Thinking about refinancing your mortgage? Bridget and John dive into the pros and cons of refinancing and help you determine if it's the right move for you. Join us as we discuss adjustable rate mortgages (ARMs), the benefits of a fixed 30-year mortgage, and key considerations when deciding whether to refinance.
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TRANSCRIPT:
Bridget: John, I'm thinking about refinancing our house. Seems like a good time to talk about this. Refinancing, should I do it or not? Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice at Middleton, Wisconsin. Before we talk about refinancing mortgages, I want to remind everybody to hit that subscribe button. That helps other people find this information on YouTube. And with that, I mean, you just bought this house. What do you mean refinance? What's going on here, lady? All right. Let’s talk about this.
Bridget: Well, we bought it about a year ago. And when we bought it, we actually got an ARM, an adjustable-rate mortgage. So first part of this is let's get to a 30-year. And interest rates have gone down. We got a call from our mortgage guy. And the interest rates that we can get on this is over a half a percentage point lower.
John: …than what your current percentage is.
Bridget: Right. And one of the rules of thumb that we've talked about before is that if the rate is a half a percent lower, that's kind of a cutoff for saying, “It's probably going to be a good idea.”
John: It usually makes sense.
Bridget: Yeah. And after a year, it’s kind of slam dunk.
John: Yep.
Bridget: It's not even hard to do the math.
John: Well, let me pick out a couple of things. Let’s talk about this adjustable-rate mortgage; it's fixed for a period of time, three years, five years, seven years.
Bridget: Ours was seven.
John: And after that, then it goes at whatever the current interest rates are. So one of the drawbacks to that is you know what your rate is for the first seven years, and then if inflation goes up, interest rates go up in seven, eight years, nine years, you could be paying significantly more in interest. So you don't have the guarantees. I used an adjustable-rate mortgage when I bought one of my investment properties. And I was planning to refinance and do some things. And then 2007, 2008 came around and nobody wanted real estate. But what happened at that time was interest rates actually went down. So when I had my ARM, instead of it going up, my rates kept going down and down and down. I was scared about it, but it ended up being a good deal. So you never know exactly what you're getting into.
Bridget: Right. I had clients that were in that same situation. You think with ARM that you pay less now, but you're gonna get fill in your bad word over the long term.
John: Right.
Bridget: But they actually got the benefit of the lower rate.
John: And that's the advantage of the ARM. The rates are typically lower than the 30-year mortgages. That's the reason in the first place.
Bridget: Yeah. And we had a pretty decent idea that the situation would change, and we'd be able to get a better rate later just because of how the whole deal went down. And we're betting at some point in the seven years of the ARM that interest rates would go down, which is a bet. It might not happen, but that's what our bet was.
John: One of the reasons, as you think about what should we do, is that having a long-term fixed mortgage is one of the only advantages we've got over a bank.
Bridget: Yeah. So the consumer protections with a mortgage are really phenomenal. You can't get an interest rate that doesn't go up like you can with a fixed mortgage. 30 years. There's so much that can happen in 30 years. Just take a step back and look at our situation now. There's a lot of mortgages out there that are at 3% or lower yet interest rates for safe, 100% guarantee, bank accounts and CDs, etc. are 4% or 5%. So the bank's paying out 4% or 5% and getting in 3%.
John: Yeah, I just gave you a hard time, saying, “You just bought the house. Refinancing?” But we did a similar thing when we bought our vacation place. We bought it, then rates went down, so we refinanced. I've got two of those 3% mortgages. So if you think about. I have my deposits at the same bank. I borrowed money from them, and I'm paying them 3%, and I take money, and I loan it to them and they're paying me 4.5% on the backside. And they can't change that. I'm the only one who can change it. I can write a check and pay off my mortgage. They can never stop it. That's one of the places that we have an advantage over the big guys.
Bridget: And are bank's doing this out of the goodness of their hearts? Not, it's because this is what's required.
John: Yeah. Well, it's required in the United States. If you go to Canada, you can't get a 30-year mortgage. So this is one of those places.
Bridget: If you've got a business and you want to buy a property, you can't get a 30-year mortgage. It’s shorter terms.
John: Right.
Bridget: You might be able to refinance. And there’re just so many things that can happen in 30 years, and banks are well aware of that. So thank goodness for the people that have gone before us and insisted that this is how it's set up.
John: So one of the things I think about when this question comes up is how long do you plan to stay in the place? And I think the average that somebody stays in the house is something like seven or eight years.
Bridget: Right.
John: So if you're going to stay in the house for seven years, maybe that's why there's a seven year ARM, adjustable-rate mortgage. It’s because that's what people do. I've been in my house for well over 20 years. I'll be there another plus 20 years. So a 30 year fixed mortgage makes sense. You just bought the place. If you’re going to retire and stay in that place, then having that long-term fixed mortgage gives you some leverage. And as you know, what happens if rates keep on going down? You lock in at 6% or 6% or whatever, then you refinance. If rates go up, then you're pretty happy.
