Does Paying Extra on our Mortgage Make Sense?

[phantom]

My husband and I would like to start having kids in a little over a year. When we do, we would like it to be possible for me either to quit working or to work part time, reducing our total income. So, we are exploring ways to get our monthly expenses down. Our biggest expense is our mortgage with a minimum payment of $1400/month. We have $173,000 left at 3.25%. If we pay $2250/month on the mortgage, we'll have it down to $150,000 in about a year. My thinking is that, if we could get our mortgage down to $150,000 and refinance at 2.75% for a 15 year term, our minimum payment would be $1000, freeing up $400. Of course, this plan assumes interest rates will still be around 2.75% in a year.

We have no other debt and will be putting 18% towards retirement when my husband becomes eligible to contribute to his 401k in a couple months. We also have an adequate emergency fund and are setting aside enough each month to meet our short terms savings goals. If we don't put the extra $850 on the mortgage every month, I'm not sure what else we would do with that money.

The question is: Should we put an extra $850 on our mortgage each month in an attempt to get our monthly payment down or could we be doing something smarter with that money? If you need any other details about our financial situation or goals, just ask. I didn't want to write a book if I didn't have to.

[feh]

Why not refinance now?

While it's great to get your house paid off early, your money would be put to better use through investments, rather than paying down a low-interest loan.

[MonkeyMama]

This sounds like a solid plan.

What I would do in your shoes is come up with the money as soon as possible, while interest rates are still low. Forget retirement contributions and tap some of your cash. Lock it in. You can always put more into retirement at the end of the year to make up for it. (Or if you miss a few months of contributions, big whoop. You are doing well).

I would also consider just getting a 30-year mortgage. I am 15-year *all the way* and is what we did before kids. BUT, with kids, I much prefer the flexibility of the 30-year. If things go well, just pay it down faster. That said, I have seen 15-year rates as much as 1% lower than 30-year rates these days, so the 15-year might just make more sense for you. $1,000/month sounds pretty reasonable, though I do not know your income. So, this is some food for thought, but I totally understand if the 15-year works best. With these interest rates, is easier to get the best of both worlds - fast payoff without tying up a lot of resources.

[sblatner]

I totally agree with MonkeyMama. I would go for a 30 year fixed mortgage if the payment was less than a 15 year. You can always pay more and pay it off early but if something were to happen to your finances and you had a 15 year mortgage, the payment amount would be higher than a 30 year and you would be stuck with higher payments. I think if you were to play with an amortization table, you would see that the interest amount paid wouldn't be a ton different (with paying extra).

I just checked Fremont Bank's website. For the parameters I input ($173k loan, great credit), there is a $400 difference between a 15 year loan and a 30 year loan. I would rather pay $1200 but have the flexibility of paying $800 if I needed to.

You might want to check into refinancing now. Even at an interest rate similar to what you have now, you might be able to get a lower payment than what you have now because you are refinancing a lower amount. Maybe if you refinance now, you could continue to pay the $2250 and pay it down even quicker.

Difficult to know without all the details but it might be worth it to check it out.

[Petunia 100]

I suggest you save the extra principal payments you might have made in a plain vanilla savings account. You don't know what interest rates will be a year from now, possibly they will be higher and a refi will be unappealing. Sometimes there are unexpected medical expenses with a new baby, and you may wish you had that cash on hand to pay them.

Once the baby has arrived, you can decide at that time if using your saved mortgage principal payments to do a refi makes sense. Or, you could use them to make regularly scheduled mortgage payments and take a longer maternity leave.

Having cash on hand gives you options.

[disneysteve]

I suggest you save the extra principal payments you might have made in a plain vanilla savings account.

Having cash on hand gives you options.

I agree. Your interest rate is low, and after the tax deduction, even lower, like less than 2.5% effectively. I'd rather see you stockpile cash knowing that a major life change is on the horizon.

Once the baby is born, then you can decide what you'd like to do regarding the mortgage and working. Having that cash cushion will give you more options.

[JoeP]

I think saving cash is a smart move in your situation. Last thing you want to have happen is to pay extra principal or get locked into a higher monthly, and then have to access that money through a home equity loan.

Once junior is born, you'll probably find that you'll want to allocate some of your money toward: his/her 529, your life insurance (term!), your emergency fund.

[esb3357]

I would not count on the interest rate dropping lower than it is currently. The interest rate is at an all time low.

[parafly]

Personally, I would refinance the mortgage now, then focus heavily on cash savings. This is a best of both worlds approach ... lock in record low mortgage interest rates AND build up a nest egg to lean on when the child is born.

I do not think it would be wise to tie up your extra funds in the non-liquid equity of your home. Also, I would opt for a 30 year fixed mortgage over a 15 year term as this will give you flexibility in your future payments, and the difference in interest rates is relatively small.

EDIT: I just noticed that your current mortgage has a 3.25% interest rate. In this case, I would leave the mortgage alone, start building up cash/short term investments, and only contemplate a refinance if 30 year fixed rates go down to 2.5% or lower.

