Now is the Time to Save Big

Gary Alt |

Right now, there is a tremendous opportunity to save a huge amount of money.   The best part is that the outcome of the election has no impact on this opportunity.   Most people think about saving as setting money aside with a goal in mind – retirement or college for kids.    It’s a cash flow way of saving and contributing to an account.  Money comes in, and money goes out. 

The opportunity I’m talking about is refinancing your home.  Rates are extremely low right now, and may continue to stay low for a while.  If you own a home, and haven’t refinanced in a while, it’s a great opportunity to do so.  Not just lowering your payment, but also lowering the term of your loan will provide significant savings.  You see, interest is cash out of your pocket, so why spend the money if you don't need to?

Right now, there’s talk of whether mortgage interest will remain deductible.  It’s not likely that Congress will eliminate the benefit, but if lawmakers were ever forced to reform the nation's tax code, all bets are off.  This once-holy write-off could be the first on the chopping block.  

Mortgage interest is not a dollar-for-dollar deduction.   It’s based on your income-tax bracket, so those in a higher tax bracket save more in taxes.  For example, if you are in the 35% tax bracket, you'll get back 35 cents for every dollar in mortgage interest you spend.  For those in the 15% bracket, that savings is only 15 cents.

If we look at someone that purchased their home 4 years ago with a 30-year mortgage at 6.5%, the mortgage could easily be $500,000.  Especially, if that home was in San Francisco, where the median sales price as of August was $542,000 (Nationally, it’s $181,500).  The monthly principal and interest payment for a $500,000 loan is $3,160.   The total amount of interest that would be paid over 30 years would be $637,722!!!

In today’s economy, let’s say you were to refinance at 4% into a new 30-year mortgage of $480,000 (your present balance of $475,298, plus $4,702 in closing costs wrapped into the loan amount), your payment will drop to $2,292 – a significant monthly savings of $868!  

But you'd be starting the clock all over again.  So as a result, on top of the $126,994 (yes, that’s what you’ve paid in 4 years!!!) in interest you've already spent on the original mortgage, you'd be paying an additional $344,974 in interest over the term of the new loan for 30 years – total interest paid over 34 years is $471,918.

As you know, most people don't keep the same house or the same mortgage for 30 years.  In fact, the average life of a home loan is about 7 years.  But if you have found the home you want to die in then you will be paying for it for 34 years, not 30.

Suppose instead of refinancing for a lower monthly payment, you decided to keep it around the same, but reduce the length of the loan.   A new $480,000 mortgage at 4 percent over 20 years will run $2,909 a month.

With as low as rates are right now, that move alone cuts your monthly payment by about $250 and saves a whale of a lot of interest over the life of the loan — $345,084 would be the total interest paid on a 20-year loan at 4%.  $471,918 is the total interest for the 30-year loan at 4%  and $637,722 for your original loan at 6.5%.

Along with this savings, it's nice to have a nest egg or options should the need arise to tap into the equity in your home.

Let’s say 10 years from now, Johnny is ready to go off to college.  If you haven’t been building that 529 Plan, you are going to need some cash.   You might be able to borrow what you need for school at the going interest rate, or you might decide to take it out of the equity you've built up in your house. 

How much equity might be available a decade from now will depend on two factors: appreciation, or how much your place has increased in value, and the term of your mortgage – which is the only sure thing.

If you opt for the new 30-year loan in the above example, you will have accumulated $101,137 in equity by making your payment every month over 10 years.  This may seem like a small amount, but you have to remember that in the early years of any mortgage, the lion's share of the payment goes to interest.  It’s not until the 20th year or so that a majority of your payment starts going more to principal than interest.

Mortgages with shorter terms pay down faster than those with longer terms. So if you decided on the 20-year loan above, you will have amassed $192,707 in equity after 10 years. That's almost double the equity buildup in the 30 year.

Shortening the length of your mortgage isn't for everyone.  But, if you are comfortable making about the same payment you are now, it is worth considering.  When you do the math, it makes a lot of sense.