Introduction
We weren’t in the market to refinance our home, but when your friends/coworkers mention a new hour or interest rates, I like to ask my mortgage broker what the current rates are. We were on a 30 year fixed at 3.75% that we refinanced just last year and was quoted 3.625% for a new 30 year refinance with no closing costs. While the rule of thumb essentially is – if you can lower your monthly payments, even a quarter point drop may make sense to refi, but for me, a 1/8 drop just wasn’t worth the time and effort (which realistically is minimal if you think about it.) Anyway, if I had done it at 3.625%, I would have saved about $35 per month x 29 years = $12,170 savings over the life of loan. So in theory, I should/would have done it at 3.625%.
Negotiations
I then replied back to my broker, “Any way we can get it down to 3.5% if we added some more money down?” Remember – she is a broker and not a bank, so she can shop around. After a day, she did eventually find a bank at 3.5% but “is slow.” I didn’t care about speed of my refi, so I told her to lock it in.
30 year or 15 year
After talking to some people, one person recommended I go for the 15 year loan. I then asked my broker if I could change it to 15 years and she said that rate would be 3.125%. I told her that’s what I want and she was able to change it even after locking in 3.5% for 30 years. By switching to the 15 year, I’ll pay less in interest over the life of the loan and my monthly payments rose 33%. We had the means to cover the increased payment, and that’s what ultimately led me to the decision to do the 15 year.
However, days later, I had second thoughts about doing the 15 year. In a previous post, I had mentioned that I love mortgages. Where else can you borrow hundreds of thousands of dollars for 3.5% over 30 years? If someone ever gives you that option, you should take it! Because if you take that cash and can invest it [in the market, a business venture, etc] and earn 5%, then you are essentially making 1.5% on that loan. So by me switching to a 15 year loan, I’m forgoing more upfront capital. See this article and quote:
Imagine, then, a $300,000 loan, available at 4% for 30 years or at 3.25% for 15 years. The combined effect of the faster amortization and the lower interest rate means that borrowing the money for just 15 years would cost $79,441, compared to $215,609 over 30 years, or nearly two-thirds less.
…..
For example, in the previous example a 15-year loan monthly payment was $2,108 and the 30-year loan monthly payment was $1,432. A borrower could invest the $676 difference elsewhere.
The back-of-the-envelope calculation is how much (or whether) the return on the outside investment, less the capital gains tax you owe on it, exceeds the interest rate on the mortgage, after accounting for the mortgage interest deduction. (For someone in the 25% tax bracket, the deduction might reduce the effective mortgage interest rate from, say, 4% to 3%.)
This gambit, however, demands a propensity for risk, according to Shashin Shah, a certified financial planner in Dallas, because the borrower will have to invest in volatile stocks.
For me personally, I’d rather invest that extra capital in the market, but for less risk averse people, the 15 year fixed would make more sense if they can afford the monthly payments.
App-o-rama effect
Remember, I had no idea I was even going to do this refinance, or else I wouldn’t have signed up for 3 new credit cards recently for my wife. My broker pulled my wife’s credit and asked us to sign a form stating why we had those 3 credit pulls. The un-edited template she gave us said, “Those credit pulls were NOT for new lines of credit.” I had to reply to her and say, “Ehhh, those WERE for new lines of credit.” She then told me to edit the template and send back.
Also, those pulls also made her average credit score dip a tad below 740, which would have disqualified her for the “best rates.” My broker still made it happen, but clearly that’s the main reason why you don’t want to do an app-o-rama before a refinance. The issue isn’t the new lines of credit (which you can explain) – it’s the temporary dip in your score that may push you below 740.
There was also an issue on an AMEX Platinum card. Since that card is a charge card, she had a balance of $1203 and a payment of $1203. My broker asked why the payment was so high and I told her why. This was an issue because it caused my wife’s debit to income ratio to go above 50%, which would have disqualified her from the loan. If it had been a credit card, then the monthly minimum balance would have been small and not been an issue. So be careful about charge cards when you are applying for loans. Another issue was that I had to show proof that I paid for it and sign a letter saying that it was paid from my account. Luckily I didn’t have to show that account’s statement, or I would not have been able to explain all the MS.
Lessons Learned
The best and cleanest way when applying or refinancing a home loan is to keep a “clean” bank account that shows payroll direct deposits. You’ll have to show 3 months worth of bank statements, so try not to deposit lots of MO’s in so you don’t have to explain it.
