Pay off Your Small Mortgage Cheap
By Bob Moeller
WEAC Member Benefits
October 2004
Financial
Planning Seminars
Achieving
Financial Independence
This past summer I met with a large number of individual
members, and it was a pleasure helping them. Several members were carrying
fairly small mortgages and intended to pay them off before they retire
in a few years. Often, their mortgage carried a high interest rate since
refinancing costs prohibited a refinance. I have some suggestions for
reducing the rate of interest the last few years of your mortgage and
for handling the loss of the tax deduction for mortgage interest when
your mortgage is paid off.
First, realize there are many new inventive financing
alternatives in mortgages. Next, realize there are many banks, savings
banks, etc., that are anxious to loan out their money. If they have
little or no risk, they will loan money at very inexpensive rates.
My personal experience is a good case in point. I had
a very reasonable mortgage at 4.5%. However, I concluded that I would
like to pay it off more quickly. This was based more on “feeling
good” after it is paid off than investment logic. Coincidently,
a local bank in Madison had a special deal on a three-year mortgage
(not a three-year ARM, but an actual three-year pay-off-in-full mortgage).
Their deal, in April, was 3.75% with total set-up costs of $161 (the
September rate for the same deal was 4.70%, or 4.45% if you move your
checking account there). I took it. Subsequently, I met with individual
members who might have also benefited from a similar deal, but this
bank didn’t want to offer the product beyond south-central Wisconsin.
So, I talked to WEA Credit Union officials, and they have
agreed to do a similar package with the following terms as of September
15, 2004:
- Three-year payoff first mortgage.
- Maximum loan of 50% of the home market value.
- Interest rate of 4.50%.
- Total cost to set up of $150.
The WEA Credit Union’s five-year rate is 5%, and its seven-year
rate is also 5%, with the same costs. You can check the current rate
and apply on its Web site at www.weacu.com.
Those of you with larger mortgages should be aware that rates have
again come down. The Wisconsin State Journal reports local 30-year rates
as low as 5.625%, with no points, and 15-year rates as low as 5.1%,
with no points. A couple of phone calls to my contacts would indicate
closing costs of about $700 should be available if an appraisal isn’t
required; maybe $1,000 if one is. Remember, closing costs are negotiable.
Here is a quick lesson in one method to help determine whether you
should refinance:
- Take your mortgage balance.
- Multiply it by the difference between your old and new rates.
If the result is at least half of your closing costs, consider refinancing.
Take this example, with a $110,000 balance at the old rate of 6.25%,
new rate of 5.875% and closing costs of $700: The first-year savings
would be roughly .00375 x 110,000 = $412.50. The closing costs would
be saved in less than two years. While this is not a precise calculation
due to monthly principal reduction, it’s close enough to give
you direction.
Low-balance mortgage
If you have a low-balance mortgage, your 2004 interest deductions are
not a lot, and once your mortgage is paid off, you have no interest
deductions. Here is a tax method that might work for you, particularly
if your total itemized deductions are close to the standard deduction
(which, the CCH Tax Manual projects to be $9,700 for married filers
and $4,850 for single filers for 2004). The idea is to alternate years
of standard deduction and itemized deductions, paying property taxes
and charitable gifts (as much as possible) in one year, and using the
standard deduction the next year.
For example: You pay $4,000 per year in property taxes. You contribute
about $1,000 per year to charities. You pay $5,000 in state income taxes.
You have few other deductions. Your total itemized deductions over two
years amount to $20,000.
New strategy for people with relatively few deductions: Hold off on
paying your December property tax bill until the following January and
July. When you get your next December property tax bill, pay it in full
in December of the same year. Your total property tax deduction for
Year One then is $8,000. Also, pay as much as possible of your charitable
contributions that same year (we will assume you can contribute $1,500
this time). You itemize in Year One. Including your $5,000 state income
tax deduction, you might have total itemized expenses of about $14,500.
In Year Two, you take the standard deduction of $9,700. The total for
the two years is now approximately $24,200 instead of $20,000.
In Year Three, you repeat the strategy from Year One, etc.
Check out your old income tax returns first to see whether you benefit
from doing this. For most of you, an extra $4,200 in deductions is worth
$1,050 in tax savings.
Posted September 30, 2004