Refinance

I've got some big news on the mortgage front. After only 11 months of owning our house, we decided that conditions were favorable to refinance our mortgage. This is rather unusual since ordinarily there needs to be a big change in market conditions, interest rates, or the amount of principal outstanding for it to make sense to refinance.

Then why did it make sense for us to refinance? A perfect storm of reasons, actually.

When we were buying our house, we had to decide which mortgage to get. We narrowed our choices down to a 30-year conventional fixed rate at 4.875%, or a so-called 5/5 ARM at somewhere around 3.5%. It's called a 5/5 ARM because the interest rate and payments only update every 5 years, instead of every year after the first 5 years. The interest rate increases are capped to 2% at any transition, and 5% for the lifetime of the loan. So, for example, no matter how high interest rates would be 60 months into the ARM, the maximum the interest rate could go is 5.5%.

I'm inherently untrusting of ARMs because I'm irrationally averse to assuming interest rate risk. It's offered by Pentagon Federal Credit Union, and they pay your non-tax closing costs, which is a pretty sizable benefit. Our monthly payments would be a few hundred dollars lower for the first five years, and our total interest would be lower for 10 years, so there were quite a few advantages to the ARM. I flip-flopped a few times between which one I thought we should go with. In the end we decided based on timing: we only had a few weeks until closing and PenFed couldn't commit to securing the financing on time. My girlfriend had always preferred the ARM.

Now fast forward to January. Interest rates were even lower, the possibility of which I did not even consider when we were buying our house. I think 30-year fixed rates were at 4.25%. That's super low, but it wasn't low enough to justify refinancing after only half a year, mainly because with closing costs it would take years to break even.

But wait! The 5/5 ARM was still an option! They were still offering to pay closing costs, and the initial interest rate was 3.25% (!). There was one big reason I had a change of heart and decided that the ARM was our best option (my girlfriend, like I mentioned, had always liked the ARM better).

Due almost entirely to my conversion to Mustachianism, I had given up my previously held belief that you should hold on to your mortgage for as long as possible. I've been itching to start pre-paying our current mortgage and have the debt snowball kick into gear. But our payments are high enough that it's difficult to find extra money to throw at the mortgage, and it's hard to justify on the grounds that we've got a few big expenditures to plan for, like replacing the roof and waiting for the central air unit to die.

My girlfriend and I had a team meeting where we decided that we wanted to refinance with PenFed. The difference in our principal and interest payments would be like $400/month for the first five years, and we agreed that we would immediately use part of that savings to make extra principal payments. So there's a Mustachian change right there.

It gets better. Last time I wrote about our house, I got some criticism that the house we bought was too expensive for Mustachian sensibilities. I responded that while the criticism was largely justified, I considered this particular house a deal at the price we bought it for. I've been vindicated in that belief. We bought our house for $457k, and it just appraised for $520k. I don't know that we could sell it for quite so much, but what counts is that our Loan To Value (LTV) ratio has skyrocketed.

With our conventional loan we were paying PMI to the tune of $147/month. I'm happy to report that because of the refinance and our favorable appraisal, we have eliminated our PMI payments. Getting rid of PMI was one of my longer term goals — I was aiming at 2015 to be rid of it — so this is a huge win.

But wait, there's more. Our escrow payments will also be lower under the new mortgage. With lower escrow, lower P&I payments, and no more PMI, our mortgage is going to be around $2250, or $550 lower than we're paying now. We'll be paying an extra $100 toward principal starting out, and I'm hoping to up that in a few months as our balance sheet continues to improve. Of course, after five years, our payments will almost certainly increase. Here's where some mischievous Mustachian fun starts. If I understand the 5/5 ARM correctly, P&I payments for years 5 through 10 depend on interest rates and principal outstanding. While I can't do anything about interest rates, I can affect how much extra I pay toward that loan. Every dollar we prepay during this first five years is going to make our future payments lower than they otherwise would be — that's incentive. Not to mention, in 4 years and 11 months, we'll be able to change our monthly payments for the next five years by paying a lump sum toward our mortgage. I actually really like that our payments will change because of the incentives that that provides for paying down our debt early.

Lastly, the refinance is going to have a big positive effect on our cash holdings. Technically I think we're cashing out some equity, which wasn't my intention but it's pretty minor. I think our loan payoff amount was $407k and our new loan will be for about $413k. $2k of that is coming right back to us, so we could turn around and throw it right back at the mortgage, but most likely we'll put it toward getting a new roof. We've also got $2300 coming to us from our other escrow account — our new lender is pre-funding our new escrow account, which I think is why the new loan is a few thousand dollars higher. And, this is pretty cool, we won't have a mortgage payment in April since mortgages are paid in arrears. That's an extra $2800 that I'm really looking forward to.

All in all I feel the refinance was a big win and it far exceeded my expectations. When the dust settles we'll have far more cash on hand than ever before. Some of that will go toward home improvements, but some will go toward paying down debt.

I feel that we are on a more Mustachian footing already.