When to Refinance Made Stupid

Imagine that you did not know all you should about the ins and outs of mortgages. It is not that hard to do. Try. Now suppose you searched the web for a good place to learn about mortgages. A place where you could trust the NYTimesBldgByLuigiNovi-Nightscream source. Not some dumb blog. Someplace prestigious and maybe even a specialist on the topic.

How about the New York Times’ weekly Mortgages column? The Times is as august and authoritative as you can get in the old media world. And real estate has been an obsession for New Yorkers for as long as anybody can remember. (Rome has a foundation myth involving twin orphans and a wolf. New York’s centers on buying Manhattan really cheap. Tells you something.)

Vickie Elmer writes the column for the Times on mortgages every Sunday. It appears to be all she does there, and it is reasonable to suppose that it is her full time job. So she must be an expert. This must be the place for the confused to learn about mortgages.

I would not have brought it up if it were. To be fair, I have no place else to nominate, but last week’s installment of the Mortgages column leaves me wondering if maybe living in ignorance is preferable.

The topic was a relatively basic one in the mortgage area: when should a person refinance? It is the sort of thing you would assume that Elmer would rehash often enough that she would have it down pat by now. Alas, no.

She gives a few reasons why a person might not refinance. The one she discusses the most, spending about a fourth of the column on it, is the misbegotten idea that you should not refinance if your current mortgage is old enough that your payments contain relatively more principal and less interest.

Quoting a woman identified as a “financial planner in Manhattan”:

“When you refinance, you’re not building equity,” Ms. Walker Hartwell said. “You’re starting at the beginning” of the amortization tables.

This is staggeringly, eye-rollingly, jaw-droppingly, and you’ve-got-to-be-kiddingly dumb.

To begin with, the idea seems to assume that paying off the principal of the mortgage is some kind of special privilege that you earn from making payments for a few years. This is not so. You can pay off principal any time you have some cash you feel like sending in.

In fact, if you refinance you will have a lower monthly payment and will have some more cash laying around that you could, if you so chose, use to reduce your principal. A person with a flair for tidiness might just continue to send in the old higher payment every month on the new mortgage. That will pay down the principal faster than sticking with the old one, guaranteed.

But that would only make sense as advice if you took as given that paying down principal was a good thing. Elmer and Walker Hartwell appear to be confusing building equity in your home with building wealth. As if taking $1000 in cash and paying down your mortgage by $1000 makes you richer. Of course it does not, at least not in the short run.

Moreover, interest rates are now so low, and the whole point of the exercise is to get yours even lower, that paying down any more principal than you absolutely have to is likely a bad idea. Particularly if the interest is tax deductible and you are in the 25% bracket or worse, which I think describes most homeowners. An after-tax rate of 3% is not atypical, and that is remarkably cheap money, likely once in a lifetime cheap.

Even taken a face value, the effect that Elmer is talking about is trivial.

[The amortization effect is] “very important,” said Edward Ades, a partner in Universal Mortgage in Brooklyn. He noted, for example, that in the first year of a $300,000 30-year mortgage at 4 percent, a borrower would have paid off 1.76 percent of the balance; in the fifth year, that rises to 2.06 percent.

0.3% of $300,000 is $900. A person is supposed to hold off on refinancing because of the golden opportunity to pay off $900 in principal over the course of a year? This is more attractive than lowering your interest rate by, say 0.5%?

Indeed, this is so unconvincing as an argument against refinancing that I am pretty sure Mr. Ades, a broker who makes money if people refinance, is having a little fun with Ms. Elmer.

Happily for her, she and her editors are not in on the joke. Too bad about the readers.

[Photo: Luigi Novi – Nightscream]

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