Vail Daily column: Considering compounding interest
Ryan Summerlin February 1, 2013
Unless you have been hiding under a rock for the past two years, you are well aware that mortgage rates have broken historical low levels time and time again. If you are a homeowner with a mortgage, you have most likely refinanced your mortgage at least once if not more than once in the past few years. You may be in the midst of or contemplating another refinance at this very moment.
As a mortgage professional, I have many clients and potential clients in this exact scenario of contemplating a refinance. The process can be long and arduous. Mounds and mounds of paper work are now required. Property valuations can be tricky and potential deal breakers. Government programs may have to be utilized. All said and done, the process can be more than a lot of people want to deal with, and I do understand that. While there are numerous ways to analyze the pros and cons of a refinance, let’s consider compounding interest.
For simplicity sake let’s assume a borrower saves a mere $150 per month by refinancing a $350,000 loan from a rate of 4.25 percent down to current rates of 3.5 percent on a 30-year fixed. For now, let’s not get too caught up in the borrower’s ability to complete the refinance, but rather let’s focus on the $150 per month savings. While any one of us would certainly like an extra $150 a month in our pockets, the number is not necessarily that staggering. Maybe the monthly savings are just not quite staggering enough to make some borrowers want to go through the entire loan approval process.
However, by analyzing potential compounded interest earned on that $150 per month, one’s thought process may change a little. Let’s assume the borrower sets up an auto-payment for that $150 per month to go in to a retirement account such an IRA. If the borrower keeps the $150 per month going in to the IRA account, at the end of 30 years the balance would be $54,000. It should also be noted that once the borrower reaches a certain age (59 1/2), withdrawal of money from the Roth IRA can be done without tax liabilities.
If the $150 per month, or $54,000 total investment at the end of 30 years, were to average a yearly return of say 4.5 percent, the account balance at the end of 30 years would be significantly higher. The balance at the end of 30 years would be close to $175,000 due to the interest being compounded. Compounding interest is a powerful tool. Refinancing a mortgage in order to utilize monthly payment reductions is one way to access the full benefit of an investment with compounding interest.
As I have written about in previous columns, a mortgage is no longer a debt against one’s home. In the current complex financial environment, a mortgage can prove to be a key piece of one’s overall financial plan. This is especially true when interest rates are at historical lows and for all intensive purposes below the annual rate of inflation.
There are numerous ways to consider the finances to determine if refinancing a mortgage is in one’s best financial interest. Utilizing a tax free investment with compounding interest is just one of the many.
William A. DesPortes of Central Rockies Mortgage Corp. can be reached at 970-845-7000, extension 103, and firstname.lastname@example.org.