Refinance my mortgage

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LifeExplorer
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Refinance my mortgage

Post by LifeExplorer »

I bought a house last year with a 5-year adjustable rate of 2.2%. Currently, to refinance it to be a 15-year or 30-year loan, the interest rates are about 2.5% and 3% respectively, and it costs $3500.

I read an article recently talking about mortgages. It says it would be best to have a mortgage duration as long as possible. The reason is inflation. Over time, the currency will debase but the loan amount stays the same - I would pay back the loan with inflated currency.

What do you guys think? My original plan was to pay it off within 5 years since I had the money, but the article argues that would be a dumb idea. It would be better for me to put my money to work and let the inflation eat the loan.
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grabiner
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Re: Refinance my mortgage

Post by grabiner »

With all else equal, it is good to have a duration as long as possible, because you have the option of paying off the loan early or continuing to borrow at the lower rate.

But all else is not equal, and the bank realizes this. That is why the bank charges a higher rate for a 15-year mortgage (effective duration 7 years) and an even higher rate for a 30-year mortgage (effective duration 12 years, not 15, since the earlier payments have a higher present value) than for a 5-year ARM (effective duration 5 years, since the loan will refinance itself at the then-current rate when it resets). You pay the price for having the bank take more of the inflation risk.

If you have the money to pay off the mortgage early, the risk-free return of 2.2% over 5 years is pretty good, unless the interest would all be deductible in a high tax bracket.
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Re: Refinance my mortgage

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (mortgage).
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Watty
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Re: Refinance my mortgage

Post by Watty »

If you decide to not pay off the mortgage early then I would refinance it.

There are endless threads and opinions about paying off a mortgage or not and there is a wiki on this.

https://www.bogleheads.org/wiki/Paying_ ... _investing
LifeExplorer wrote: Mon May 17, 2021 7:35 pm I read an article recently talking about mortgages. It says it would be best to have a mortgage duration as long as possible. The reason is inflation. Over time, the currency will debase but the loan amount stays the same - I would pay back the loan with inflated currency.

What do you guys think?
You may also want to consider if your mortgage will be paid off by the time you want to retire. Once you are retired and living on your savings the "I would pay back the loan with inflated currency" argument is a lot different. At least for me having a paid off house really made my retirement numbers work better.

That said a 30 year fixed rate mortgage can be very good when there is high inflation so it could work out good. One fly in the ointment though is that few people actually keep a mortgage for the full 30 years so it might not be as lucrative as it sounds. Another is that you will also be paying down the mortgage so if there is high inflation ten years from now your loan balance will be smaller.
LifeExplorer wrote: Mon May 17, 2021 7:35 pm It would be better for me to put my money to work and let the inflation eat the loan.
One glitch with that is that if you invest with your normal asset allocation, like 60% stocks and 40% bonds, then you would be using 40% of the mortgage money to buy bonds that will be badly hurt if there is high inflation.

You also have to keep in mind that even though interest rates are low investing the money and earning a higher return is harder than it sounds because if you will have a large sequence of returns risk. Here is a very simplistic example of that which I have posted before.
If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To pay off the mortgage at the end of the second year you would need about $96.5K so you would need to gain back $12.5K and another $6,000 for the next years mortgage payments which combined is $18.5K. That would take a 22% return on the remaining $84K to get back to the point where you could pay off the mortgage.

In the past portfolios have declined in roughly one of four or five years depending on the asset allocation. (20 to 25 percent of the time)

https://personal.vanguard.com/us/insigh ... llocations

The sequence of returns risk can also go the other way and you could get lucky and have the first couple of years get good returns that would put you on the path for large gains over the years. There will sometimes be very optimistic projections on just how much better not paying off the mortgage could be but one limiting factor that needs to be considered is that few people actually keep a 30 year mortgage for the full 30 years. It is difficult to put a number on it but many people who own a home will sell it in less than 10 years.
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LifeExplorer
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Re: Refinance my mortgage

Post by LifeExplorer »

Watty wrote: Mon May 17, 2021 9:16 pm If you decide to not pay off the mortgage early then I would refinance it.

