Reducing my mortgage payment

reducing my mortgage paymentOne of my goals this year is reducing my mortgage payment. So earlier this year, I looked at some options. Here’s what I considered and my decision.

Meet my mortgage

My mortgage as of the end of February.

Mortgage Balance $213,104
Interest Rate 4.375%
Monthly Payment $1,197.03
Remaining Months 282 (23 years, 6 months)
Interest to be paid $131,423

The monthly payment is currently about $800 in interest and $400 in principal. It’s a fixed rate loan. The total monthly payment is constant and over time the interest will reduce with a corresponding increase in principal until the loan is paid.

If I continue paying per the schedule, I will pay an additional $131,423 of interest over the life of the loan.

However  my Income Fund is providing around $850 a month. I thought it would be nice to reduce my mortgage payment so that my Income Fund payment covers it. So my plan was to reduce the mortgage payment to about $850 a month.

Pay down mortgage or invest the money?

Paying down your mortgage vs saving / investing is an endless topic over at the Bogleheads forum, with new posts asking the question every week. Their wiki has some general points to consider.

Like most things in personal finance, there’s no magic answer. It’s a personal decision based on your unique situation.

In my case, I can afford to pay my mortgage entirely if I sold investments in my Income Fund. I have not been aggressively paying down the principal for two main reasons:

  1. I like the liquidity of having money available rather than having it locked in house equity. Yes, a HELOC could access the equity if needed but depending on the hypothetical situation occurring, the loan could be hard to acquire or at a bad interest rate.
  2. It’s an inflation hedge. My monthly mortgage payment is constant. My income is increasing. So over time, especially 30 years, the mortgage payment becomes less and less significant.

The options

To meet my goal, I’m willing to pay an additional $60,000 into the mortgage. Let’s see what can be done using some options below.

Pay additional principal

While paying additional principal reduces the amount of interest to be paid and reduces the life of the loan, it still requires the same monthly obligation. However, the effect of the payment would be:

Interest Rate 4.375%
Monthly Payment $1,197
Remaining Months 14 years, 1 month
Interest to be paid $53,853

This approach saves $77,570 in interest payments and reduces the loan term by 9 years, 1 month. However the monthly obligation is still above my $850 target.

Refinancing to a new 20 year loan

I did get some quotes for refinancing but the interest rate was the same as what I currently pay. Interest rates are on the increase so this isn’t a great time to refinance. Here’s the quote I received – a 20 year fixed rate refinance @ 4.375% with an assumed $2,000 in closing costs.

Interest Rate 4.375%
Monthly Payment $971
Remaining Months 20 years
Interest to be paid $77,895

This option saves a total of $53,528 in interest compared to doing nothing and reduces the loan by 3 years, 6 months. However the quotes I received didn’t meet the target monthly amount of ~ $850.

Recasting the loan

Recasting is a less common option where the loan is set back to its original duration. So the additional payment doesn’t reduce the length of the loan. Instead it reduces the monthly payment by amortizing the loan over the original completion date, so you pay more interest.

The advantage of this approach is that there are usually no closing costs and it’s simple to do. However there’s no change in the interest rate either.

Interest Rate 4.375%
Monthly Payment $831
Remaining Months 25 years, 6 months
Interest to be paid $101,215

Well we met the target monthly amount. However this option extends the loan by 2 years and only saves a total of $30,208 in interest. Financially it’s the worst option of the three but better than nothing.

Initial thoughts

So at first glance, it’s clear that the cheapest option financially is to pay down the mortgage.

But the one option meeting the monthly target amount is also the most expensive option in terms of interest paid.

Or is it?

A second look

The thing is, I’m currently paying $1,197 a month towards the mortgage. And I want to continue paying that amount. However I don’t want the obligation of having to pay that if I needed to save money.

The refinance and recast options above show a lower monthly payment of $971 and $831 respectively. What happens to the comparison if I continue to make a monthly payment of $1,197 where the extra money goes to principal?

