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Refinance, or not?

Chris Farrell Dec 18, 2008

Question: In 2006 we bought a house in a pretty strong real estate market with a 30 yr fixed rate that wasn’t stellar, (6.75%). We have no problem making the payments and putting away ~10-11% into retirement funds. We have student loan debt (<30k, @2.45%) and are paying those down on a 10 yr plan with no problem as well. My question is with the recent fed rate cuts, and our mortgage being our biggest debt, shouldn’t we consider refinancing, and should we be sinking more money into our retirement funds, or into the principal? I’ve been quoted 30yr rates as low as 4.75% for our situation with closing costs of ~$3.5k, so the savings on the interest rates seems substantial. If its relevant, we plan on keeping the house for at least 5 more years, no matter what, after that it is total unclear. Luke, Baltimore, MD.

Answer: The Federal Reserve Board made history this week by cutting its benchmark interest rate between 0% and 0.25%. Since Thanksgiving weekend the impact of the Fed’s campaign has been noticeable with mortgage rates–and a pick up in mortgage refinancings. The gap has widened enough that for many homeowners it makes financial sense to refinance. However, the pool of qualified applicants is relatively small compared to previous refinancing booms because lenders are limiting their interest to those with a good credit score and equity in the home.

First of all, I would run some numbers. There are a number of good calculators. Check out the ones at www.dinkytown.net.

While there is nothing wrong with accelerating mortgage payments, here’s why I am cautious about the strategy: You end up putting too much of your financial nest egg in one basket–a home. That’s why I still prefer building up a well-diversified portfolio, even in a market like this one. I would still save for the long run in a diversified retirement savings plan.

For many people a reasonable way to shorten the life of the mortgage without cutting back on retirement savings is to make an extra monthly payment a year. I’ve recommended this before. By writing 13 monthly mortgage checks instead of 12 you’ll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.

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