Mortgage Fun

You currently have a $200,000 mortgage with 2 years left on your 5 year fixed rate mortgage at 5.3%. You are in year 18 of a 20 year ammortization.

You are considering breaking your mortgage and refinancing at the currently lower rate. The current 5 year rate is 3.7%

Your bank will charge you a penalty if you break your mortgage however.

You could wait 2 more years for your current mortgage contract to expire and then get the lower 3.7% but that means you will pay more interest for the next 2 years. (assume the 3.7% will still be available in 2 years)


What is the maximum amount of penalty charge that you still save money by breaking your mortgage?

Originally posted by uzless
You currently have a $200,000 mortgage with 2 years left on your 5 year fixed rate mortgage at 5.3%. You are in year 18 of a 20 year ammortization.

You are considering breaking your mortgage and refinancing at the currently lower rate. The current 5 year rate is 3.7%

Your bank will charge you a penalty if you break your mortgage however.

You could ...[text shortened]... hat is the maximum amount of penalty charge that you still save money by breaking your mortgage?

Just to clarify:

1. Was the original mortgage for $200,000 total, or is there $200,000 remaining on the mortgage at this point? If the original mortgage was for $200,000, I'll assume the interest rate was always 5.3% for simplicity.

2. Was the original amortization period for 20 years, and you're now extending the total amortization period by 5 years (with the new mortgage lasting 7 years from the 18-year mark given), or was the amortization period always 25 years? If it was originally for 20 years, the mortgage will be paid off if you continue for 2 more years so there's no need to re-mortgage at 3.7%.

Originally posted by PBE6
Just to clarify:

1. Was the original mortgage for $200,000 total, or is there $200,000 remaining on the mortgage at this point? If the original mortgage was for $200,000, I'll assume the interest rate was always 5.3% for simplicity.

2. Was the original amortization period for 20 years, and you're now extending the total amortization period by 5 years (wi ...[text shortened]... will be paid off if you continue for 2 more years so there's no need to re-mortgage at 3.7%.

1. You have 200,000 remaining on the mortgage

2. Your original mortgage was ammortized over 20 years. You are in your third year, so there are 17 years left.

You are considering breaking your current 5 year fixed mortage and replacing it with a new 5 year fixed mortgage

(My bad)

Took a shortcut here using a variable rate mortgage calculator spreadsheet I made a few years ago, but the calculations are relatively simple once you get the cash flows in place.

Scenario 1
Hang on to your current mortgage at 5.3% for the next 2 years, then switch to the 3.7% mortgage for the next 5 years. Assume an average interest rate of 4%-5% for the remainder of the amortization period (last 10 years of the mortgage).

Scenario 2
Switch to the 3.7% mortgage now for the next 5 years, incurring an immediate fee "F" to break the mortgage. Assume an average interest rate of 4%-5% for the remainder of the amortization period (last 12 years of the mortgage).

I ran both scenarios twice, assuming 4% for the average interest rate after the current mortgages, and then again using 5%. In each run, the mortgage amount was $200,000 to start, amortized over 17 years, with 12 monthly payments per year.

Results


Scenario 1 at 4%:

Total Payment $278965.66
Total Interest $78965.66

Scenario 2 at 4%:

Total Payment $273257.07
Total Interest $73257.07

F = $278965.66 - $273257.07 = $5708.59


Scenario 1 at 5%:

Total Payment $286721.78
Total Interest $86721.78

Scenario 2 at 5%:

Total Payment $284178.55
Total Interest $84178.55

F = $286721.78 - $284178.55 = $2543.23


So, depending on how you think interest rates will behave in the future, the mortgage breaking fee is worth somewhere between $2500 (if you think rates will remain lower for a long time) to $5500 (if you think they'll drift higher) to you.

In the previous calculation, I didn't include the fee as part of the mortgage amount (which I understand banks do so the home owner doesn't have to pay the fee in cash). Adding this back in and using an iterative method, it looks like the range is now between $2000 (higher future interest rates) and $4500 (lower interest rates). Same ballpark, but slightly more cramped.