We have discussed basic #RefinancingDecision in other posts. If you are just starting on this topic read “Refinancing 101” first. The greatest issue with most refinancing decision is the failure to account for:
Time Value of Future Dollars
Time Value of Money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.
Additionally, future payments are worth less (if you hold to this thinking) than payments made today. For example, if you make monthly mortgage payments of $2,000 over a 30 year period, and can earn 8% on your money invested elsewhere, your last payment (360th) would only be worth about $182.90 today.
Tax Benefits Lost by Refinancing
Interest paid on a mortgage is tax deductible. So, when making a refinancing decision, it only makes sense to account for the tax benefits lost by refinancing.
Suppose a homeowner currently pays taxes of $0.25 for every dollar of additional income, then each dollar of interest deducted reduces taxable income by a dollar thus reducing taxes by $0.25. For example:
6 percent interest that is deductible would cost only 4.5% ((1-.25) x 6)).
Alternative Options for Effectively Lowering Interest Rate
Many homeowners refinance for the purpose of getting their loan paid off faster. They may have a 30 year mortgage and want to take advantage of lower15 year mortgage rates. Consider the following:
Option 1: 30 year, 4.5% interest, $300k loan amount = $1,592.18 monthly payment
Option 2: 15 year, 3.25% interest, $300k loan amount = $2,108.01 monthly payment
If these were the 2 options available and you were already locked into a 30 year amortized loan (option1) you could simply make 15 year mortgage payments of $2,108.01 and pay off the 30 year amortized mortgage in under 17 years.
This is only one of many ways to effect your mortgage without refinancing. Take into account that this method of quicker repayment does not cost you the 2%-3% in closing costs that is normally required.
Sit down with someone that can help you determine the best path to reach your financial goals. The purpose of this post is to show you that simply knowing you will pay back the cost of refinancing in a certain number of years doesn’t necessarily paint the whole picture. Find someone you know and trust that can help you factor in all of the factors above so your decision to refinance is clear. It’s important that you make a point to understand #TheWhy in making your decision because ultimately you are the one that will be affected for many years to come.