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Advice on 'no-cost' refi

Posted by mikesbikes (My Page) on
Thu, Nov 11, 10 at 17:31

We're seven years into a 30-year mortgage at 5.5% interest. We owe $210,000, our monthly payment is $2,055, and in addition to this we pay $1,000 each month toward the principal.

We have an opportunity to apply for "no-cost" refinancing (at least that's what our mortgage lender calls it). The rate is 4.25% for a 15-year period. The monthly payment would be $2,077 and we would continue to pay $1,000 extra to the principal each month.

Is there any reason not to do this?


Follow-Up Postings:

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RE: Advice on 'no-cost' refi

Not sure if this info makes a difference, but we're in our early forties, no children, and no debt other than the mortgage.


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RE: Advice on 'no-cost' refi

I don't have an answer to your question, but can't figure out why your current payments are so high. I have a $200,000 mortgage, paying bi-weekly, at 3.4%, and I pay around $950/month (will be paid off in under 25 years)


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RE: Advice on 'no-cost' refi

I'm not a numbers guy... I do know that our $5,000 annual property taxes are rolled into the monthly payment.


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RE: Advice on 'no-cost' refi

Hi Mikesbikes,

Is there any reason not to do this?

Quite a few reasons, actually.

If you aren't financially independent yet (meaning your after-tax passive cashflow income from working assets are more than enough to cover all your costs of living,) then you need to focus on achieving THAT before you spend any focus (or any dollars) into your real estate equity.

Let me put it this way; In awareness of the state of the markets, are you thinking that investing your cash into real estate is your best option? Better than alternative long term investments?

If not, don't send your cash into your primary residence real estate equity. If *YES*, then you're still better off accumulating your cash on the side to invest in INCOME producing real estate.

NEXT ISSUE;
If you are strongly certain you are going to stay in your current primary residence for longer than 5 years, you are much better off using your existing equity to pay the closing costs (including buy down points to get the lowest permanent rates) on your refinanced loan.

NEXT ISSUE;
15 year terms are financial poison (assuming you aren't already financially independent yet.) They accelerate the very problem explained above... they force you to invest more of your money into non-income-producing real estate equity... and your invested money doesn't grow nor compound.

NEXT ISSUE;
Burying your working capital into real estate means it becomes illiquid... which means if you need to access it you have to HOPE you can qualify, and HOPE that there are available loan programs & lenders willing to make an offer, and THEN PAY their administrative closing costs for the privilege of accessing your own money.

EVERY SINGLE FORECLOSURE has been a problem of insufficient cash to make payments, and a SURPRISING MAJORITY of foreclosures occur with equity in the home... trapped, because the owner thought it was a smarter idea to throw their capital into the real estate equity (and then they failed to qualify for refinance to get access to their money.)

The SAFEST, FASTEST, and MOST EFFECTIVE way to eliminate your mortgage liability is by building a separate "Mortgage Freedom Account" from which you will eventually be able (but not required) to stroke out a single check for the entire remaining balance of your mortgage. The less you are required to pay to the mortgage bank, the more you can afford to build up in your MFA... the safer you will be, and the faster you will become financially independent.

Hope that helps,
Dave Donhoff
Leverage Planner


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RE: Advice on 'no-cost' refi

Thanks for your thoughtful response. I don't know a lot about finance and this is a lot of new info.

I GUESS we're financially independent; we've accumulated a healthy retirement fund and contribute $1200 to it monthly. We have a $25,000 rainy day fund and increase it monthly. We have no vehicle loans, no credit card debt. The house is worth about $525-550,000.

I guess my question is, why not go for the 15-year to get the lower rate, since the basic monthly payment will remain the same ($2077 vs the current $2055)?

Sorry if I'm not getting this. Mike


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RE: Advice on 'no-cost' refi

If you do a Google search on "why not prepay your mortgage," you'll find lots of good article that will expand on what Dave is saying. As I understand it, the big downsides are that you lose liquidity and that you can be seduced away from fully financing your retirement.

Dave, are you saying that Mike should not refinance at all, or that he should not pay the extra $1,000/month? I get the argument for not paying the $1,000, but if it's a true no-cost refi (i.e., it's not just that the costs are rolled into the mortgage), then what's the downside? He pays the same amount and gets more for it, no?


