After chatting with Frank, we discovered:
He had 2 big-ish debts; a SUV payment and a line of credit, totalling 35K (payments were +/- $800/mth, total)
Frank’s mortgage balance was $178,000 (he lived outside of Ottawa) & his monthly payment was $960/mth
He had 18 years left to pay off his mortgage and 3 years left on his current term (he signed a 5 year term, 2 years ago).
First thing, we looked into Frank’s penalty to “break” (get out of) his current mortgage. His penalty was only $1800. I say “only” because that’s very low (see my disclaimer at the end).
We crunched some numbers and things got spicy!!
When we added the $35K from his debts, 10K for his renovations & 2K for his penalty to his $178K mortgage balance and extended his amortization to 25 years, his new mortgage payment would only be $70 more than his previous monthly payment.
With the debts being paid off by the refinance, Frank was saving $800 (from debts that we paid off) less the increase to his mortgage payment of $70. After the refinance, Frank would have $730 more in his pocket every month!
You might think, “Wait, Frank now has 25yrs left on his mortgage! That's 7 years of extra mortgage payments! Was it worth it?" Like all financial questions, the answer (queue the eye-roll) is " it depends". It depends what Frank does with the extra $730.
Let’s throw some extra spicy sauce on Frank’s budget….
I suggested that Frank put $400/mth towards his mortgage (see disclaimer). By doing this, his amortization dropped to 17 years!!!! That’s a whole year less than his original mortgage!
If Frank puts this plan in place;
He still has $330 ($730-$400) more per month in his pocket.
He has no more debts, other than the mortgage
He pays off his mortgage is 17 years, instead of 18
He has the 10K he needs for the renovations
It’s a clear win-win-win for Frank. Plus, the new plan is less stressful because he only has 1 payment and his monthly budget is predictable.
If Frank wanted to be a Financial Rockstar, he could take the additional $330 and invest it. (If you're thinking "I wouldn't know where to invest", a simple and easy way is to buy a few bank stocks. Most banks allow you to buy stocks through online banking…. Canadian Banks stocks are considered some of the strongest investments in the country! Ask Google, she'll tell you)
Frank’s situation is a prime example of how a refinance can improve someone's finances…. His situation was picture-perfect. In fact, all the factors in his situation were ideal. Admittedly, for a lot of people, a refinance is definitely not worth it. Here are some reasons...
The Fine Print…. (disclaimer).
Frank's penalty was low, less than $2K because he had a variable rate. Penalties are only 3 months interest for a variable rate. What happens with a fixed rate? The penalty is calculated differently (interest rate differential, for my fellow nerdy pals). If Frank had a fixed rate, the penalty would’ve been closer to $10K.
Technically, you can’t put $400 on your mortgage every month. You can only increase your monthly payment by 10-20% (depending on the lender). But, Frank’s new mortgage allows him to pay 20% of balance once a year, so Frank would have to put the $400 in savings every month and make one lump sum payment every year.
The plan is fantastic as long as Frank follows through. If he dips into his "$400/mth Fund" to buy patio furniture or buy a new snowmobile with his newly emptied line of credit, he’ll just end up with more debt, a house that will take 25yrs to pay off and a bigger monthly payment.... this will lower his Net Worth.
Are you debating on refinancing, but aren’t sure if it’s a smart move? I’d be happy to crunch the numbers for you!! Hit the “Contact Me” or “apply now” button.
Wishing you a healthy financial future,
Natalie