Home › Forums › Financial Markets/Economics › Can refinancing to a lower rate increase the amount of interest you pay?
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October 31, 2015 at 10:44 AM #790872October 31, 2015 at 11:27 AM #790873no_such_realityParticipant
Yea, in the current environment with a hypo $400k 2.75% 15 yr. you could make an additional $20 principal payment on the first put and shortening the life to 14 years. You essential trade that $20k for twelve fewer $2700 monthly payments fifteen years from now That’s $32,400 nominal. Purchasing power over the last fifteen years basically a wash. Investments in QQQ or DJIA from 2000 to today, well QQQ is about even so a loser in the scenario, DJIA about even with the savings. Shift the analysis 12 months post 9/11 and $20K in QQQ blows the savings out of the water
So it depends, if you expect the low inflation to continue for fifteen years the a prepayment will be on par with the cost differences in the future. If the inflation doesn’t remain negligible, then the future purchase power loss favors not prepaying.
Essentially continuing a mortgage turns you place into a long term fixed rental were you’re responsible for maintenance but get all upside or downside capital appreciation
October 31, 2015 at 11:30 AM #790874scaredyclassicParticipantexcept the principal does go down. so you get that little bit extra edge.
October 31, 2015 at 11:42 AM #790875no_such_realityParticipant[quote=scaredyclassic]except the principal does go down. so you get that little bit extra edge.[/quote]
No. In both scenarios you pay $400k in principal. It’s your choice if you want that in the form of 180 $2700 payments or a $22,700 payment with 167 $2700 payments
You still make a $2700 payment every month until the 169th payment in both scenarios.
For future refis, yes the balance is now $20k smaller. But if you think you will refi lower why would you prepay to finance less and get even less savings from refi-ing
October 31, 2015 at 12:10 PM #790876scaredyclassicParticipanti just mean in distinction to a long term rental, a mortgage at least get the benefit of the principal going down a bit through various restarts and refinancings as you make the monthyl payment. so it’s not just the gain or loss you get at the end of the day,w henerv that is, but some level of principal reductionalong the way. If I had to choose between renting my place at the mortgage payment for ever or having a mortgage with just the difference in purchase price being at stake, it wouldnt quite be as good a deal as with at least some princiapl paydown..
October 31, 2015 at 5:46 PM #790879AnonymousGuest[quote=Hobie][quote=harvey]Don’t get confused by strategies involving paying early in the loan term vs. late in the loan term, etc. They are flawed.[/quote]
I’d like it if you expand on this.[/quote]
NSR’s explanation is quite good.
Here’s an example that helps illustrate the misconception:
– Person A took out a 30 year loan 15 years ago. The remaining balance is $100K and the rates is 5%
– Person B just refinanced with a 15 year loan. The balance is $100K and the rate is 5%
I’ve often heard pseudo-strategies claiming that it is better to make extra payments “early” in a loan, along the lines that person A and person B should have different payment “strategies” because person A is halfway through the payments and person B just started making payments. Of course that is silly because at this point in time they are exactly the same scenario.
At any point in time a debt is defined by: the principal, the remaining term, and the rate. The cost of the debt is the interest rate times the current outstanding principal. It doesn’t matter whether the debtor is on the first payment or the hundredth payment.
Along the same lines, some think it is “bad” that the early payments in a ordinary fixed-payment loan consist mostly of interest cost, with a small portion going to principal. From an investment and opportunity cost perspective, it’s actually good.
Imagine you borrowed $100K at 4% and only had to pay the interest on your mortgage for the next thirty years with a balloon payment of all the principal at the end.
Does a $100K bill due in thirty years sound scary? If you have any financial discipline, it would actually be a more advantageous scenario than making principal payments along the way.
If one could borrow $100K today, pay only 4% for the next thirty years, it is extremely unlikely that a balanced portfolio would not be able to make at least 4% average returns over a thirty year period by investing the principal payments that you did not give to the bank. (The appreciation on the mortgaged property alone would likely be enough to cover the final principal payment.)
For me, paying mortgage principal sucks; it means I have to give back some of the money I got at a bargain price.
October 31, 2015 at 6:51 PM #790881plmParticipantIt still seems to me the earlier you make extra principal payments the less interest you pay and the sooner you pay off the mortgage. Kind of like 401K but in reverse. The sooner you put money in the 401K the longer you have for it to grow before you retire.
October 31, 2015 at 7:16 PM #790883AnonymousGuest[quote=plm]It still seems to me the earlier you make extra principal payments the less interest you pay and the sooner you pay off the mortgage.[/quote]
True
[quote] The sooner you put money in the 401K the longer you have for it to grow before you retire.[/quote]
Also true.
That’s the crux: If you have extra cash at the end of the month, where does it go … mortgage payment or investment?
