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Refinance what to do

Posted by helpseeker (My Page) on
Thu, Oct 28, 10 at 9:35

We are trying to decide if we should refi and if so what option to choose. In 03 we refi. our 30yr. to a 15 yr. @4.5% and currently owe $145k. Since then, our family has grown by 4 kids. We have not been immune to the raising costs of everything-real estate taxes have gone from around 4500 to 8000; insurance has double, med. premiums up, you know the list goes on and on. Just like everyone else, salaries have not kept up with these rises and bonuses are pretty much gone as well. I know sob, sob. To the point, we are now finding ourselves getting closer and closer to not making ends meet despite living modestly. I am beginning to fear that when the time comes to need to do home repairs (our home is 10 years old) we will not be able to afford it. That coupled with our kids getting older, means their costs rise (our grocery bill will not be low when we have 3 teenage boys in a few years). It is likely that when our youngest goes to school in a few years I can work part time. I just don't think we should count on part time income-and I would have to have summers off b/c child care would negate any earnings.

So, what to do, refi, to a 15 or 20 year? The unfortunate thing is that we are really at a sweet spot with our current mortgage-paying a lot more principle than interest. However, with a 20 year, our payment could be reduced by almost 1000 a month. If we take conservative approach, and save 500 of that (yes, we can be that disciplined) a month, we could more than make up for the additional interest. Am I right in this assumption-I was figuring a return of 6%.

I just feel that if we wait and see if we do really start have a situation where more goes out than in, that we will lost out on these super low rates and if we start to sink when inflation hits we will be screwed.

For what it is worth, we max out 401k, and ira. Sadly we contribute little to 529s, partly b/c we have (had)hopes of our mortgage being gone by then-not so sure now. My husband will flat out refuse to not fully fund his 401k and IRA.

Well, thank you for reading this jumbled saga and if you have any thoughts that would be great.


Follow-Up Postings:

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RE: Refinance what to do

You haven't said what the interest rates are for the 15 and 20-year loans. If the rates are the same, there is no reason not to take the 20-year, because you can always pay it off more quickly whenever you want. If they're not the same, the situation becomes more complicated.


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RE: Refinance what to do

Personally, I think this is getting close the the "playing with fire" scenarios that have gotten a lot of people in trouble. If I were you, I would take a much more conservative approach.

Yes, I would refinance. Lock in an lower rate and lower monthly payment so you can have a bit of cushion. However, you are making the monthly payments right now. That means you should be able to afford to put 100% of the payment difference into a savings account. Start doing that immediately and keep doing it until you have a legitimate emergency fund - 8-12 months of living expenses. I you know major repair expense are coming up, you need to save up for those too. Do not spend 1 extra penny above your current levels until this is accomplished. Do not count on any earnings from this account. If you can get a percent or 2, great, but the primary objective needs to be keeping the money 100% safe.

Once that is accomplished, you could go 1 of 2 paths. Either start paying down the house aggressively or continue to save but put the new money in an investment with more growth potential (6% would be a realistic but conservative assumption there). Personally, I would pay down the house. I think people tend to follow through with that plan more than just a generic "saving" plan.


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RE: Refinance what to do

Hi helpseeker,

So many parts & pieces, and only so much we can really cover anonymously on a message board.

Let's look at a few of the pieces;

Since then, our family has grown by 4 kids.

What an amazing joy (says me as a fairly new Dad! ;~)

We have not been immune to the raising costs of everything-real estate taxes have gone from around 4500 to 8000

$8,000 property tax implies a tax assessed value (generally a bit under actual market value... or it should be,) around $500,000 - $750,000-ish... and the fact that it has risen while you have owned it tells me you are not in California (where Prop 13 freezes property taxes during ownership.)

At a $500,000 value, minus your remaining $145,000 leverage balance, you have roughly $350,000 of your net worth tied up in real estate as an "investment class" of your family balance sheet. A higher amount if the home value is higher.

Question #1;
What percentage of your overall net worth does that real estate equity investment represent?

Question #2;
What's been your functional rate of return (growth? decay?) on that equity... or, put another way, on each dollar you have been sending into your real estate bucket instead of other growth accounts?

Clearly you've been saving the cost of interest on each dollar... but that rate of interest saved would actually be the 4.5% face rate *MINUS* your tax deduction (the inverse of your marginal tax bracket.) Thus, if your total marginal tax bracket (state & fed) is 40%, your real savings is 60% of 4.5%... or 2.7%

Has the 2.7% rate of savings been rewarding enough to continue adding to the exposure in real estate as an investment class for yoru retirement dollars?

To the point, we are now finding ourselves getting closer and closer to not making ends meet despite living modestly.

Reserves Question:
Do you have at least 12 months worth of all living expenses set aside in safe & liquid reserves? If not, how would you handle an uninsured and unexpected lack of income? Do you have family who have such reserves available for you in such a case?

It sounds to me like you are aggressively sending your cashflow into illiquid directions (which are robbing you of safety & security,) at rates of reward that are in no way sufficient for the kind of safe growth you'll need... let alone opening you up you to greater & greater tax exposures.