Bridget: If rates go down again, I will refinance again. And that's my plan. And that's what I've done in previous houses, too. Refinance, refinance, refinance. That's one of our strategies when we bought the house. People were saying, “Oh, how can you buy a house now? Interest rates are so high.” I think of it like practicing my chip shot. I don't even golf, but it's like you just chip away at it and get it lower. And I was one of those people with our old house who benefited from a mortgage that was under 3%, so just keep chipping away and saving money. That's how I look at it.
John: One of the things we talked about is how when Bridget and I grew up and our parents had paid off houses. And that's the American dream, right? You have a mortgage burning party, and you own your home free and clear and all those things. And what that doesn't take into account is that I've still got this asset. My house is worth whatever it's worth, whether I have it 100% paid off or I've got it 50% paid off. So it's not like I've got a mortgage, and I don't have this other thing. And in order to pay off the mortgage, I've got to take either on a monthly basis or some other way, I've got to take money from someplace else.
I got to take it out of one pocket and put it into the house. It's not like the money comes out of thin air, and I go, “That's a great idea to pay off the house as fast as I can.” And so, it's this idea of, hey, if you’re going to keep on with your higher payments that you have with your current mortgage, if you refinance, your payments go down a little bit. But then you've got more money in your pocket. So the one thing people will say, and I hear it all the time, and it makes sense because you see it on the mortgage statements, is, well, here's what interest you're paying on this mortgage. And if you get a new mortgage, here's the interest you pay on that mortgage. You go, “Why would I want to pay any more interest?”
But that ignores the fact that my payment is $100 a month less or whatever it is. I've actually also got other money here. And if I'm going to just waste that money, then, yeah, take the higher pay. But you can't look at just the interest without looking at what you're giving up to get that interest. And so that's one of the components for viewers to think about. As you look at that decision, look at that difference in not just the interest, but what are the payments? If I'm saving a month, that means something over the next 20 years.
Bridget: And I think we would both agree to kick it out as long as possible. So I was looking at an example of would this whole thing make sense if I had ten years? And I would pay more total interest if I stayed in this place ten years, and then I got another 30-year mortgage, instead of a 20-year mortgage, which I don't even know if I could get. But the availability of the funds is worth a lot. And again, you're chipping down at how much you pay. For a 50/50 portfolio, the average earnings is 8.5%. And guess what? A mortgage rate at 7% right now is common and lower than that is common. So even currently, you're probably gonna be doing better.
John: It's not guaranteed.
Bridget: Right.
John: And that's a fair comparison. If you pay off your mortgage, you're getting a guaranteed rate on whatever your mortgage payment is. Chances are that you make more than your mortgage rate, but we just don't know those things. So if you're somebody who's really fiscally conservative, thinking, “Golly, any kind of risk scares me.” There's a place for it. We were talking before we hit record.
What I think is important is to know the differences, know that it's not just this one binary. How much interest do I pay? There’s a case when having a long-term fixed mortgage is advantageous mathematically, but how you feel about that might be very different. And it's okay to make a different decision. Not every decision is calculated on a spreadsheet. One of our friends says spreadsheets don't sleep at night.
Bridget: Exactly.
John: Sometimes I know that I'd be better off refinancing, but I just feel more comfortable doing it the other way. Okay, cool. But you've looked at it and made that decision as opposed to blindly saying, “Well, this pays less interest, so I'm not going to factor in all these other things.”
Bridget: The other option you brought up, too is you could refinance and keep your payment the same and your interest rates lower and then pay it off faster.
John: Right.
Bridget: So if your goal was, I want to pay off my mortgage as fast as possible. Refinance, so your interest rate’s lower, then pay off your mortgage.
John: And that gives you some flexibility.
Bridget: Yeah, if all of a sudden, it's hard for you to pay your mortgage.
John: I lose my job, and now I'm not hooked into this larger mortgage. The other thing about that too is, remember, we can always pay off the house…in 99% of the situations; there're probably some exceptions. But on most of our mortgages, at any point in time, I can say, “I'm going to take money out of my savings,” maybe I'm retired, so I can take money out of my 401k. There're places that you can take the money out and say, “I want to just pay it off because that's what I feel like.” You can't always take money out.
If I'm retired, I can't necessarily take a loan out against the house. They can look at that funny. But I can always pay it off. So again, I've got control. If the interest rates go up, I've got leverage on the bank. I can choose to cancel the mortgage by paying it off. So I've got choices. And again, that leads us to where refinancing continues to give you choices, and that's just really big for me anyway.
Bridget: Yeah. And I think a lot of people end up resenting banks…
John: just in general😊
Bridget: In general. But I think this is one area where the consumer actually has the advantage over bank. And so, it's like, have at it. That's my two cents.
John: Yep.
Bridget: Anyway, this is a great time to wrap it up. I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients. We'd love to talk to you, but we're also both members of the Alliance of Comprehensive Planners, which is a nationwide group of fee-only, tax focused financial advisors. So if you like what you hear on our show and would like to find an advisor in your area, check out acplanners.org.
Bridget: And please subscribe.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.