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RE: Advice on 'no-cost' refi

Hi Mike,

I GUESS we're financially independent; we've accumulated a healthy retirement fund and contribute $1200 to it monthly. We have a $25,000 rainy day fund and increase it monthly. We have no vehicle loans, no credit card debt. The house is worth about $525-550,000.

That doesn't fit the definition of financial independence.

QUESTION:
Do you now recieve (or could you now receive) enough after-tax cashflow income from your retirement accounts, without withdrawing principal, to pay for all your current and future anticipated expenses? IOW, can you stop all employment immediately and live in the lifestyle of your choice on your investment yield alone?

If yes; CONGRATULATIONS, you have reached financial independence.

If NO...
A) don't quit that day job, and more importantly,
B) don't burn your growth money in non-growth directions.

I guess my question is, why not go for the 15-year to get the lower rate, since the basic monthly payment will remain the same ($2077 vs the current $2055)?

Because focusing on the payment as the primary determinant is distracting you from the much more critical issues in your financial life.

Again; The wiser outcome (for responsible people) is NOT to try to eliminate your mortgage a little snip at a time, but to accumulate a SINGLE LIQUID ACCOUNT big enough to completely pay off the mortgage all at once... and AVOID sending a single dime to the mortgage that you could have otherwise sent into the growth account.

If you do the math (or work with a knowledgable advisor who can do it for you) you will see that you will eliminate your mortgage as a liability faster this way, safer this way, and with far less uncertainties.

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Hi Joanne,

Dave, are you saying that Mike should not refinance at all, or that he should not pay the extra $1,000/month?

No....

Assuming Mike is mature & responsible with his money, the most conservative plan would be to refinance at 80% of the value (or more, if hte existing balance is more) using a 30 year term (unless a 40 year term is available at the same rate.) If he is statistically likely to stay put longer than 6-8 years, he would be wisely advised to buy the interest rate down at the point of rate lock to the lowest rate he can which will lock in enough interest savings to recoup the up front points by the 5th year.

That will likely drive his total monthly mortgage payments down (even lower than his current $2,055,) and then all of the payment savings and every dollar of additional discretionary cashflows ought to go into a "cascade of buckets" (meaning a hierarchy of funded accounts, starting with immediate cash reserves, annual reserves, major repair reserves, and then longterm insured tax-advantaged growth accounts.)

Further, it is *likely* that once he has his reserves properly funded he will also be able to adjust his various insurance coverages to reduce his premiums. Because of the safety reserves he will be able to increase his deductibles, increase his co-pays, and extend elimination periods. All these savings flow right into his longterm growth funds, which establish a self-climbing UPWARD spiral of funds for a change.

but if it's a true no-cost refi (i.e., it's not just that the costs are rolled into the mortgage), then what's the downside?

If your finances are poorly structured, and you replace the structure with an identical financial structure but merely drop the rate (all for "free") you are still left with an inefficient structure. GIGO.

Most people lose much more money from financial leaks & inadvertant monetary giveaways due to not understanding amortization, taxes & insurance premiums than they can ever gain in a lifetime by increasing their investments by a percentage nor from decreasing their mortgage by a percentage.

IOW... most people are trying to sail a boat full of holes across the ocean... and their best idea of a solution is a bigger horsepower engine. Yes, it will make a difference... but plugging the leaks & eliminating the barnacles will do it much faster, safer & more certain.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Advice on 'no-cost' refi

Mike,
To illustrate, I thought I'd run out a very vanilla example given your numbers.

Assumptions;
Home value $525,000
Existing loan balance $210,000
All closing costs & points $10,000 (3-4% is normal, so I am going overboard in an abundance of caution, and perhaps assuming some buydown points.)
New rate on 30 FRM = 3.75%
Average tax-free retirement return = 6%
Marginal tax rate (Fed + State) = 35%

New loan = $420,000 (80% of $525,000)
@3.75%, payment is $1,945.
After tax mortgage rate is 2.4375%
(face rate)*(1 - marginal tax rate)
After tax actual monthly interest at start = $1,023.75
(Plus amortization will naturally force down the amount of interest each month after month 1.)

