trying to advise friend -- is it wise to refinance to a 15-year mortgage?

[Anonymous]

Friend has a 3-year with a pretty good interest rate but pays PMI (roughly around $120). Friend can refi with a 15-year at a whole point lower and drop the PMI (due to increased value). Friend is about 4 years into the 30-year. The refi would add roughly $450/$500 to monthly payment but would pay off house by age 55 instead of age 66. Friend doesn't anticipate moving.

Friend (it's actually a married couple) can afford the increased payment, but they're still a little nervous about it.

Lots of articles out there suggest it's worth staying with a 30-year in order to have more flexibility (so long as the 30-year rate is good). Not sure of the implications for taxes given the reduced interest deduction.

Advice? I'm torn about what to recommend. I grew up in a working class family, so on the one hand, I'm naturally biased toward having a house paid off (but the conventional thinking on that seems to have changed). On the other hand, growing up in a working class family that faced layoffs, I also see the value in keeping monthly payments low in case of unforeseen issues.

Any financial wizards out there who can offer some insight into this question?

[Anonymous]

^^^ that should read "Friend has a 30-year fixed mortgage," not a 3-year, LOL.

[Anonymous]

A lot depends on security of jobs. If you are both is secure jobs then I like the 15 year, lower interest rate. If you are in professions where lower payments might be necessary then stick with 30.

[Anonymous]

Just because a mortgage is written as 30 year, it does not mean it MUST be paid off that way. I have a 30 year mortgage that I would very much like to pay off in 15. I am on track to do just that. I could refi to a 15 year and save maybe 1 point, but it would cost me the closing costs and eliminate my flexibility in case of job loss/other circumstances. That flexibility costs me something on my 600K mortgage - about 6K/year, or $500/mo, which of course will decrease as I pay it off.

This is a very personal decision, but I'm on my second house that we'll pay off this way, and having that flexibility is really nice in terms of piece of mind. I can make the monthly nut really small if I need to.

[Anonymous]

We did it several years ago. We went from a 3.7 30 year loan to a 2.5 on a 15 year loan. Our payment went up a few hundred. It was worth it. I usually pay a few hundred extra on principal on top of it.

[Anonymous]

What about a 20-year refi? Payment wouldn't go up as much, would allow them to get rid of PMI and would get them a lower rate.

[Anonymous]

If they can afford $500/month extra + the cost of the refi, have them throw that at the current mortgage and get rid of PMI that way. I think the flexibility of a lower mortgage payment is worth the extra interest, since they can choose to pay it off earlier but not be locked in if they end up in dire straits (job loss, medical issues). Not worth it to me, especially if the new mortgage amount makes them nervous.

[Anonymous]

If the house has appreciated enough to remove PMI based on that alone, they can request PMI cancellation and get it removed from the current loan. Then throw extra payments at the existing loan.

That's one option. Another would be to seek out a 20-year.

15-year loans are obviously the best in the long run, but if your friend is nervous about the payment it might add a layer of anxiety that isn't worth it, if they can have the choice of whether to throw extra at the mortgage.

[Anonymous]

Anonymous wrote:If the house has appreciated enough to remove PMI based on that alone, they can request PMI cancellation and get it removed from the current loan. Then throw extra payments at the existing loan.

That's one option. Another would be to seek out a 20-year.

15-year loans are obviously the best in the long run, but if your friend is nervous about the payment it might add a layer of anxiety that isn't worth it, if they can have the choice of whether to throw extra at the mortgage.

Actually, this is not true. Wells Fargo won't let you remove PMI due to house appreciation alone. You have to show receipts that you've made improvements in the same amount as the increase in value. Wells Fargo is horrible, by the way. This was truly a bait and switch situation. My friends were given the impression they could remove the PMI so long as they paid it for 2 years and the LTV was at a certain ratio. They were never told in the beginning that that LTV couldn't be based on market appreciation alone and had to be based on improvements.

[Anonymous]

Anonymous wrote:If they can afford $500/month extra + the cost of the refi, have them throw that at the current mortgage and get rid of PMI that way. I think the flexibility of a lower mortgage payment is worth the extra interest, since they can choose to pay it off earlier but not be locked in if they end up in dire straits (job loss, medical issues). Not worth it to me, especially if the new mortgage amount makes them nervous.

It actually doesn't work out that way. The cost of the refi can be rolled into the loan, and it really isn't much. The $500 extra a month if paid as extra to principal will pay off the house in 22 years, not 15. You have to remember, the new higher payment has no PMI. So even though it's $500 more than the current, it still means so much more of the original payment amount is going toward principal.

The question is whether the monthly flexibility now is more valuable than having the flexibility at age 55 of a paid-off house.

Honestly, I might just tell them that it really seems like 6 versus a half dozen.

[Anonymous]

I would refi at least just to get rid of the PMI, if I have enough equity in there.

[Anonymous]

What does it mean they are "nervous" about the increased payment? If it will stretch them or even come close to stretching them, then I would just look for a refi that will let them drop PMI. If it won't stretch them then I would do it to drop PMI and drop the interest rate by a percent.

[Anonymous]

Anonymous wrote:What does it mean they are "nervous" about the increased payment? If it will stretch them or even come close to stretching them, then I would just look for a refi that will let them drop PMI. If it won't stretch them then I would do it to drop PMI and drop the interest rate by a percent.

It won't stretch them. They can handle it. Their concern is that they are a two-income household, but they like to keep monthly expenses down as low as possible so that if they ever (through some unforeseen circumstance) have to get by on one income, they can manage for a short period of time without depleting their savings. I think that is what makes them nervous.

But that is also a reason why having the house paid off by 55 would be good: they'd be in a good position then because it would significantly reduce their monthly expenses at a time in life where the chance of health issues and stuff increases.

[Anonymous]

That's a reasonable decision but they should sit down and calculate how much they are paying for that wiggle room-- I bet its more than they realize.

[Anonymous]

Anonymous wrote:

Anonymous wrote:What does it mean they are "nervous" about the increased payment? If it will stretch them or even come close to stretching them, then I would just look for a refi that will let them drop PMI. If it won't stretch them then I would do it to drop PMI and drop the interest rate by a percent.

It won't stretch them. They can handle it. Their concern is that they are a two-income household, but they like to keep monthly expenses down as low as possible so that if they ever (through some unforeseen circumstance) have to get by on one income, they can manage for a short period of time without depleting their savings. I think that is what makes them nervous.

But that is also a reason why having the house paid off by 55 would be good: they'd be in a good position then because it would significantly reduce their monthly expenses at a time in life where the chance of health issues and stuff increases.

I think this is a good point - as you age the chance of protracted periods of unemployment and illness increase.