Yes You Should Refinance. But How?

With mortgage rates dropping like a brick, it’s becoming a no-brainer for us to refinance our home loan. Even though we just got a 30-year loan 2 years ago at 5.875%, we can get 30-year loans now for around 4.5% or lower. You might be in a similar situation.

Rule of Thumb

The rule of thumb I hear thrown around a lot is that if you can drop 1% off your mortgage rate, you should refinance. To get a more precise idea if refinancing is good for you, you should really take into account how long you expect to stay in your home and see if you break even on your refinance costs before then. A good tool for this is the Mortgage Refinance Breakeven calculator found here (thanks MyMoneyBlog).

Breakeven Point on Our Mortgage

I plugged our numbers into the tool:

  • $180k original loan
  • $235k appraisal
  • 5.875%
  • 28 of 30 years
  • income tax rate of 25%
  • $175k loan balance
  • 4.5% new rate
  • 30 years
  • 0 origination and points
  • $3000 in closing costs

The tool tells me that I’d break even on this refinance in 18-22 months. We’d save $177* per month on our payments, and so as long as we’ll be here for 2 years we’ll make up the refinance cost and then some. Since we are planning on staying here for at least 2 years, we should refinance.

* The spreadsheet says $147… must have used slightly different numbers.

Yes But

The only real questions now are (1) should we wait for rates to go lower and (2) what kind of loan should we get.

I’ll avoid (1) for now. I think there is a real chance rates go lower, but I don’t want to be too greedy. I want to take advantage of a good thing while we have the chance. So I’ll assume we can refinance at the current rates.

RE (2): if your home loan situation is anything like mine, you have a lot of options to consider when refinancing. In our case, we have a second mortgage for $30k which is interest only at a rate of prime plus 1% (I think about 4.25% right now). We also have more cash flow than we did 2 years ago and can afford a bigger payment if it means we’ll be paying off the mortgage sooner and saving money on interest rates.

So we have questions like:

  • Should we roll the second mortgage (M2) into the new mortgage to lock in this low rate?
  • Should we get a 20 year loan (at 4.25%) instead of a 30 year loan (at 4.5%)?
  • Should we keep the M2 loan as is and make principle payments toward it?
  • Should we refinance the M2 separately?

A Spreadsheet!

Calculating all of this can make your head explode. I created a spreadsheet that calculates just some of the factors, while leaving others out, and focuses on the most promising options for us. You can see it here: Coleman Family Refinance Options.

The main scenarios I focused on are:

  1. The status quo, i.e. keeping our current loans.
  2. Refinancing just our first mortgage (M1)
  3. Rolling our second mortgage (M2) into M1 (we’d pay PMI for 3.5 years since we’d have less than 80% equity)
  4. Refinance M1 for 20 years
  5. Roll M2 into M1 for 20 years (PMI for 3.5 years again)
  6. Refinance M1 and pay difference into M2
  7. Refinance M1 for 20 years and pay extra $2k/year into M2

The columns of the spreadsheet show:

  1. The scenario #
  2. A description
  3. Rate on M1
  4. M1 monthly payments
  5. M2 monthly payments
  6. PMI payment if applicable
  7. Total monthly payments
  8. Term of M1
  9. Annual Payment
  10. Total M1+M2 debt in 2 years
  11. Total M1+M2 debt in 4 years
  12. Total M1+M2 debt in 10 years
  13. Lifetime cost of loan (rough rough estimate)
  14. Notes

Note on the columns. Some of them are updated when you tweak the numbers, but the 2, 4, 10, lifetime columns were entered by me after running numbers in that break even calculator linked above.

The second table has the same columns as the first, but shows the difference in payments/debt/etc compared to the status quo. So it can tell us how much we’d save (or spend extra) on payments and how much more (or less) debt we’d have after 2, 4, and 10 years.

mortgage-options

There is also a table at the bottom of the spreadsheet showing expected returns if we made monthly investments at a 6% return. This is to help us calculate what we could be making with that extra $147/etc per month if we didn’t use it to pay off M2 or get a 20-year loan.

Some Pre-existing Notions I Had

Before I pull some numbers out and explain how we’re leaning, let me relay a few biases I had going into this.