$420,000 total loan minus $210,000 payoff and $10,000 closing costs = $200,000

$200k goes to lump-fund your growth account.
(Assuming for this purpose an indexed universal life cash account with a 2% floor and 13% ceiling, which averages 8.4% historically... we'll drop that 25% down to just a 6% growth expectation.)

$200,000 * 6%/year = $12,000/year = $1,000/month (the FIRST month.)

$1,023.75 1st month mortgage interest costs (reducing monthly)
$1,000 1st month retirement account growth (increasing monthly.)

Ignoring all other savings, and looking *ONLY* at the compounding growth at the average of 6% on the $200,000 seed funds....

Your Mortgage Freedom Account will be more than your entire mortgage balance by your 13th year (likely sooner actually when we look at the unavoidable reduction of mortgage prinmcipal simply due to amortization.)

At 6%, the $200,000 grows to $426,585 by the end of your 13th year. AT THAT POINT YOU ARE DEBT FREE! (And you didn't have to take the additional risks of lacking liquidity by paying into your real estate equity.)

Does that now make more sense?

Cheers,
Dave Donhoff
Leverage Planner


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RE: Advice on 'no-cost' refi

I don't see a reason not to do the refi. Although Dave is technically correct, there is a good feeling (so I've heard not experienced) to being debt free.

I think maybe taking a middle ground of taking that 1K a month and putting it into savings and do a no-cost refi to a 15 year. That way you're saving your liquidity, and are paying off sooner at a lower rate.

when you save enough to pay off the rest, you can do it.

the big thing that is always uncertian is what happens if you lose your job, or have an illness or something that requires cash now and its all tied up in your house.


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RE: Advice on 'no-cost' refi

Many times, "no cost" doesn't mean no cost;
it means no money out of pocket.

The lender rolls in thousands of dollars of closing costs into the mortgage, so that your principal balance goes up.

Just for fun, you might ask for a good faith estimate of closing costs.


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RE: Advice on 'no-cost' refi

I just received a refinance offer from Chase -- they are targeting "responsible" home owners with lots of equity in their homes through a program they're calling "Chase Rate Reduction Program". I received a FEDEX letter from them and they are truly offering a NO COST refi. They're not rolling closing costs into the loan balance, but the rate they're offering on a 15 year refinance is not the same rate I'd get if I shopped around. We refinanced two years ago at 5.5 and they're offering us 4.5, NO COST. My SIL is a mortgage broker and he said he could get us 4% but then we would be paying closing costs. MY SIL says it's a legit offer, they're trying to retain good customers on their books instead of risking us refinancing with someone else.


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RE: Advice on 'no-cost' refi

We just did a similar re-fi (though into another 30-year loan vs. a 15-year---but had the payments been close, as yours are, we would have gone to a 15- or 20-year loan).

Here's why we did it:
- No cost was important (though note that nothing is "free"--you're probably paying a slightly higher interest rate in lieu of paying closing fees). In our case, they did not roll the fees into the loan, though you can sometimes do that too---but I'm not sure they're allowed to call that "no cost," at least not in our state. They simply waived them and (I assume) gave us a .125 or so higher rate than we might otherwise have qualified for. We were fine with this, as we're in the middle of a kitchen remodel and wanted all of our cash liquid right now, and we weren't sure what rates were going to do, so we wanted to get the process moving (and get an appraisal) before gutting the kitchen.

- We wanted to stay in a fixed rate loan because we're not sure how long we'll be in this house, and when we do move, we might decide to rent it out rather than sell it, depending on what the market is doing. An ARM, while giving a lower rate, would have locked us into another refi if we don't sell, and we're in a volatile housing market where we don't know for sure what values will do or whether we'll still have equity at the time of a future refi.

In your shoes, I'd go for it. You are already paying an extra $1K a month over what's required, so if you needed to cut back, you could do that pretty easily. Your monthly payment isn't going up significantly, so you're not really changing your obligations in that respect. And you're cutting the loan term down significantly, which saves a huge amount in interest.

There is probably a different discussion on whether to keep paying the $1K towards principle outside of what the loan requires you to pay, and others can tackle that. In our case, we do not have much other cash available to go towards housing costs, so it didn't make a difference.


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RE: Advice on 'no-cost' refi

Yes, they offered us 3.875% on a 15-year, but said that it would cost approximately $2,500 to get that.


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