Refinancing Madness

There are times, when I'm doing my Zen-in-the-garage thing, focusing on the task at hand (which, this weekend, is replacing the driveshaft in the '85 635CSi), I feel that, at my core, I am a mechanic, a guy who likes to work with his hands and get things done.

Then, when I'm sitting in a coffeehouse, waiting my turn to do my singer/songwriter thing at an open mike, and marveling at the talent, craft, and human interaction in this glorious little corner of the world, I know that I am, at my core, an artist.

And when I'm at work, doing my software / system / unexploded ordnance / geophysics thing and integrating some new sensor, I'm totally at ease with the role that engineering has played as the core of my professional life.

As someone once denigrated Walter Mondale for telling one too many special interest groups that he felt their cause "to his core," perhaps I just have a really big core.

But the engineering me is the part that wants to dig down and find out the answer to things. Although I am by no means a financial whiz, I've developed a high degree of facility with Excel. When our first son Ethan was approaching college, I needed to understand how the hell I was going to pay for it. Despite the number of web-based college savings calculators, I found them all totally unsatisfactory. What was required was a spreadsheet that combined past money (savings), current money (cash flow), and future money (loans) and rolled them together along the projected college costs (indexed for inflation, of course), any merit scholarships or other grant aid, Stafford loans, a time-frame for drawing-down the savings, and an annual contribution from the child, and calculated the difference between the college bill and what you could actually pay. This produced "the answer" -- the amount that you or your child would need to borrow to pay the bill. Then and only then could you begin to wrap your head around the question of how to come up with this amount ("Plus" loan, refinancing the house, etc). Oh, and I needed to build in the fact that we have three kids, two of whom overlapped in college for two years and one who doesn't. It was truly The Spreadsheet From Hell. Nothing like it existed, anywhere. I had friends ask me for copies because it was the only sane way to even begin to answer the question "how the hell am I supposed to pay for this?" By using it, I could look the beast in the face and determine that, if all three of my kids went to in-state schools, we could afford it, but if all three wanted to go to private schools, the "delta" was so large that we'd need to refinance the house into retirement, and I wasn't willing to do that (and if you think that makes me a bad person, that's fine). It was a joy coming up with something I regarded as "the answer," in which I understood every step.

Fast-forward to this week. Interest rates have fallen to the point where I can roll my already-incredibly-low 4.875% 15-year mortgage and my 5.5% home equity loan (what I used to finance the construction of the garage) together and refinance them both with a new 15-year note at a bottom-of-the-grand-Canyon-like rate of 3%, and either reduce my monthly payments and stretch out the term of the loan, or continue paying the same monthly amount to pay the loan down quickly and save a boatload of interest, or some combination.

And then, of course, the immediate question: Is it worth it? When people refinance, they tend to overly fixate on lowering the monthly payment without realizing that, by restarting the loan, they push out the end date, and thus are paying a ton of extra interest. What are the numbers? What are the tradeoffs? What is the answer?

Spreadsheet time.

As with the college exercise, there is no one on-line mortgage calculator that does everything you really need, which is:

--Takes your current mortgage

--Looks at the outstanding balance

--Calculates the interest you have yet to pay

--Does the same for your home equity loan (different loan parameters than the mortgage)

--Calculates the total current payment, total outstanding balance, and total outstanding interest

--Allows you to try out new loan parameters (interest rate and term)
--Calculates the new monthly payment

--Calculates the monthly savings

--Calculates and forces you to look at the motherload of extra interest you're paying with the newly restarted loan

--Allows you enter an extra amount of principal to pay every month to see if, by continuing to pay your old monthly value every month to shorten the term of the loan and save on interest, you actually save money in the end or not.

It took a while, partly because it turns out that the function you need in Excel to calculate the interest between two loan payments (such as from now 'till the end of the loan) is called CUMIPMT, and it is not supported in Excel 2000-2003 unless you've installed the Analysis Pack. I looked but, not surprisingly, could not find the set of ten-year-old Microsoft Office CDs. Fortunately my other computer had a newer version of Excel on it.

"The answer" is startling.

Between the mortgage and the home equity loan, the outstanding balance is about $110k. The current monthly payment is about $1700. Both loans only have about five years left on them, but even in that short time, there's about $20k of interest to be paid. So, again, the goal is to see what the trade-off is between the lower monthly payment and the increased interest over the life of a new loan.

Below are real rates, available today (1/13/2012) from www.penfed.org.

A 30-year loan at 3.875% drops the monthly payment by about $1200, but accrues a whopping $60k increase in interest.

A 20-year loan at 3.75% drops the monthly payment by about $1050, but creates about a $29k increase in interest.

A 15-year loan at 3.0% drops the monthly payment by about $950, with only an $8k increase in interest. In other words, in about eight months, in comparison to doing nothing, the 15-year loan pays for itself.

Wow. 

Then I looked at the effect of paying down the principal faster. If I take the 15 year loan at 3% and merely continue to pay my old $1700 monthly payment, the effect is also startling -- the loan is paid off in six years (about what is remaining now), but instead of an $8k increase in interest, there's about an $9k decrease. In other words, if I refinance, I can pay what I'm paying now and save about $9k over the next six years, or if I lose my job and my income is interrupted, I can let the term of the loan be 15 years, pay about a grand less every month, and the $8k privilege for this risk reduction will be paid back in eight months.

Want to see how quickly I can pull this trigger on this?

Next time I'm in the garage, I will still be blissfully focused. Next time I am at a coffeehouse, I will still be transfixed by the use of art as the mechanism for human connection. But in this moment, my engineer is dominant, I completely understand this mortgage tradeoff, and I am grateful for this small clear thing.

(Thanks to my friend Gary Mercier at work for mentioning the idea of refinancing as a method of risk reduction -- that's what started the wheels turning.)