says he can save you $75-150/month depending on the size of your mortgage, on top of that, no cash at closing out of your pocket! This sounds great, and it works on 90 out of 100 customers, and in all reality it probably can and should work on the other 10 listed above too, but those 10 above are you and me, and we think a little differently.

The framework I always consider is “how can I lower my interest rate, pay no closing costs out of pocket, and continue to make the same payment to then pay off my house sooner”.  The beauty of this framework in my opinion is I’ve created optionality.  You see you could probably save even more on interest by dropping to a 15 year mortgage but your payment goes up and you are locked in to that payment; make the new payment, or else.

With the new 30 year mortgage you’ve just signed, while still making the same payment as you were previously, you can simply ask your broker what payoff timeline that puts you on and they’ll calculate that and tell you.  Let’s say for example you had 26 years left, if you keep making the same payment, perhaps it reduces you to 22 years (purely a guess).  In the 8 years we’ve owned our current home we had our original mortgage, then refinanced it and lowered our payment but still paid more than required to keep it about on pace for our original 30 year term while still paying less per month than we had previously.  Then we refinanced again and continued to pay the same as the first refi and that accelerated our payoff by a few years.  Finally, right after COVID started we refinanced again dropping over 1% on our rate, still paying the previous monthly payment, and we pay every other week (more below) and we are now on pace to pay it off in 19 total years instead of the original 30.

The final note or teaser I gave in that last refinance is the “every other week” payment option.  Not all banks will offer this, nor will they love it if you utilize this feature.  My bank doesn’t officially allow it, but we found a unique loophole that we tested and it worked.  Essentially what we had to do was make 1 full payment a month ahead of schedule so we were paid up early, then we setup bill pay from our checking account to make 50% of one months’ minimum payment directly to our mortgage each time we get paid (every other week).

Effectively what this accomplishes is a few things.  First, in year 1 of this process, you’ve made one full payment ahead of schedule directly to principle to start the program.  Second, 2 weeks later you pay 50% of a normal payment which also goes entirely to principle.  You’ve now reduced your amortized interest by knocking down your principal 6 weeks ahead of schedule.  This might not seem like much, but take a look at an online banking calculator and compare a $200,000 amortized interest loan’s interest per day, versus the same rate in simple interest per day, the difference is significant.  Third and finally, you end up making an “extra payment” per year each year ongoing by making 26 payments equal to 50% of a monthly payment, and thus overall accelerate your payoff without noticing it hit your pocket book all that much.

What you’ll find is that on a 30 year mortgage, paid in this manner from day 1, you can cut 2-4 years’ worth of payments by simply knocking down principle 2 weeks in advance.  When you look at the cost to you, its pretty minimal.  You knock out one payment up front, and for those of us paid every other week you find yourself with 2 months out of the year where you get 3 paychecks, right? Instead of that 3^rd paycheck being all gravy, some of it goes to that “extra payment” you’ve baked into your payoff plan.

Certainly, if you have a very low interest rate on your home below 4%, then in theory you could do better using the extra money to invest, and perhaps that is the right answer for you.  In my personal situation this felt fitting, and helped further solidify my home as mine, with less risk of ever having a chance of losing it.

As a closing note, if you should find yourself in a situation where you are months or dare I say years ahead of schedule on your mortgage and fall on hard times, you can call your bank, ask for a “recast”. The bank will take your remaining balance and re-amortize it over the remaining years you have to pay, effectively lowering your payment without a refinance required.  In turn you’ve bought yourself flexibility of a lower payment, and when you are back in your traditional situation you simply return to making the normal payment you were before and continue your fast(er) track to paying off that mortgage!