Q: I’ve been in this house for 10 years of a 30-year mortgage. If I refinance with another 30 years, then I will be paying for a total of 40 years – which seems forever. But I would save $309 in monthly payments, which I could in turn put towards retirement or a ROTH IRA, or something. (I’m 53, single, and don’t have a good retirement plan in place).
If I refinance for 20 years, then my payment is lowered $130 per month which will not add much to the retirement fund, but is better than nothing. If I refinance my loan for 15 years, my payment goes up $51 per month with nothing extra saved for retirement.
Which seems to be the better option? The interest rate for the 30- and 20-year terms is 4.875 percent and for 15-year term is 4.75 percent.
A: You’ve presented an interesting issue: How do you balance the need for retirement money versus a monthly mortgage payment. A lot of the answer depends on how much you have already saved for retirement, what income streams you’ll have in retirement (other than Social Security), when you plan to retire from your current job and if you plan to continue to work, though perhaps at something else and perhaps again part-time. Obviously, I don’t have those answers, so let me try to frame out the issue for you so you can think it through for yourself.
Let’s look at Option 1: If you save $309 per month, that’s about $3,700 per year. Over the length of a 30-year mortgage, you’d save (assuming you still work) $111,240. If your cash compounds at 4 percent, you’ll have $182,600, which is about $73,000 in today’s dollars. That sounds great, but you’ll be 83 and probably already several years into retirement.
Will you have enough cash in retirement to continue paying your mortgage until the loan term ends? If you retire at 67, that’s 15 years of payments you’ll have to make. Not a great picture. However, you might get some help at that time from a reverse mortgage. If you’ve paid down enough of your loan, you might be able to take out a reverse mortgage, which would wipe out your monthly payments. But you won’t have anything like $182,000 in 15 years.
I’m also not a huge fan of losing (adding) 10 years of interest that you’ve already paid in order to “save” $309 per month. You might do a lot better by refinancing into a 20-year loan, and save $130 per month, or $1,560 per year, especially since you’ll get more of a break in the interest rate.
With Option 2, over 20 years you’ll amass almost $43,000 (which will feel like $28,000 in today’s dollars). But your mortgage will be paid off, and you’ll only be 73. That should free up quite a bit of cash each month just when you need it. You’ll still owe property taxes and insurance, but you’ll free up $600 or so each month in mortgage payments.
Also, if you decide to do a reverse mortgage at age 67, you’ll have virtually the entire loan paid off, and would be able to not only pay off the loan but tap into your home’s equity for additional cash or a monthly stream of income. Read my story at ThinkGlink.com about how seniors might use reverse mortgages to stave off foreclosure for details on how this might work.
I don’t see much benefit in refinancing for a 15-year loan, which is Option 3. I’d rather see you save some cash.
We haven’t talked about closing costs, but you have to weigh just how much you’re saving and how long it will take to pay off your closing costs. If it takes you 2 to 3 years to pay off your closing costs, and you’re adding 10 years onto your payments, I don’t see how this really works for you. But if you can pay off your closing costs (with your monthly savings) in 18 months or so, and you’re refinancing for the same term length and are still saving money, that seems like a solid financial move.
Tax-wise, while you may get to deduct the interest on your mortgage payments on your federal income tax return, if you’re able to sock money into an employer sponsored retirement account, you may have additional income tax savings from that money over the deduction you would get from the interest you pay.
It’s a small issue to consider, but run the numbers to see what happens tax-wise if you put the money into a retirement account rather than in interest payments.
One last issue, you indicated that your options were for three types of loans with different maturity dates but all of the loans have the same interest rate. You might want to shop that around. There are many lenders that are offering better deals on 15-year loans than on 30-year loans. And, the 20-year loans are typically getting the same rate as the 15-year mortgages, not the 30-year loans. The difference in the rate may be small, but wouldn’t you want to pay less?
I hope this gives you something to think about.
May 15, 2009