One 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.
|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:
- 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.
- 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.
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:
|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.
|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.
|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.
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.
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.