On Shelter Comings and Goings, and Refinancings: The Certainty of Uncertainty

One week off from writing, and I felt at a loss for a topic, until listening to Dave Ramsey on the radio this morning and then . . .

I listened to Dave answer an emailed question along the lines of, “Dave, I can re-fi my mortgage, which is at 5.125%, but I’m moving in three years. Should I do it?”

First, a quick note on language: the word “re-fi” is short for refinancing, which is the process whereby a person exchanges one mortgage lender for another. The word re-fi is usually pronounced with the accent on the first syllable and with a long I sound, as in REE’ fie, rhyming with BEE’ fly, which is what the kitty killed a couple of weeks ago — a monstrous half bee/half fly creature that was no match a’tall for the kitty’s feline apparatus.

To that question Dave’s answer was something along the lines of, “Well, you’d be going from a 5 percent to a 3 percent mortgage, and it looks like it’d be about a wash, so I wouldn’t bother.”

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I disagree with most, but not all, of Dave’s answer. Here’re the yays and the nays and the whys:

1. The First Digit. In his answer, Dave focused in on the first digit of the interest rate (the “5” in “5.125”). I agree with that. Thinking about eighths of a percent (0.125% is one eight of a percent) is something you should only do when you get down to the detail of choosing a mortgage, but not when eyeballing them. And, fairly often, when you do do the detail, eighths of a percent aren’t worth thinking about at all (though they can be great for bragging rights and big-fish stories).

2. The Wash. In financial-speak, when something is a wash it means the pluses and the minuses are just about equal, so you end up in the same place because the negatives wash out the positives. Here I assume what Dave meant is that the upfront cost of doing the re-fi would just about offset the savings the caller would receive via three years’ worth of lower interest payments as a result of having a 3-something percent mortgage rather than a 5-something percent mortgage.

Whether these pluses and minuses would’ve washed has a lot to do with the size of the mortgage. The escrow-based cost of a re-fi tends to not change all that much relative to the size of the mortgage, so the bigger the mortgage being re-fi’ed, the lower would be the cost of the re-fi relative to the savings of interest.

To make this concrete, let’s assume that doing the re-fi costs $4k — which is about what they cost in California, excluding origination points, but including the appraisal, title insurance, escrow fees (escrow is a process in which an independent company holds everything, such as money, documents, etc., until the transaction is all set to happen, at which time it gives everyone the documents, money, etc. they’re getting out of the deal), and the lard-up-the-process fees that escrow companies so love to put in there, etc. In that case, Dave’s caller would need to save about $1,333.33 in interest for each of the three years, post-re-fi, that the caller planned to be in the house with the new mortgage ($1,333.33 in saved interest for each post-re-fi year, times three years of saved interest, equals the $4k escrow cost upfront) (yes, I’m ignoring the time-value of money, but these days that’s not ignoring much at all!).

On a $66,666.67 interest-only mortgage, a 2% lower interest rate would save just about that amount (I assume an interest-only mortgage to keep the math simple, which is that 2% of $66,666,67 equals $1,333.33). By the same token, on a $666,666.67 interest-only mortgage, a 2% lower interest rate would save ten times the amount, or $40,000 total over three years, which swamps — and then some — the $4,000 it cost to save that $40,000. So, the bigger the mortgage, the more reason to do the re-fi (all things being equal).

Note: $66,666.67 mortgages are rare in SF CA and Northern California in general! I use one here for illustration purposes. Also, sorry for these beastly numbs — they just worked out that way . . .

3. The tax benefit. I agree with Dave when he probably ignored the tax benefit of the mortgage deduction (briefly, if you have a big enough mortgage payment, you can deduct, for federal income tax purposes, the amount of interest you pay on your mortgage — at least for the time being, as this is one of the tax expenditures that is seemingly in play for being phased out/killed off entirely).

I say that Dave probably ignored the tax benefit because it was hard to tell what his math was all about. Nonetheless, I agree with ignoring the tax benefit for two reasons. First, the context for Dave’s answer was his radio show, which is entertainment, and the arithmetic of talking about the tax benefit would not be entertaining (I leave it to you to decide what the context here is all about).

The tax benefit math would be ugly because the better, lower interest rate mortgage would have, relatively speaking, less tax benefit (because the borrower would be paying less interest), so the gain that would come from the lower interest rate on the mortgage would also result in a loss of some tax benefit. Yes/no, plus/minus, bigger/smaller — it hurts the head just thinking about it, yes? So it doesn’t belong on radio (or, for brevity’s sake — such as it is — in this piece).

Second, as a matter of approach, I just about always ignore the tax benefit. I do this because (a) the tax benefit might go away one of these days (for mortgages on first homes, I doubt it, though I think the deduction for mortgages on second homes could be kiboshed fairly soon), and (b) people tend to not understand that it is a tax benefit tied only to real Money-Out (as opposed to being a tax benefit tied to no Money-Out) (a topic for another day), and (c) it is, in my financial planner make-it-harder-for-the-numbers-to-work conservative approach, best viewed as icing on the cake which should be enjoyed after the cake, and not while calculating whether to eat the cake in the first place (in other words, just because).

4. The Certainty of Uncertainty. But most of all, and the instigating motivation for writing this piece, is that no one knows with any kind of certainty that they will change their shelter within three years, and, in fact, my experience is that most people find that they vastly under-predict the time they will spend in their current shelter. Inertia of rest, as it happens, vastly outweighs the inertia of motion (they do not wash!).

One exception to this generality is that, when people have wee ones, they often have more apparent visibility (a parent visibility?) on when they will change shelters, based on their child’s life stage, e.g., many residents of SFCA raising young families plan on moving to the burbs when their eldest child is of school age because there’s nothing like a $30,000-plus tuition bill for your five-year old staring you in the face (which your friendly neighborhood financial planner will advise you to view as the first $45,000 of your annual income, straight off the top, since you’ll be using after-tax money to pay that tuition) to make that prediction often come to pass. But, even then, I’ve seen families change their mind once they figure out how to navigate the oh-so-burdening process of getting their kid into the right public elementary school in EssEff CA.

But think of all the people over the last five years who thought they’d be moving and have wound up staying put, for many, many reasons, most of them out of their control. Tomorrow never knows.

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So if the re-fi is a wash, do bother. You just might end up staying where you are for longer than three years and you will feel like such a schmo for passing up that 3 when you could have had it and then come to find yourself, ten years later, still in the same house, still with that five and an eighth mortgage. No big-fish story for you! No bragging rights for you! How’s about, instead, a little self-deprecating humor pointed at your poor-schmo (mortgage-wise, at least) financial self?

As a bottom line, then, if you have a re-fi that will pay for itself in three years, I’d say get ye to your mortgage broker (or to the bank, but usually the broker will do better for you).

As to whether you should get a five-year fixed mortgage (because, hey, you’re only going to be in the place for three years . . .) that’s a question for a different piece (quick ‘n dirty, data- and explanation-free answer that will not fit many folks: No. Go for the 30-year fixed and do take a look at the 15-year fixed).


1269 swords (about a thirteen minute read sans links)


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