How I saved my family $270,000!

What a title! Honestly the number is more like $267,793.86 but $270,000 sounded so much better.

You may be wondering how in the world did YFS (Your Finances Simplified) pull that off? What did he do?

The answer is simple. I refinanced my home from a 30-year fixed mortgage with a 5.25% annual percentage rate to a 15-year fixed mortgage with an annual percentage rate of 3.375%.

I’m kicking myself because we could afford a 15-year mortgage all along but decided to go with a 30-year mortgage for “flexibility”. Thank goodness we didn’t spend the difference on something frivolous or unnecessary. So I did what my fellow blogger Ramit Sethi talked about in his article “Use barriers to prevent yourself from spending money“. I used the 15-year mortgage as a barrier.Details please! Our current mortgage payment breaks down in the following manner:

Principal = $488.74

Interest = $1,557.17

Escrow = $509.44

Total Amount = $2,555.35

The new mortgage payment breaks down in the following manner:

Principal = $1,518.27

Interest = $996.96

Escrow = $509.44

Total Amount =$3,024.67

Why does this matter?

Well, for a long time the 30-year fixed rate mortgage has been amongst one of the most popular loan products because it allows a person to obtain a larger loan and buy a more expensive house or in my case have a sense of “flexibility”. Because the 30-year fixed rate mortgage allows a person to get into an otherwise unaffordable home loan, this pleases would be home buyers, mortgage lenders and real estate agents.

The 30-year mortgage sounds great!…..So what’s the catch!

As you can see from the amount I will be saving above there is a significant cost to having a 30-year loan. In my instance a $270K cost! So, before deciding on the type of mortgage you will take make sure you weigh the cost and the benefits. To gain “flexibility” I was going to be paying a whole lot of interest with the 30-year loan relative to the 15-year loan. The $270,000 saving from refinancing to a 15-year fixed loan results from 2 sources:

A lower interest rate Paying interest for half the time

The interest rate on my 30-year mortgage was 5.25%. Not bad by any means if you’re speaking historically. But, due to the current economic and political condition in the USA. Mr. Bernake stated that interests are holding until 2013. Mortgage rates fell of a cliff! This is good news for those who are credit worthy. So I jumped at the free money. Also, by only paying 180 payments versus 360, I pay a significantly less amount of interest in return for an additional payment amount of $469.32 a month. But you savvy investors are saying whoa YFS you forgot one thing. Yes, you save $270,000 in interest with the 15-year loan. But, you give up the ability to invest that $469.32! When you switched from the 30-year loan. What about that!

YOU’RE RIGHT!

An alternative would be to take the 30-year loan and invest the $469.32 so that after 15 years the invested funds would be more than the interest savings and equity build up that the 15-year loan would provide. Under some circumstances that is the right decision. But, that’s why personal finance is just that PERSONAL. Mrs. YFS and I had a talk and weighed the options. Since we max out our retirement accounts we felt that the best decision would be to pay off our home in 15 years and retire by 40. So let’s just say instead of putting money into equities we put the $469.32 into a bond that pays a rate of 3.375%.

Attention Readers: How are you taking advantage of today’s historically low interest rates? Would you have kept the 30-year fixed or refinanced to the 15 year? Assume it is 15 years later what would you do with the money?