Q: I have a mortgage on a rental property in the amount of $17,000 at 7.0 percent. Refinancing would be no problem, as this is my only debt. My question is: Is there any way to lower this interest rate without the expense of a new appraisal? I think the expense of the appraisal would wipe out any savings I'd get from the interest rate, and I plan to pay off the mortgage in 18 months.
A: This kind of question is important, because it highlights the difference that sometimes exists between the theory and the practice of financial management.
On paper, of course, refinancing at current mortgage rates would be a no-brainer. In contrast to your 7.0 percent mortgage rate, current mortgage rates are below 4.0 percent even at a thirty-year term. For your purposes, given the short repayment period you have in mind, you could probably get a shorter-term loan with a mortgage rate below 3 percent.
Again, sounds good on paper, but what's different about your situation compared to most mortgage discussions is your relatively low principal balance. In the greater scheme of things, this is a good "problem" to have, but it does reduce the savings available to you by refinancing. You would pay about $958 in interest on a $17,000 balance over 18 months at 7.0 percent, and about $407 at 3.0 percent. It's easy to see how the various costs involved in processing a new mortgage could eat up the $551 differential.
The answer, then, might lie in a different approach. Under the circumstances, it might be worth dipping into a savings account to pay down your principal, if you have some kind of savings available. Of course, ordinarily it is good to keep some savings liquid in case you have an unexpected need for money, but there are three reasons it might make sense for someone in your situation to use savings to pay off some or all of the mortgage principal:
- You can rebuild this savings in 18 months or less, since that is the period over which you would have been making a similar amount of mortgage payments.
- Since you have no other debt, you could use a credit card for any emergency liquidity needs. This would not be a recommended long-term strategy, but as a short-term back-up in your situation, it seems viable.
- The interest rate differential is even more compelling than the case for refinancing. Why hand a bank 7.0 percent on your mortgage while earning less than 1 percent (the rate on most savings accounts these days) on your savings?
If you don't have any likely liquidity needs for your savings in the next 18 months, this is a solution worth considering.
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