October 31, 2015 at 7:44 PM #790884plmParticipantEither of the two would be a good decision. What I did was not which was to put the money in a brokerage account earning no interest for a year now. I need to either pay down the mortgage or buy some stocks soon.
November 1, 2015 at 7:41 AM #790894no_such_realityParticipant[quote=plm]It still seems to me the earlier you make extra principal payments the less interest you pay and the sooner you pay off the mortgage. Kind of like 401K but in reverse. The sooner you put money in the 401K the longer you have for it to grow before you retire.[/quote]
Except with a house the 401k is already funded to $400k on loan, the investment is already made. The choice is between a new investment or buying out the loan in today’s dollar at 2.75% with return phased out 15 years instead of dollars fifteen years from now. That’s the stinger on principal repayment, the return isn’t realized until the loan is paid off and then it’s in future dollars.
Prepayment doesn’t change your cash flow, minimally changes the interest payment in the near term and delays the return until the end of the loan.
November 1, 2015 at 9:15 AM #790899scaredyclassicParticipantOur lifespans are so short. 15 years ago I was a young new dad. 15 years from now I’ll be an old man. Yet when I hear 15 years I think, that’s not so long.
November 1, 2015 at 10:45 AM #790901HatfieldParticipant[quote=harvey]
– Person A took out a 30 year loan 15 years ago. The remaining balance is $100K and the rates is 5%– Person B just refinanced with a 15 year loan. The balance is $100K and the rate is 5%
[…]
at this point in time they are exactly the same scenario.[/quote]
I think this misses several important differences. 1) where they are on amortization curve. The person with the 15 year loan is almost entirely paying interest at this point. The person 15 years into a 30 year loan in is paying roughly half interest, half principal. You can see where the curves cross pretty clearly in Karl’s Magic Mortgage Calculator linked previously. 2) the person with the 30 year loan has a lower monthly payment. The 30 year guy has the option of making a larger payment if he wants to, but the person with the 15 year loan does not have the option of making a smaller one.
Earlier in the thread:
[quote=joec]
Paying it off early at that point doesn’t help you lower your interest paid since the interest was front loaded and you already paid it.
[/quote]Not true at all. Let’s go back to my hypothetical $300k / 5% / 30y loan. Making the normal $1610.46 monthly payment pays the loan off in 360 months. Over the life of the loan, the total interest paid is $279,767. The meager $50/month overpayment that shortens the loan by 23 months also has the effect of reducing the total interest paid by almost $22k. A $250 monthly overpayment will save you over $81k in interest. Play around in Excel and see for yourself.
November 1, 2015 at 11:08 AM #790902HatfieldParticipantWhen we did our (hopefully last, ha!) refi, I got quotes for 15y vs 30y. The interest rate spread at that time was about half a percent. I compared the amount of time till payoff and total interest paid for the 15 year vs the 30 year making a monthly overpayment to equal the 15 year monthly payment. The 30 year loan ended up taking about 15.5 years to pay off, and with a bit more total interest paid over the life of the loan.
However, we were looking to make a more significant monthly overpayment, which closes this gap considerably. In the end, we went with the 30y. We will pay slightly more in overall interest, but liked the flexibility of being able to drop back to the minimum 30y payment if a change in income required it. And I suppose if interest rates rise above our loan rate, there’s a compelling case to be made for dropping back to the minimum payment in that scenario too.
November 1, 2015 at 11:21 AM #790903HatfieldParticipantAnd apologies to joec, I just realized sorta misquoted you. That’s what I get for rereading the thread after posting, and now I can’t edit. So let me rescind some of the words I kinda put in your mouth. Again, apologies.
It is true that late in the loan, you are mostly paying interest. Paying down the loan will still lower the total interest paid, just not as much as it would have earlier in the loan.
November 1, 2015 at 5:58 PM #790906joecParticipant[quote=Hatfield]And apologies to joec, I just realized sorta misquoted you. That’s what I get for rereading the thread after posting, and now I can’t edit. So let me rescind some of the words I kinda put in your mouth. Again, apologies.
It is true that late in the loan, you are mostly paying interest. Paying down the loan will still lower the total interest paid, just not as much as it would have earlier in the loan.[/quote]
Heh, that’s good. Having worked professionally IN financial advice, I’d assume I know a little about this topic…I’d also admit to actually loving reading/studying tax strategies so these exercises are good fun for me…
But yeah, if you pay a little more principle each month right off the bat, you will pay considerably less interest, but if you look at an amortization chart, near the end of a loan term, it’s not 0 interest, just a lot less compared to say the 1st 5 years in a loan term.
One thing to also consider like it was mentioned is do you want the flexibility compared to a shorter term, higher payment loan?
As someone who is self employed and dealing with more cash flow issues and high costs to run business, having cash on hand is worth it to probably most business owners than getting rid of their loan payment ASAP.
Add in the chance of layoffs for older employees in general, I’ve always been a bigger fan of just keeping your monthly low to deal with the ups and downs of life.
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