There are endless threads and opinions about paying off a mortgage or not and there is a wiki on this.

https://www.bogleheads.org/wiki/Paying_ ... _investing
LifeExplorer wrote: Mon May 17, 2021 7:35 pm I read an article recently talking about mortgages. It says it would be best to have a mortgage duration as long as possible. The reason is inflation. Over time, the currency will debase but the loan amount stays the same - I would pay back the loan with inflated currency.

What do you guys think?
You may also want to consider if your mortgage will be paid off by the time you want to retire. Once you are retired and living on your savings the "I would pay back the loan with inflated currency" argument is a lot different. At least for me having a paid off house really made my retirement numbers work better.

That said a 30 year fixed rate mortgage can be very good when there is high inflation so it could work out good. One fly in the ointment though is that few people actually keep a mortgage for the full 30 years so it might not be as lucrative as it sounds. Another is that you will also be paying down the mortgage so if there is high inflation ten years from now your loan balance will be smaller.
LifeExplorer wrote: Mon May 17, 2021 7:35 pm It would be better for me to put my money to work and let the inflation eat the loan.
One glitch with that is that if you invest with your normal asset allocation, like 60% stocks and 40% bonds, then you would be using 40% of the mortgage money to buy bonds that will be badly hurt if there is high inflation.

You also have to keep in mind that even though interest rates are low investing the money and earning a higher return is harder than it sounds because if you will have a large sequence of returns risk. Here is a very simplistic example of that which I have posted before.
If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To pay off the mortgage at the end of the second year you would need about $96.5K so you would need to gain back $12.5K and another $6,000 for the next years mortgage payments which combined is $18.5K. That would take a 22% return on the remaining $84K to get back to the point where you could pay off the mortgage.

In the past portfolios have declined in roughly one of four or five years depending on the asset allocation. (20 to 25 percent of the time)

https://personal.vanguard.com/us/insigh ... llocations

The sequence of returns risk can also go the other way and you could get lucky and have the first couple of years get good returns that would put you on the path for large gains over the years. There will sometimes be very optimistic projections on just how much better not paying off the mortgage could be but one limiting factor that needs to be considered is that few people actually keep a 30 year mortgage for the full 30 years. It is difficult to put a number on it but many people who own a home will sell it in less than 10 years.
Very nice write-up!!!
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JoeRetire
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Re: Refinance my mortgage

Post by JoeRetire »

LifeExplorer wrote: Mon May 17, 2021 7:35 pm I bought a house last year with a 5-year adjustable rate of 2.2%. Currently, to refinance it to be a 15-year or 30-year loan, the interest rates are about 2.5% and 3% respectively, and it costs $3500.

I read an article recently talking about mortgages. It says it would be best to have a mortgage duration as long as possible. The reason is inflation. Over time, the currency will debase but the loan amount stays the same - I would pay back the loan with inflated currency.

What do you guys think? My original plan was to pay it off within 5 years since I had the money, but the article argues that would be a dumb idea. It would be better for me to put my money to work and let the inflation eat the loan.
I think I would refinance to a fixed, low percentage rate as soon as possible. And I wouldn't pay it off early.
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LifeExplorer
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Re: Refinance my mortgage

Post by LifeExplorer »

JoeRetire wrote: Tue May 18, 2021 6:38 am
LifeExplorer wrote: Mon May 17, 2021 7:35 pm I bought a house last year with a 5-year adjustable rate of 2.2%. Currently, to refinance it to be a 15-year or 30-year loan, the interest rates are about 2.5% and 3% respectively, and it costs $3500.

I read an article recently talking about mortgages. It says it would be best to have a mortgage duration as long as possible. The reason is inflation. Over time, the currency will debase but the loan amount stays the same - I would pay back the loan with inflated currency.

What do you guys think? My original plan was to pay it off within 5 years since I had the money, but the article argues that would be a dumb idea. It would be better for me to put my money to work and let the inflation eat the loan.
I think I would refinance to a fixed, low percentage rate as soon as possible. And I wouldn't pay it off early.
I would be refinancing a lower variable rate (2.2%) for a higher fixed rate (3%) and changing my plan to pay it off within 5 years to 30 years.
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