Recently, one of our team found themselves considering a radical solution to saving money. Spoiler: It’s not that radical; it’s actually downright sensible.
After weeks of consideration, he signed on the dotted line and refinanced his apartment, promising the bank to pay back a huge amount of money in exchange for a cash injection into his bank account now.
So why had he done this? After much consideration, examining spreadsheets, and thinking it over, he knew this was a good idea. The process can seem daunting, and seeing the total amount of money owed to the bank looks horrifying. Still, under certain circumstances, it makes complete sense to release equity in your home by refinancing.
So why did he do this? There were several aspects to the process. Firstly, he could secure a better mortgage rate, thereby reducing the amount of interest he was paying each month. Secondly, he received an additional loan amount, added to the repayable mortgage amount, as an equity release. This means that the bank agreed to lend him more money because his property had gone up in value over the previous few years.
Including the money he took out, his total monthly interest payment went down! Essentially the bank gave him free money in comparison to what he was already paying back monthly. These additional funds are going to be invested, along with his monthly savings.
So the real estate market in many countries has been a massive expansion in the last couple of years. While not everywhere can see the gains of New York, London, or Paris, it’s generally a golden rule that property always goes up in value. That rule is likely to remain while pressure remains on the stock of available properties.
Even in times of depression on the housing market, you still don’t lose out. If your property drops by 40% in value, so too does the rest of the market. If you have liquid funds available, this is the perfect time to swoop in and buy the most expensive property you can afford, as housing prices, historically, have always rebounded.
Out With the Old, In With the New
The original mortgage had a discounted fixed rate for the first few years, but it switched to a variable rate at the end of the discount period. At the time of remortgaging, the rate was 5.25%.
By refinancing, the new mortgage rate is 2.25%, fixed for 15 years. This 3% rate is simple to understand monthly saving.
By borrowing an additional $30,000, our colleague is back to spending the same every month for his mortgage, but that money is now free to be invested.
Suppose you brought your house several years ago, hope online, and check out the sales prices of your nearest neighbors. There are sure to be a few representative sales of similar properties that will help guide you to gauge the current value of your property. You’ll see that your house price appears to have gone up. This is house price appreciation.
It is this incremental increase in price that allows refinancing of your mortgage. Essentially, the difference between what you owe the bank and what the house is now worth is the amount of capital you possess. The more capital you have, the safer the risk you are for a bank, therefore allowing them to loan you more.
Why This Was a Good Idea
So many people will say taking out loans to have the capital for investments is a bad idea. Generally, we agree with them, but there are always exceptions. If you can borrow money at a super low-interest rate and reinvest it in a significantly higher rate investment, that is one of those times an exception can be made.
Be aware, the following section contains a lot of numbers. Nerds will be happy.
Comparing Before and After
When comparing the before and after scenarios, we would want to look at the interest our colleague was paying on his original loans and the interest he is paying now. If we compare those, we get the following result.
Straight Forward Calculation
|Amount||Interest Rate||Yearly Interest|
As you can see, when looking just at the raw interest rates, he is essentially being paid by the bank for taking out additional capital.
Of course, the world is never as straightforward as this. We have to take into account tax deductions on the interest paid and the net fees for refinancing. If we incorporate those, we get:
|Amount||Interest Rate||Yearly Interest||Remarks|
|149,800||1.14%||1,708||Applied 40% deduction|
|8,700||2.04%||177||Applied 40% deduction|
|158,500||0.85%||1,1331||Applied 40% deduction|
|29,000||1.40%||406||No deduction on secondary mortgages|
|29,000||-0.51%||-148||Less profit but still the bank pays me while handing over money|
|Net interest saved over 6 years (fixed rate term)||-888|
|Net refinance fees and costs||1,200|
|Total net costs||312|
|Net costs per year||52|
|Yield on 27,800||0.19%|
|Break even 2nd mortgage||1.46%|
That means that he will have to make an easily attainable 0.2% interest on the money to break even with the original mortgage after considering any tax-deductible interest and the refinancing fees.
Worst Case Scenario
The worst that can happen is that both stocks and apartment values will decline during a market crash. If that were to happen, our colleague would have to stay put. Making the monthly payments would not be difficult, but moving house might be harder for a few years. Anyway, like us, he has an emergency fund in case things go south.
With the money in the bank as of last week, all our newly minted friend has to do is buy us a round of drinks and then invest the rest in the highest yield account or investment vehicle he can find. Check out our investment strategy for how we’d do it.
Do you consider refinancing your property too? What are your thoughts? Please let me know in the comments below.