Well, it looks something like

Option Monthly Payment Additional Payment Interest to be paid Loan Reduced by
Pay Down $1,197 $0 $53,853 9 years, 1 month
Refinance $971 $226 $55,221 8 years, 10 months
Recast $831 $356 $53,445 9 years, 1 month

Interestingly, on this basis the recast option comes out the cheapest in interest charges. Obviously this is contingent of making the additional payments but in making a fair comparison it’s important to consider what the extra money saved would be used for.

The total interest payments all come out fairly similar since all the options are using the same rate. The refinance option is penalized a bit more because of fees associated with closing that weren’t applicable to the other two options.

And so, recasting is what I did in March. The process required getting a simple form notarized and sending to my mortgage company who offer free and unlimited recasting on my mortgage. The only condition being a large enough down payment. Starting in May, my new monthly payment works out as $826.86 and I’m making an additional payment of $363.25 a month towards the mortgage.

Where the money came from

Although I’ve not been aggressive in paying down my mortgage, I have been putting some money aside as part of my monthly Savings with a long-term view to pay off the mortgage using that money. The majority of the savings have been in WWELX. This is an actively managed fund with approximately two-thirds in stocks and one-third in bonds. It has a low expense ratio of about 0.25% for the investor shares.

As of 22nd February, I had saved a total of $46,946.14 since my first purchase of $3,000 in October 2013. The total value of my holdings had grown by $3,132.80 to $50,078.94.

To fund the $60,000 I sold the entire holding, of which $2,722 were long term capital gains and $410 were short term gains. So I’ll owe a bit more at tax time next year. I put $40,000 towards the mortgage and Ms. DL put in $20,000.

The remaining $10,000 went back into new investments for long-term savings which will be the subject of another post.

Summary

So I have a shiny new mortgage payment of $827 a month that was achieved with a minimum of hassle and I’m happy about that! Recasting isn’t always offered as a choice in evaluating mortgage options so it was interesting to evaluate that. Refinancing can definitely be cheaper if the change in interest rate is high enough (say 1% or so).

 

Quote of the day

Behind every great man is a woman rolling her eyes.

5 thoughts on “Reducing my mortgage payment”

    1. Hi Lanny,
      Yes the recast option is only possible in conjunction with a lump sum payment. The size depends on the lender; for my bank it had to be at least $20K. But basically I just had to request the recast, then make the payment, then the bank sent a form for us to sign.
      Best wishes,
      -DL

  1. Very interesting. I was a little confused about the $60,000 part of it. But it seemed like you saved as long as you continue making the same payment. But have the option to pay less if need. Awesome. As someone about to sign off on a mortgage myself next month, It’s a nice option to think about for the future.

    1. Hi Dividend Seedling,

      It’s not a very common option – refinancing tends to be more commonly promoted and is better if there’s a big gap between your current rate and your refinancing rate. There can be fees associated with refinancing though. In a rising interest rate environment, the recast option is another thing to consider. It’s pretty much a wash as long as I continue making the same payments. And if I can’t, for whatever reason, then at least I’m not stuck with the higher payment.

      To qualify for the recast, the bank required a lump sum payment of at least $20,000. But rather than the payment just shortening the loan, this option recalculates the mortgage back out to the original term resulting in a lower monthly payment.

      I’ve been putting some money aside each month that I ear-marked for paying down the mortgage in the future. But I preferred to keep the money liquid until I could pay out the mortgage in one go in 10-15 years’ time. The recast option was a good compromise in reducing my monthly payment and improving cash flow if ever needed.

      I hope your mortgage goes well and that you get a good rate!

      Best wishes,
      -DL

  2. Thanks for sharing your first hand experience! Found your reasoning very interesting and also followed the Bogleheads Link with interest.
    Personally, I would always adopt the radical option of paying down the mortgage as fast as possible. Given I don’t have any, it’s theoretical reasoning only.
    Best regards
    MFF

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