I love answering email questions. Especially questions like this one. Whereas I hated good, better, best multiple-choice questions in school, a question like the one below can only be answered with an explanation of why a particular option is best. There are a few different ways to go on this one, as you will see. But I hope to explain to the emailer why my strategy will win the day.
Additionally, this emailer has agreed to call into my radio show this weekend, and discuss his situation on the air. I think people can learn a great deal from a question like this. I hope you enjoy the Q&A, and I hope you listen to the show.
Question for the show.
I make about 75 K a year, but that’s working two jobs. I work for a software company in addition to my writing gig. I’m going to drop one, and cut my income back to 55K temporarily until my wife goes back to work when our 4 year old goes to preschool in the fall.
Last year, we bought a house for $108,000 with 5K down.
I have a 15-year mortgage at 2.5%. My payment is like $990 or so monthly, but I send a check for an even thousand every month.
We don’t have much by way of savings (2 K or so) thanks to 9 years of missionary work. We are completely debt free apart from the mortgage. No CC or car payments, but we do drive 15 year old vehicles that will eventually need replaced. We do have decent life insurance.
So here’s my question: Are rates so low right now, that I should be thinking about a 30-year mortgage instead? I know that would lower the monthly payment. Basically, what I’m asking is whether we are better off trying to cut the monthly payment and build savings or just continue pounding away at the mortgage so we’ll be debt free before the kids hit college? When I do get close to paying off my house, should I consider a home improvement loan/2nd mortgage for tax purposes? Is that a good thing/stupid thing to do?
In this kind of a situation, what the benefit vs consequence of a 15 vs. 30 year mortgage? Did I make the right choice going for 15 and if not, is it even worth considering the cost of refinancing.
This is a very smart person. You can tell. His judgement is sound, and you can sense his discipline.
Do you remember when we were kids? And six months felt like five years? Do you remember that? One of the craziest things about getting older is watching time fly by. Six months went from feeling like five years, to feeling like two weeks. How in the hell does that happen? Anytime you are faced with a financial conundrum that has a time component to it, just remember how fast time goes by. You will see why I say that, in just a few moments.
This emailer has two main issues. One happens over the next seven months and one happens fourteen years from now. Issue #1, the temporary absence of income and the opportunity to improve his cash flow. The emailer is right, he has a little bit of a cashflow issue…for seven months. That’s it. So, is it worth paying $36,000 more in interest over the life of the loan, in order to address a temporary cash flow issue? Nope. The emailer’s mortgage payment would go down about $400/month if he were to refinance to a 30 year mortgage, but that would be a mistake. He would more than triple the amount of interest he’d pay over the life of his loan. Based on the numbers he provided, he’ll pay a total of $16,000 in interest on his current loan, and he’d pay approximately $52,000 in interest on a 30 year loan at the current market interest rate of 3.5%.
So, is this feasible? Well, he said his gross income will be cut back to $55,000 temporarily. That’s approximately a net monthly income of somewhere around $3200. Based on this new (temporary income), the emailer’s mortgage payment would account for 31% of his net monthly income. This is doable. As we discussed at length yesterday, managing your mortgage payment in relation to your net monthly income is crucial to your financial survival. While 31% is not ideal, given his lack of consumer debts, and given the short timeframe of just seven months, he can handle this. Under no circumstances do I think that he should refinance his mortgage. A 2.5% 15 year mortgage is basically nothing. In fact, it may possibly be the best mortgage deal I have ever seen. Seriously.
As to his issue #2, saving money for the future, he doesn’t realize what a great opportunity he has. The emailer and his wife have to live lean for the next seven months. This is a blessing in disguise. Because as soon as his wife’s income starts back up, then they can primarily use her income for their financial priorities because they’ve already taught themselves to live on less. Any additional income, on top of what you are used to living on, should be used for your financial priorities. In fact, you should assign these additional chunks of income to very specific tasks. Personally, I use my radio show income to fund my kids’ college savings plan. I used certain speaking gig income over the last two years to save to finish my basement. The emailer mentioned that he’s a writer. If I’m him, then I would assign his future writing income to a particular financial goal. That way when you accomplish the goal, you can look back and see how the savings happened. I can’t wait to tell my kids that my radio show paid for their college education, literally.