1. I’m okay with our interest-only second mortgage. At 4.25%, that is a cheap price to borrow money right now. We’re making more than that on our money that we invest in our business and in our retirement accounts. Paying toward the principle on that loan would be like buying a 4.25% bond. Decent return, but not as good as we’re getting elsewhere. So I’m happy to loan at that amount indefinitely basically. However, I do think that rates will go up in the mid-long term. I don’t want to get caught with higher rates that are a strain to pay. Our idea has always been that we would use some kind of windfall (e.g. if we sell one of our website properties) to pay off that loan in one foul swoop. However, we should at least consider somehow locking in a rate for this.

2. I’m against paying PMI in theory. (That’s why we got a second mortgage before instead of one loan with PMI.) If you have the credit, other options are probably better for you. Some good info on PMI here.

Findings From the Spreadsheet

The key columns to focus on to compare options is the Annual Payments and the difference in debt in years 2, 4, and 10. The second table shows the difference in these numbers compared to the status quo. And so I can see that if I go with option #2 (refinance just the 1st mortgage), we’d save $1,764 per year and have $5,966 less debt/more equity after 10 years. If we held the loan the whole 30 years, we’d pay $21,985 less.

Now if I rolled M2 into M1 and payed PMI, we would still save $435 per year ($1,500 per year after 3.5 years) and have $12,538 more equity after 10 years since we’d in effect be paying principle on that M2 now. However, we would spend an extra $3725 or so on PMI those first 3 years, and sometimes it can be difficult to get PMI removed once you do have enough equity in the house. Overall though, it seems like using our savings from the refinancing to pay down M2 is a good use of our capital. It lowers our debt risk in the future.

You should be reminded here that not only do we have $5-12k more equity after 10 years, we could have invested the saved payments to have an extra $18-24k in our retirement accounts. Refinancing really is a good deal.

One option I really wanted to calculate was keeping our interest-only M2 and making principle payments to it instead of rolling it into the new mortgage or refinancing on its own. This would avoid PMI or additional refinance options. If we are disciplined, we can pay off M2 just as fast… but we’d also have some flexibility if we needed some monthly cash flow. Scenario #6 lays this out. We would end up paying as much per month/year as we do now. So no savings there, but we’re really okay with our current payments. We would however have an $31,336 less debt across both mortgages.

Scenarios #4, #5, and #7 basically come down to paying a little bit (or quite a bit) extra per month in exchange for less debt in the future and less interest payments over all. One nice thing about these plans is that 10 years out, we could have nearly $50k in equity built up in the loan. Combined with an appreciation in home value (I know, but we’re talking 10 years from now… let’s hope) we could have a nice size chunk to use as a down payment on a larger home.

Summary

I’ll let you know what we decide when we go through with things. I think I’m leaning toward refinancing just the first loan and making principle payments on our second mortgage/line of credit. Some things we need to think about:

  • Can we really get 6% on investments on money saved? 4.25-4.5% might be a good return for our extra cash in this market.
  • What is the risk that interest rates go much higher in the future, raising our minimum payment on M2?
  • What do we want our debt situation to be 2, 4, 10 years from now?
  • Can we really get the rates/fees I’m assuming here? 😮
  • Are deductions for interest payments, reductions in PMI or M2 payments, or other things I’m leaving out important?

I hope this helps people in a similar situation as me. And as always, I appreciate any feedback or advice you might have based on this. Cheers!

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“Payback Time” Analysis for GOOG

Image representing Google as depicted in Crunc...I still own a few shares of GOOG. It’s felt overpriced recently, but I’m holding onto a minimal amount at all times and trying to add more over time. So I’m hoping the price drops a bunch so I can pick up more cheaply.

Do a search here for GOOG for my previous thoughts (years old), but I basically think that the world will continue to be drowned in data. Google’s goal to organize the world’s information and their expertise at scaling Internet apps puts them in a great position to be a contender in just about any future technology.

Phil Town Payback TimeAnyway, I’ve recently read Phil Town’s new book Payback Time. The title there, like most investing books lately, takes advantage of the recent drop in the stock market to entice readers. However the content and tone of the book isn’t as whiny as you might think, and is generally applicable to investors in all markets.