[phantom]

Thanks for all the input so far!

I probably should have mentioned that we currently make $136,500/year before taxes. If my husband was the only one with an income, we'd be at $76,500. My husband is 34, and I'm 30. We currently have $64,000 saved for retirement, so we're a bit behind in that department, which is why we're saving more than 15% now. For a while, we were focusing more on eliminating this mortgage than on saving for retirement, but we're starting to correct that.

The idea of getting a 30 year mortgage is interesting. I just checked Bankrate and our current lender, and it looks like the best we could do with a 30 year mortgage would be to keep our current interest rate of 3.25%. So, we'd be buying a safety net and the flexibility to take as long as we want to pay off the house for the price of closing costs. I might not consider that a bad deal if we were comfortable taking the full 30 years to pay off the mortgage and putting any extra money in retirement savings instead of on the mortgage. 30 years would take us right up to retirement, and by that time, the extra money saved for retirement almost certainly would have out-earned 3.25%. But, I really dislike the idea of having a mortgage for another 30 years, and I think my husband dislikes it even more. We want the freedom of being mortgage free, and we like the idea of getting our mortgage paid off a few years before we have a kid ready to enter college. So, we really don't want to take much more than 15 years to pay off our house. That being the case, I'd rather not pay extra for the flexibility of taking longer.

I like the idea of getting a rate locked in sooner rather than later. I wouldn't want to refinance right this second as that would only get us down to $1200/month. But, if we're really confident that our goal is a mortgage payment of $1000, it makes sense to get that locked in before rates go up. We have some cash saved up for home improvement projects that we continue to add to each month. Rough math says that we could use that money to get the mortgage down to $150,000 in 3-4 months. I'd hate to see rates drop again right after we refinance, but not as much as I'd hate to see rates go up right before we get the mortgage down to $150,000, which seems the more likely senerio.

I definitely like the suggestion to keep any extra money in cash until we actually refinance too. That would eliminate the possibility of getting the mortgage way down and being stuck with both the higher payment and less cash. I'm not sure I want to wait until I actually have a baby to see whether or not a refinance still makes sense though. I'd rather be prepared with a lower payment already locked in place. But, it's hard to argue that having a large pile of cash isn't being prepared.

[sblatner]

I would look for a no-closing cost loan. We have never paid fees when refinancing. Yes, we might pay a little more in an interest rate to go no-closing costs but then if the rates do go down, you haven't paid so you can refinance again. I do agree that interest rates are so low, they will not go down much farther so maybe it doesn't matter. Also, if you do an amortization table, you will find that an 1/8 of a point or maybe even a quarter of a point doesn't affect your payment very much.

[Petunia 100]

You know, another way to reduce your mortgage payment is to pay a lump sum and then recast. It is not a new note, so no closing, no closing fees, etc. A recast simply recalculates your required monthly payment based on your new lower balance.

My mortgage servicer (Wells Fargo) will recast my mortgage at any time, for a fee of $250 (charged by Freddie Mac). Some lenders and/or servicers have different rules, such as they may require you to make a lump sum payment of at least a certain amount.

I suggest you contact your lender and ask if they will do a recast, and if so what the requirements are. It seems a better alternative than paying closing costs if you aren't going to substantially reduce your interest rate.

[phantom]

Recasting sounds like a really good idea in this case. My husband and I discussed the possibility of doing that a while back, but I don't think we've ever actually investigated whether or not our lender allows it or what their rules may be. I just sent an email to customer service asking about it. We'll see what they say.

[phantom]

with a recast you are effectively refinancing at the same rate for a fee of 250. if the loan has not been sold, many banks will let you do a refinance to a new lower rate (usually a little bit higher than the current market rate) without going through any sort of closing. that is the same as a recast but you have the opportunity to get a lower rate as well. then there is a refinance where you finance the fees. this may be a little inconvenient, but you get a market rate if it is lower. if you just do the numbers, you can take the best deal...

A few months ago, when our lender started advertising a rate of 2.75%, my husband called to ask if they would lower our rate without a refinance and they told him they don't do that. We weren't sure if that really meant they don't do that or if it meant we need to negotiate harder to get them to do it. In any case, we plan to ask again if either rates drop again or when we're really ready to refinance. It's looking like I'm going to need to call them at some point anyway as my email to customer service received a thoroughly unhelpful form letter response.

[MonkeyMama]

@Phantom - given both your individual incomes, I think $1k/month is beyond reasonable for a 15-year mortgage payment. I'd go for the 15-year in your shoes.

Just to be clear though - on the 30 year mortgage option - I'd only actually keep the mortgage for 30 years if things went really wrong financially. It buys flexibility, but in no way shape or form means one would want to keep the mortgage for 30 years. It just means you don't have such a high monthly payment during times of unemployment or financial uncertainty.

Cash is no doubt very important. I'd arrange the refinance or recast ASAP and then save up a decent cash cushion. I was just presuming you would do both. Best of both worlds - as parafly stated.