Why Bother Refinancing – IV
by Evan Vanderwey on 12/03/10 at 9:27 am
I’m almost done with my debt snowball and will be working on my mortgage next. I should be able to pay off my entire mortgage within the next 7 or 8 years. Should I even bother with a mortgage right now?
Since we have been working with Churchill Mortgage out of Tennessee, we’ve had the pleasure of speaking with listeners of the Dave Ramsey Radio Show. He airs all over the State of Michigan, and when his customers call the only mortgage company that Dave has ever endorsed they call Churchill Mortgage.
Churchill mortgage has to decide how to handle changing call volume and difficult states. Last year they decided to use a preferred provider for Michigan – they called Cornerstone.
When Mike Hardwick of Churchill Mortgage calls and asks if you’d like to be a preferred provider for callers of the Dave Ramsey show, you say yes and ask questions later. This has been a very good thing for us, and I trust for them as well. We’ve talked to hundreds of Ramsey Show listeners over the past few months alone!
At least once a week, I have a call that goes something like this:
“Hello, my name is Joe and I’m calling to determine if it’s worth my while to refinance.”
Because I know he’s a Ramsey guy I usually ask him how long he’s been listening to Dave. Then I ask him where he’s at with Dave’s seven “baby steps.” Most often the client is in step two.
That means that they’ve put away $1000 into an emergency savings account. They then listed all of the debts they have except their mortgage from smallest to largest on a piece of paper. They attack, with Gazelle like intensity, the smallest debt on the list until it’s gone, and then they go on to the next one. This is called working the debt snowball.
This particular client had been working his snowball down from almost $70,000 (remember, no mortgage included, just credit cards, car loans and student loans) to around $15,000. His average monthly payment, against the smallest account only, was over $1500 every month. He now has two accounts left to pay off, a combined payment of $2000 a month for the next eight months.
After I get this information, I ask about his mortgage. His mortgage balance is just over $200,000 and he has a 6.75% interest rate. The normal calculation would say that this guy should refinance because he could save 1.5% on his rate if he got 5.25%. That’s an annual savings of $3000 per year. That would make back his closing costs in the first year, and then he would be ahead $3000 per year every year following. Right? Wrong.
Dave Ramsey listeners eat credit card debt for lunch and pay off auto loans for dinner. They do not stop when the consumer debt is gone. They keep going and going and going.
Once the consumer debt is gone, these folks start contributing to their 401k – yes, this does eat into the $2000 snowball a little bit. They then take the remaining $1500 per month and begin over-paying their mortgage.
At that pace, they would have to pay 89 payments on their mortgage in order to eliminate it. That’s about 8 years from today.
So, we look at refinancing. When you apply the interest rate savings of 1.5% to a seven year mortgage you get a much different result than if that loan is around for 30 more years.
Their current payment is $1350. If you add $1500 to it you get $2850. That would be the amount this client pays every month starting in eight months, and as we’ve shown, that’s an 89-month pay off.
But if he were to refinance into a 30-year fixed, add the closing costs of $2500 to the loan first, then finish his other debt in eight months (at which point he could really attack the mortgage), how long would it take him to eliminate the mortgage if he paid the same $2850 per month?
The answer is – 85 months. This is a savings of four months of payments of $2850 for a grand total of $11,400 in savings.
In this case, the client actually said, “why bother?”
Your situation may be different:
- If you have more than 10 years left to pay, then your savings will be larger.
- If you are less sure than this client about how fast you will eliminate your mortgage, then you might want to lock in savings now, because they might total more in the end.
- Your mortgage rate savings may be greater.
- You may have much longer to pay on your other debt first and the mortgage payment savings could help increase the size of your debt snowball – this would increase your savings.
Get the facts and stay committed to eliminating all of your debt and payments.