We were big fans of the first Phil Town book, Rule #1, mostly because it described things in layman’s terms and gave readers a clear method for putting the books theories into practice.

Payback Time works the same way and repeats a lot of the ideas in Rule #1. There are still the 4 M’s (Meaning, Moat, Margin of Safety, and Management) for example, but instead of using technical analysis (in the form of Rule #1’s red/green arrows) Payback Time recommends a form of dollar cost averaging, Town calls “stock piling”.

Of course, Town has a section in the book titled “Why This Isn’t Dollar Cost Averaging” that I’ll try to summarize here. Town says (emphasis his), “DCA means investing a fixed dollar amount at fixed intervals no matter what the price of a given stock.” He then goes on to list the numerous flaws and criticisms of dollar cost averaging.

For further reading, Christian writes why you should consider “Averaging Down“, and here Steve “The Undertrader” describes his stockpiling-like investing style.)

So Town calls stockpiling “DCA with a brain”. You don’t buy any time or on predefined schedules. You buy when the stock price is within your Margin of Safety. And you don’t hold indefinitely. You sell if the stock price goes about your Margin of Safety.

I’ll buy that. And I like this a little better than using “the tools” or “the arrows” or technical analysis to judge a stock because it’s one less thing to calculate. If you are calculating a “sticker price” and MOS price anyway, might as well use them to trade. If you thought of stocks as commodities or discounted dollars, this kind of trading would make even more sense. I value $1 at $1. If the market is pricing it at $0.80, I buy. If the market is calculating it at $1.10, I sell. Sure I could have waited for the price to drop to $0.70 before buying, or $1.20 before selling. I would have made a better trade, but I’m always making a winning trade if I buy when the price is lower than what I value it at (plus my MOS) and sell when the price is higher than I value it at.

So the Payback Time strategy should be a little easier to follow than the technical analysis from Rule #1. Well, to a certain extent. Town introduces another calculation called “the payback time” (maybe that’s the true meaning of the title) to pretty much calculate the MOS from a different angle. And he brings technical analysis back in, talking about support and resistance levels. Here’s a good recent analysis from Hipegg on Google.

Alright, so that out of the way, let me share some of my calculations on Google stock (GOOG). I’m basically running through the Payback Time Spreadsheet found on the Payback Time website. It’s a handy tool.

Here I would want to do a large Google Moat analysis, but I’m lazy. So I’ll say hey, they have a huge margin and virtual monopoly in search. And while there stance is vulnerable (MSFT is gaining ground lately), this moat is fairly stable because (1) it takes a lot of knowledge and investment to serve billions of searches a day quickly and (2) advertisers and publishers benefit from consolidation and drive the market towards one winner.

Charlie Munger and Warren Buffet at Berkshire Hathaway like Google’s moat. Not sure if they are investing. Buffet shies away from tech.

Here I would want to do a large Management analysis, but I’m lazy. I’ll say hey, these guys strive to do no evil. Page and Brin seem like great folks who are in it for the long term. They are standing up to China vs. going for short term profits. They don’t fudge their numbers (other than tweaking the Adsense lever). They don’t mess around with finance gimmicks like splits, etc. They are smart and clearly have a better understanding of the future than the average C-Level exec.

Some numbers:
* 5 year EPS Growth has averaged 34%.
* 3 year OPS (operating cash flow per share) Growth has averaged 17%.
* 5 year Sales Growth has averaged 40%.
* 5 year BVPS (book value per share) Growth has averaged 58%.

Nice all around. You usually want to go as far back as you can on these numbers. We can’t go much further back than 5 years because Google only started trading in 2004. If you wanted to be more conservative, you could use more recent (last 2-3 years) numbers since Google basically went from nothing to a top 10 company in 2 years and since then has grown a little slower.

Some more numbers:
* ROIC (Return on Invested Capital) = 18%
* ROE (Return on Equity) = 18%

Nice again. BTW, you can get some of these numbers in chart and spreadsheet form at YCharts.

Google has no debt!

Now, let’s calculate a sticker price and MOS.

