Sylvia and I just refinanced our Austin home. When we bought the home in 2010, 4.75% interest on a 30 year loan was the lowest interest rate we’d ever had on any real estate loan, ever. Yesterday we refinanced at 2.75% for 15 years. Bottom line, this will save us about $40K in interest payments and chop 13 years off the life of the loan. Let’s take a look at some numbers:
|Refinancing from 4.75% 30yr to 2.75% 15yr|
|Old Loan||New Loan||Diff|
The above numbers are taken from my October mortgage statement for the old loan, and the first December payment for the new loan, so they will actually grow more favorable over time.
OK, first let’s look at the bottom right box where you’ll see that our monthly payment increases $444 over the previous payment. I don’t care about that, and neither should you, unless you can’t afford the increase. All I care about is my Net Worth spreadsheet that I update monthly, tracking our progress toward financial freedom aka retirement. Everyone should have one of these spreadsheets and update it monthly. It helps you focus on what really matters, which is the growth of your net worth.
So how can I be adding to my net worth if I just increased my payment by $444 per month? Aren’t I “losing” $444 per month now? I assume most readers (hopefully) think that’s a stupid question after looking at the chart, and you already know the answer. But I’m surprised by the number of otherwise pretty smart people who do in fact think of a monthly payment as just one number. So, the explanation is that the interest portion of the payment decreased drastically (by $420/mo) while the equity paydown portion of the payment increased drastically (by $864).
So, almost the entire extra $444 monthly payment is actually saved with a smaller interest payment while the equity paydown is accelerated and the loan will be fully paid off in 2027 when I’m 65 years old instead of 2040 when I’m 78 years old. This is the $40K in interest savings and 13 year sooner “free and clear” date.
But I want to talk about the concept of “monthly payment” a bit more, because it bothers me that we live in such a payment driven society and that so many consumers, including real estate buyers and owners, think in terms of monthly payment instead of wealth building.
I just started reading the new book “HOLD: How to Find, Buy, and Rent Houses for Wealth“, which is the final in the three-book “Millionaire Real Estate Investor” series by Gary Keller. I love these books and I have great respect for the authors of the book but I stopped after the 2nd chapter because I disagree with the “cash flow” drumbeat beaten into the reader. I’ll probably continue and eventually finish, but the “cash flow is king” mantra is something I totally disagree with. Otherwise I would not have just refinanced my home because, in fact, doing so just reduced my family cash flow if we want to think about it that simplistically. The book holds forth as a deal breaker, any deal that produces even a dollar of negative monthly cash flow, and I think that will cause many readers to not see the bigger picture and to make bad purchase decisions because it focuses them on the wrong thing.
While I understand and don’t disagree with the idea that it’s better on some level to own positive cash flow real estate, I have personally seen how grasping for positive cash flow in a real estate investment search causes many real estate investors to “chase cash flow” out to the hinterlands and buy lousy investments that look good on paper but perform poorly in real life, especially when the market turns sour. Instead, we advise buyers to buy quality homes in good stable areas that attract quality tenants, even if that property that attends Mills Elementary in Westarn Oaks doesn’t produce as good of cash flow as a cheaper starter home in Hutto. To me, the cash flow home in Hutto or Kyle is a dumb buy, while the home in SW Austin is a smart buy.
So, what I encourage all home owners and real estate investors to do is break apart your monthly mortgage payment, run a comparison on your payment using a calculator such as this one at bankrate.com. If you can refinance at a below-3% rate and chop down the payoff years off your loan, doing so deserves a serious look, even if it increases your monthly payment. But don’t just look at the monthly payment, look at the components of the payment and how they affect your Net Worth spreadsheet going forward. Think like an investor focused on building wealth quicker.
Next, I’ll probably refinance some of our investment properties, even if it means they might go from positve 30-year-loan cash flow to negative 15-year-loan cash flow because, at these rates, the reduction in lifetime interest payments coupled with the reduction in payoff years of the loan will far outstrip any monthly “negative cash flow” that might result. Run the number(s) on your own property and see what you come up with.