Doing the Math – Part 2

In the last article we discussed a simple mathematical method for helping to make better decisions for your family’s mortgage.   I encouraged you to buy a $20 financial calculator, the Texas Instruments BA-35, widely available at office supply stores. In this article I’ll show you how you can parlay that investment into almost $50,000 by using the calculator to make more precise answers and make decision-making more efficient. Now, before   you say, No way,” let’s do the math.

Let’s back up just a minute and figure out how most people make calculations.   Let’s say that you have a current balance of $150,000 on a mortgage that you got 5 years ago.   The payment at 6.5 percent is $1,012.    You are considering a refinance because you were offered a loan at 6% with $4,000 in costs.   The payment on that loan is $899, a savings of $112.   Now some people would just ask where to sign and others would be deterred by that $4,000.   Which one is right? The answer is that you need to do the math.

Well, first, there are two issues here. One is a problem issue and the other an opportunity issue. Let’s see how the calculator can help.

First, the problem is that, although the payment is lower, you move back out to the lousy end of the amortization curve.   You have to make 360 payments on this new loan whereas you only owe 300 payments on the old one.   Let’s use the calculator now.   I’m not going to work through step-by-step calculations as you can learn that off-line, but I will give you the results, titillate you with power of this little device.

Under the old loan, you owe 300 payments, 25 years, paying total interest of   $153,843.   However, if you refinance, even though the monthly payment is lower, you owe 60 more payments and the total interest goes up to 173,757, $20,000 higher, plus the $4,000 in re-fi costs = $24,000. Even if they were to offer a no-cost re-fi at that rate, you’d still spend $20,000 more. Doesn’t sound like much of a deal does it.

Are there other alternatives that are more favorable? You bet! One answer is to keep the payment the same.   If you do that, you convert the interest rate savings to reductions in principal, shortening the life of the loan from 25 years to 22.5 years, and the total interest drops to $124,194, + $4,000 in costs = $128,194.   That’s a saving of almost $30,000.   That looks better, doesn’t it?

Here’s an even better alternative. This same lender will lower the rate to 5.5 percent if you to pay them 1.5 points, $2,250 in addition to the $4,000, a total of $6,250.   Now before you gag at the costs, do the math.   Again, leaving the payment at $1,012, reducing the rate to 5.5 cuts the loan life to a little under 22 years yields a total interest cost of $101,712 + $6,250 in costs = $107,962.   Our savings are now up to $45,880 and you haven’t spent one dime more per month than you would have had you not refinanced!

Texas Instruments has sold millions of these calculators and millions of people have learned how to do calculations just like this.   I have great confidence that you can too.

So, one last question: is $45,880 a good return on a $20 investment?