* EPS = 21.97 (according to Yahoo)
* Earnings Growth = 14% (That’s my number. Historically we’re looking at 34%, and analysts are estimating 19% for next year. Should do more “main street” analysis of this considering how large Google is.)
* Future P/E = 24 (that’s about average for Google. 2x earnings would be 28)
* MARR = 15% (This is my “minimal acceptable rate of return, i.e. I want to make at least this much per year)
* MOS% = 25% (Ideally you would want 50%, but that is hard to get with GOOG and I’m pretty confident in them.)

I get MOS numbers then like:
* EPS = 21.97
* EPS in 10 Years = $81.45
* Stock Price in 10 Years = $1,954.74
* Sticker Price Today = $483.18
* MOS Price = 3/4 = $362.39

So according to this, I am a seller above $483.18 and I am a buyer under $362.39.

For completeness, here is the Payback Time Analysis using these numbers. To recoup my investment in 8 years, I’d want to buy GOOG at $331.43. That basically means that if you bought all of GOOG at $331.43, you would earn that back in Revenues (assuming our growth numbers) in 8 years. That would be a good investment if you were buying a franchise, and should be a good investment when buying stock as well.

I hope this was informative. Feel free to pick apart my numbers. In particular, I am always interested in pondering what a company that grows at 14%+ for 10 years would look like in the future. I’ll do that in a future post.

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Goldman Sachs Traded Profitably EVERY DAY Last Quarter

From DealBreaker.com (via CrossingWallStreet):

Goldman Sachs just revealed in an SEC filing that its traders made money on every single trading day last quarter, a record for the firm. Net revenue for trading was $25 million or higher in all of the first quarter’s 63 trading days with 35 of those days bringing in more $100 million, according to the filing.

That’s pretty amazing. They didn’t have ANY down days? How is this possible? Is the new Goldman Sachs playing it safe? I thought they were doing high risk trades? Were they just lucky? Do they have one big positive trade making up for the losses? Are they rigging the game?

I think this is the graph from the filing that the original posters are referring to.

The following chart sets forth the frequency distribution of our daily trading net revenues for substantially all inventory positions included in VaR for the quarter ended March 2010:
gs-trading-revenue

As part of our overall risk control process, daily trading net revenues are compared with VaR calculated as of the end of the prior business day. Trading losses incurred on a single day did not exceed our 95% one-day VaR during the first quarter of 2010.

I had forgotten what VaR stood for; it’s “Value at Risk”. Thanks, Wikipedia.

Also of note to me is how pro-Goldman the comments seemed at the end of the DealBreaker post. There are likely a lot of traders/investors in the mix who seem to think that if you are smart enough to make money, you deserve it… perhaps a little naive (even at this time?) that people in power wouldn’t take unfair advantage to make money.

I don’t want to imply that Goldman is for sure doing something illegal or immoral, but I think it is okay to be a little skeptical and think about it. I do think it is also very possible that Goldman Sachs is just doing well like most other people’s portfolios were before last week.

But I would be interested in hearing people’s intelligent thoughts on how their trading activities could go 90 days without a single down day.

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NASDAQ Cancelling Trades After Crazy Day in The Market

Trying to figure out what to think about this: (from BusinessWeek)

The Nasdaq said after markets closed that it will cancel all trades of stocks that moved more than 60 percent from their price at, or immediately prior to, 2:40 p.m., when the slide started. The cancellation applies to trades executed between 2:40 p.m. and 3 p.m.

Were there true “errors” leading to these trades (e.g. running trades that weren’t placed, or trades triggered because a stocks price was listed incorrectly)? Or were there just a bunch of people with stop losses and automated programs setup to sell sell sell?

I get the sense that some folks with trigger fingers on the sell button are getting a chance to renege since the market ended up down “only” 3.2%. If I was one of those guys with a standing order to buy QQQQ when it was down 30% or whoever was on the buying end of things as the market tanked… and NASDAQ reversed my trades… I’d be pissed.

Should we have a market that steps in and slows things down or puts a halt on things when there is a panic? Maybe. I guess these things are almost due to an “error” and we don’t want to compound misinformation. But part of me things we’re letting some folks off the hook when stuff like this happens. You shouldn’t be able to have it both ways… have your automated algorithms buying and selling, but then vrwvrwvritvrit-reverse when you accidentally sell too soon.

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