As for credit cards, you’ll have to explain any hard pulls from the last 3 (maybe 6) months. Also, it’d be best to refrain from doing app-o-ramas so your credit score stays above 740.
While I think I should have stuck with the 30 year fixed, it feels great to know I won’t have any more house payments after 15 years.
Forgive me in advance, but.. I see things a little differently. Even if you were going to pay off your mortgage in 15 years, I see a 30-Year Mortgage as more lucrative, especially with such little of a rate difference between them on a Jumbo.
A 30-Year Mortgage, is kinda similar to the “Option ARM” or “Payment Option” home loan that was offered up until 2008. You have the benefit of making a lower “minimum” payment (the 30-year), when you want.. and a faster amortizing 15-year payment, when you don’t. (Although, unlike the real Option ARM, your loan doesn’t negatively amortize, and your interest-rate doesn’t adjust every month)
The extra money every month, can be invested or used for other purposes… but if you were to also run into something like a temporary job loss or emergency, you’d have the ability to make a smaller monthly payment for a while and not use as much of your emergency fund.
Obviously, the above example isn’t for everyone, but… I think the flexibility of the 30-Year, may help a few out there over a traditional 15-Year loan.
No you make good points. That’s why I wasn’t totally gung-ho on the 15 year fixed. My question though with the 30 – let’s say you overpay by $500 every month. Your principal and payments don’t ever “reallocate” every year, so even if you paid off 75% of the principle by year 15, you’d still be making the same monthly payment amount. Also, aren’t there early payoff fees with a 30 year fixed?
Many lenders will allow you to “recast” the loan and recalculate the remaining amortization tables once you have at least 20k in principle paid early. Probably make sense to save that amount in a side account drawing interest and then arranging the payment and recast in a lump sum.
Any suggestions on finding a mortgage broker? I didn’t shop around enough when we originally bought the house but I’m tempted to refinance it now and correct that.
Word of mouth is probably your best bet. I found mine through an Asian realtor who recommended her. I’m not sure how she can do these with no closing costs. I’m sure she’s making money by quoting me 3.5% but selling it for 3.25% or so. I’m fine with that if competitors all want 3.5% anyway w/ closing costs.
We’re currently in a 30 year at fixed 3.5%. Had a quote last week on a 20 year for 3% with $2.5k fees. Would’ve bumped our payment $200/mo and reduced the mortgage from 26 years down to 20.
With another baby on the way and my wife’s job situation in flux we opted to hold off until early next year and reevaluate then. I’m not expecting more than one rate hike (if at all) between now and then.
You make good points though about having the extra money now with a low rate and how you could leverage that into other investments. Or in our case provide peace of mind in regards to monthly payments while life is in flux. Definitely pros and cons and justifications for either direction though. As we like to say, YMMV.
Anyone with a mortgage in the 3.5 and lower range is working with close to free money anyways when you factor in historical inflation so the glass is half full regardless.
Very good points Anthony. I don’t think there is a right and wrong answer to the 15 year vs 30 year; they are both very close. Just personal preference on when you want the money.
This just happened to us too. I unexpectedly decided to refi when rates dropped. My score had temporarily dipped below 740 also so I had to pay some fee but it was still worth it. It was mildly embarrassing to listen while the broker verified every single account my husband and I had opened during the past six months and every single account that currently had a balance. I had to just keep saying, “yep, I opened that one”. But in the end it was no problem and they asked no more questions. Unlike you, I can never quite bite the bullet on shortening the term and having my payment go up even though I could technically cover it!
Thanks for sharing Kelly. Yeah, I would NOT have been able to explain all the transactions in my MS account.
The other nice thing about a mortgage is that it is inflation proof. As inflation goes up that payment becomes less and less over time! The 15 year mortgage should be a little bit of a better payoff come tax time though with a larger interest write off.
BOOM! Yeah, I had factored in the time value of money. Man, you’re really making me regret not doing the 30.
That seems high for a 15 year currently. girlfriend just refied a 15 at 2.5%
This was a jumbo loan and rates vary by location, but that sounds very good.
Hey Vinh, does your new refi loan have prepayment penalties? I can’t find a bank that will do a zero-cost refi without putting prepayment penalties on the new loan.
Are you going to a bank or a broker…probably would have better chance with a broker since they are looking to just sell the loan.
I didn’t really look that hard, but I do believe there is no prepayment penalty and ironically, it got sold to Chase, so try them? But like Mark said, use a broker instead of a bank so they can shpo around for the best rates.