By Steve Freidell
Land Line contributor
Ordinarily you would not consider driving a load across country overweight. Not only would it be illegal, but also the extra wear and tear on your engine, transmission and other vital components will reduce the life of your truck.
The extra money in your pocket may be tempting, but you know that the ultimate expense doesn’t justify those few extra dollars. Maybe you should treat your debt in the same way. Isn’t it time to unload this stressful burden before it starts taking years off your life?
For several months now we have been discussing ways to reduce your debt. From using personal finance software, to developing a budget, to reducing your monthly expenses, to managing your credit card payments, there are many things that you can do to reduce your short-term debt.
However, as you begin to pay these debts off, it’s important to plan to reduce your long-term debt, especially your home mortgage.
Let’s examine a sample case of a homeowner who is considering refinancing a mortgage. In 2001 this person purchased a new home and took out a $150,000 mortgage at 6 percent to mature in 30 years or on Feb. 24, 2031.
Eight years have gone by and the homeowner is considering refinancing to a 15-year mortgage at 5 percent, thereby reducing the interest expense and debt earlier than the old mortgage.
Normally this is sound thinking, but home values in the area have fallen too low to be able to refinance. Millions of people all across the U.S. have found themselves in this same position, but there are ways out.
With a current mortgage at a 6 percent interest rate through Feb. 24, 2031, the mortgage payment (not including insurance and taxes) is $900 per month. If you refinance to a new 15-year mortgage at 5 percent, which would retire in 2024, your monthly payment would be $1,186. Although you may be paying more monthly, you will also pay off your debt seven years earlier, saving a considerable amount of interest.
However, while the new 15-year mortgage would save a lot of money, there is another way to accomplish the same thing, only better. Keep that old mortgage and send an additional principal payment of $286 monthly. It’s the same out-of-pocket expense as the 15-year, but without the refinancing costs, appraisal fees and other expenses.
This additional $286 will all go toward paying down principal, which will result in the old mortgage being fully retired on Sept. 24, 2022, and at a savings of $44,797.74 of interest paid during the remaining life of the mortgage. That’s 17 months earlier than the 15-year mortgage and 8 ½ years earlier than the old mortgage payoff date.
So now you are probably thinking, what if I can’t afford $286 this month? That’s OK, because you aren’t locked into a new refinancing payment. Think of it as an additional savings account. The more you are able to put in each month, the more you will be getting back in interest expense saved. Here’s a chart showing how much an extra $100, $500 or even $900 each month can save you in the long run.
Even if you can only do $100 right now, consider also applying a portion of your tax refund, company bonus, or any monetary gift toward paying down your mortgage. Over time, it really adds up and suddenly the dream of retiring your mortgage isn’t a dream anymore.
If you find your current mortgage interest rate is more than 2 percent above prevailing rates and you have sufficient equity to refinance, converting to a 15-year mortgage may be a better choice than retaining the old mortgage. Be sure to ask your mortgage banker to show you both options and gauge for yourself which option is better.
Remember, it is not the interest rate you pay that is so costly; it’s the length of time you are obligated to make those payments that costs you so much money. LL
This material has been prepared for informational purposes only; it is not intended to provide and should not be relied upon for accounting, legal or tax advice.
Steve Freidell has assisted clients in their cash management, trading, and portfolio management of fixed income securities since 1975. Steve started his career at the First National Bank of Kansas City and later served as first vice president with Commerce Bank, where he served his clients for 25 years. He joined the DeWaay organization in 2006, the financial management company utilized by OOIDA.