I am beginning to fear that when the time comes to need to do home repairs (our home is 10 years old) we will not be able to afford it.

This needs to be accounted for with a "home maintenance" savings account, completely separate from your family reserves.

That coupled with our kids getting older, means their costs rise (our grocery bill will not be low when we have 3 teenage boys in a few years). It is likely that when our youngest goes to school in a few years I can work part time.

I would strongly suggest establishing a "cost of boys" reserve slush-fund as well (not that girls are necessarily "cheap" either ;~) NOW is the time to put your tax-free college tuition savings plans in place as well (even if only a trickle.)

So, what to do, refi, to a 15 or 20 year?

Neither, you are in no position to throw a single extra additional penny into more real estate equity. You need a 30 year loan... and you sound like you'd be wisely advised to rebalance equity OUT of your real estate (cash out refi) to fund your emergency reserves, and up front seed funding of your maintenance reserves and your children's educational funding (which can always be re-directed to your retirement if not needed in the future.)

The unfortunate thing is that we are really at a sweet spot with our current mortgage-paying a lot more principle than interest.

You can *ALWAYS* voluntarily invest your money in more real estate equity WHENEVER you are certain you can actually afford it.

There's clearly much MUCH more to be addressed hidden in the cracks of your comments... I'd suggest getting some professional guidance. Any financial professional worth a damn will save you exponentially more than they'll cost (based on the profile you appear to be presenting.)

Luck!
Dave Donhoff
Leverage Planner


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RE: Refinance what to do

Thanks all for the postings. I didn't expect any so quick. So, perhaps to answer a few "cracks".

alphacat: We haven't actually sought out any rates, but feel we should qualify for a solid rate-we have great credit and a lot of equity. I think in the range of 3.8 for 15 and 4 for 20. I am by no means a finance person, but the 20 year seemed more attractive b/c there should be no reason why we couldn't put $500 into some sort of savings every month. I was figuring a conservative rate of return at 6% and starting with 1k. Over 20 years, we would have around 190k.

Bill: I think we may differ on what got a lot of people in trouble. We have not used our home as an ATM, our kitchen still has the same laminate counters. We are starting to feel the effects of everyone else doing that-and having to pay for their reckless behaviors. We do have an emergency fund of about 6 months, not 8-12 months. I do know this is one area that we would like to boost. Getting the 15 year 7 years ago was for the purpose of paying down the house aggressively. It is just in the last year that we really are not sure if things keep going south with the inflow, and the "beyond our control" outflow increase if we can do it for 8 more years.

Dave, lots of info to digest-thank you. Our home assessment is 75% of market, which we feel is fairly accurate, but it is not the 500-750k. It is around the lower side of the 450 range. (Yeah, and our schools are not great) I would say without knowing the numbers (my better half's department) it is about half of net worth. I have no idea how to answer your 2 question. A 30 year?!? We certainly don't want to have a mortgage for that long!

Thank you all again! I see our evening conversation...


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RE: Refinance what to do

Hi helpseeker,

A 30 year?!? We certainly don't want to have a mortgage for that long!

Taking a 30 yr design DOES NOT mean you are prohibited from voluntarily paying it off early.

Taking a 15 or 20 year design DOES MEAN you are prohibited from paying any less than the full amortization burden every month... even if you really need the money elsewhere... even if you could have that money earn much more elsewhere.

Forced amortization is not your friend (assuming you are responsible with your money normally, and not the type who needs to be trapped into saving your money.)

The fastest & safest way to eliminate a home mortgage is almost always to accumulate a side account (what I call a "Mortgage Freedom Account") which accumulate and grows until you have enough in it to stroke out a single check and pay off the entire remaining balance on the mortgage.

Luck,
Dave Donhoff
Leverage Planner


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RE: Refinance what to do

helpseeker - I think you might have taken offense where none was intended. I wasn't implying you were a spendthrift, only that you are stretching your finances to a similar point that has gotten people in trouble.

Right now, you are house poor. The majority of your non-retirement assets are tied up in your house. If anything goes wrong, you are in just as much trouble as anyone who has engaged in "reckless behavior." What if your husband got hurt tomorrow and couldn't work for an extended period of time? Your home equity wouldn't do you any good. You wouldn't be able to refinance to a lower payment or to cash out any equity. You would burn through your liquid assets in a matter of month and then what?

There is no reason for someone who makes good money to expose themselves to that kind of risk. You have the ability to get your cash flow in line so that your monthly expenses are considerably lower and your cash reserves are considerably higher. Do not pass that up. Right now, you are putting yourself in a dangerous financial situation because you have an emotional attachment to the idea of paying off a house.


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RE: Refinance what to do

Bill,

I see your point, a very valid one at that. I think you have hit is best when you say we are, " emotional(ly) attach(ed)t to the idea of paying off a house." We are now wrapping our heads around a longer term. I know there will be no better time than now with rates this low. I feel like they are almost giving the money away.

Thanks again for the input here!


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