Refinancing Our Mortgage

About a year after we bought our house, we considered refinancing.  At the time, we were being offered a rate of 3.75%, and we owed about $152k on our house.  After doing the math, we decided that it didn’t make sense to refinance, and we kept our 4.625% loan.  But now, two and a half years later – and after spending quite a bit of time comparing rates and figuring out just how much money we could save by refinancing – we just completed the application to refinance our mortgage, and if everything goes as expected, we’ll have a new loan by March.

Here’s what’s different this time around:  $495 in closing costs (we’ll bring this to closing as opposed to rolling it into the loan), a rate of 2.44%, and an outstanding mortgage balance that is quite a bit lower now ($108k).  It all amounts to a new principal and interest payment of about $717/month (as opposed to just under $1300/month that we pay now).  The new loan has no prepayment penalties.

Right now, we have eight years left on our mortgage if we never paid any additional principal and just paid the amount due every month as scheduled.  But we’ve been setting money aside so that we can eventually just pay off the loan in one lump sum.  If we were to put that money towards the loan amount, it would reduce our outstanding balance by quite a bit.  So in reality, we have a lot less than eight years to go on the loan we currently have. The idea is that once the loan balance and the amount in the bond fund match, we could just pay off the loan – or we can choose to continue paying the mortgage and wait to pay off the loan… it would depend on what else is going on with our finances and goals at that time.  Either way, those two numbers should match within the next couple years.

Which brings us to the issue of refinancing.  We hadn’t thought about it much lately, since our plan was to be done with the loan relatively soon.  But we got an offer last week that was too good to turn down, especially since the closing costs are so low.  The new loan is a 15 year term, but it’s an ARM – the 2.44% rate is only set for the first five years.  After that, the rate adjusts annually and can go as high as 8.44%.  I can remember a time when I would have said “never in a million years” to the idea of an ARM.  But I guess this is a lesson on the virtues of “never say never”, because this loan makes perfect sense for us right now.  And we did consider the worst case scenario:  even if we were not able to save another penny in our mortgage payoff fund and just had to make the base payments on the loan, and even if the rate were to reset to the highest amount possible, our interest payment would still be less than what we’re paying now (given that the principal balance would be considerably lower than it is now by the time the interest rate reset, assuming we put just the money we’ve accumulated so far towards paying it down.  That scenario assumes that we don’t continue to set aside money to pay off the loan).

Here’s the plan:  We’ll continue to set aside a large chunk of our income into our mortgage payoff fund – that won’t change.  But we’re no longer planning to pay off the loan as soon as the balance in the bond fund matches the loan balance. Instead, we’ll just let that money stay in the municipal bond fund, possibly until the initial five year term is up on the new loan.  At that point, we’ll go ahead and pay it off.   We’ve had the bond fund now for four years, and it’s consistently made more than a 3% return on our money.  The new mortgage rate is 2.44%.  We don’t get a tax deduction on our mortgage (we use the standard deduction), and the municipal bond fund dividends are exempt from federal taxes.  So although there’s a small amount of state taxes owed, it’s roughly an apples-to-apples comparison of the two numbers.  And for now, it makes sense to just make the regular payments on the new mortgage (assuming all goes as planned and we do end up with a refinanced loan) and keep the mortgage payoff money where it is.  We can re-evaluate anytime we like – so if two years from now the dividends on the municipal bond fund drop below 2.44%, we could just choose to pay off the mortgage instead.  This decision will be different for everyone, since we all have different mortgage and tax situations. However you do it, make sure you crunch the numbers for your particular situation – never make personal finance decisions based on something a blogger does!

The main thing that sold us on this new loan was the low closing costs and the fact that our interest rate will be cut nearly in half.  Our January mortgage payment included $423 in interest.  The first payment on our new loan would include $221 in interest.  So right off the bat, we’ll be saving two hundred bucks a month in interest.  That money can go straight to the mortgage payoff fund and make us money instead – putting us ever closer to our goal of accumulating enough money to just get rid of the mortgage all together.

We talked about it last week, and on Friday we submitted our application for a refinance.  Now we just have to jump through all their hoops and hopefully by March we’ll be paying a lot less in interest on our loan.  I know a lot of people have refinanced in the years since we bought our house. When we got our 4.625% mortgage, we thought it was a great deal, since the mortgage on our old house was 6%.  We also thought ARMs were crazy.  Now we’re seeing that it really depends on the situation, and we’re happy to be getting ourselves into an ARM.  I’m curious to hear your experiences with this too – have any of you refinanced out of a conventional loan and into an ARM recently?  I know that it’s been more popular to go the other direction lately, but sometimes it makes sense to swim against the current.