When I purchased my home two, nearly three, years ago, I had a great interest rate of 5.75%. With the recent Fed rate cut of 0.75%, a question that has been swirling around the heads of my friends has been whether or not they should be refinancing. Some of them have loans at higher rates or HELOC’s and 2nd mortgages at higher rates - for them the analysis is worth performing. As for us, with the Bankrate quoted rates at around 5.40% for a thirty year mortgage (under 5% for a 15 year mortgage), the answer for us is unclear… this calls for an analysis!

Comparing Total Interest Payments

The current outstanding balance for our mortgage loan is approximately $224k and, given minimum payments for the remainder of the loan, puts us on pace for paying out a total of $217k in interest and $224k in principal. The $224k in principal is given, what interest rate do I need in order to pay less than the $217k in interest? According to the calculators at Dinkytown.net, the answer is approximately 5.16% on a 30 year mortgage. This analysis does not include closing costs, some of which I would be responsible for even if the lender paid for the closing costs (at the very least, I’d have to pay the scam that is title insurance). In actuality, on a 30 year mortgage, I would need something that’s slightly less than 5.16%.

Lower Monthly Payment

Another consideration, if I were to get the break even mark of 5.16%, my payments would be $1,200 for 360 months - approximately $200 less than our current payment. If I felt that the extra cashflow was necessary, I would definitely go for a refinance if the numbers were right. As it were, we are currently paying extra each month (approximately $300) so that the 30 year mortgage is closer to a 15 year mortgage. Having a lower payment but paying more gives us the flexibility to treat it like a 15 year mortgage but only be obligated for a 30 year, should our cash flow situation tighten up.

What If? The 15 Year Mortgage

What if we went with a 15 year mortgage? Let’s say we could get a 15 year mortgage at 4.875% (Nickel just locked in this rate) on my balance of $217k. The monthly payments would increase to $1750 each month (or $150 less than our current actual payment) but the total interest paid would plummet from $190k (the amount given the $300 extra paid) to $92k, nearly a hundred thousand dollars. Am I willing to save $100k (it’s really only a $75k savings given taxes) and lock in the $1700 per month payment? That’s a much harder question to answer.

Summary

Refinancing to a fixed 30 year mortgage doesn’t appear to be make much sense but refinancing to a fixed 15 year mortgage, given our extra principal payments, looks to save us $75k over the loan period. These all assume that there will be no closing costs but would I be willing to pay a little extra in front in order to get some savings in the long run… perhaps. I have to think about this some more, please share your thoughts in the comments and please tell me if I’ve done my math wrong!

Next Steps

I think the next step for me is to take a look at Lending Tree, where I like to go to get a quick snapshot of what’s available. When I bought the first time, I used Lending Tree to get a pre-approval letter and to help me get a better handle on what rates would actually be for me. They gave me a good snapshot, so I’m going to use them again to get a feel for what’s out there.

A little while ago I talked about how my hot water heater was old and I didn’t know when the bad boy was going to go out. Perhaps it would go this year, perhaps next year, or perhaps after I’ve sold the home. That’s when someone suggested that I preempt the water heater and replace it early so I wouldn’t have to deal with the headaches. While I’m not ready to replace it just yet, I did begin researching my options so in case it does go, say tomorrow, I’m prepared for it.

Cost?

I called up BGE and they gave me a quote of $755 for installation of a Rheem 50-gallon electric water heater with a 12 year warranty. It’s only $655 for the same heater and a 8 year warranty, $605 for a 6 year warranty. Comparatively, the water heater itself sells retail for $249.99 for the 6 year warranty version ($349.99 for the 9 year warranty). $355 for installation on the six year warranty version? Seems a little pricey.

Why Should I Replace Early?

To answer those who would say replacing a hot water heater early would be somewhat of a waste, I think that in this case it’s not that bad of a decision because of the possible consequences. At best, we are without hot water for a couple days until someone can come out to repair or replace it. At worst, one of the metal fittings (or something else) bursts, flooding my basement with water. The worst is pretty bad because we just installed carpeting outside the undeveloped room that houses the heater, preempting a burst like that would be good if I could see the future.

Another case for replacing is that newer water heater models are more energy efficient than older models. I read off the Energy Star label that the unit takes about 6450 kWh of power a year, which costs $129 at 2 cents a kWh (I had to throw that in there because that’s what the label said!). We pay approximately 10 cents per kWh so our annual cost to keep that baby running is $645. The estimated annual operating cost of the 50 gallon Rheem electric water heater, according to the Rheem brochure, is a little lower at $402. I could drill down and get an estimated kWh figure (maybe I was too lazy) but based on the brochure and the EnergyStar label on my water heater, it appears the difference is approximately $243. That means that the replacement would pay for itself in under three years of use.

Tankless Water Heaters

A tankless water heater would’ve been a great option if it were available for us via BG&E (they only do gas tankless). Tankless water heaters are generally more expensive fixed/up-front but have lower operating costs since they have to keep a huge container of water hot for instant use. I didn’t do much research into this area, and I may in the future, because BG&E didn’t offer it. Electric tankless water heaters do exist though, so if you have experience with them or have done the analysis yourself, please do share because I’d be very interested to see it.

A reader recently sent in a question on how much it really costs you to contribute to your 401(k). I’ve always advocated that you contribute to your 401(k), regardless of whether your employer offers a match, and I will continue to advocate doing so until something drastically changes in retirement planning. Now, the reader was actually in a discussion with someone else about how your contribution to your 401(k) was cheaper than it’s actual dollar cost to you, at least initially, because of the fact that it’s pre-tax. So, let’s cover the basics and give our friend some ammunition to go back to the debate stand.

First off, it’s cheaper initially because you don’t pay tax on the funds yet. So, if you’re in the 25% tax bracket, when you contribute $100 it’s really only $75 out of pocket for you. On that basis alone, I think most would accept the argument that your 401(k) contribution isn’t as expensive as one may expect looking at nominal dollar amounts. However, let’s look at it from a different perspective, from the cost of the tax being paid (either today on non-contributions or tomorrow on appreciated 401(k) assets).

However, let’s actually compare the cost today ($25) versus the cost of the taxation in the future, given a few assumptions. First, let’s assume your money earns a reasonable 8% and inflation is a healthy 4%. Let’s also assume that your tax rate remains 25%, which is probably the most risky of the assumptions. Given the growth rate of 8%, your $100 in 40 years will be worth $2,172.45. If you tax that at 25%, that’s a tax of $543.11! $543.11 is much more than $25 right? Well, that’s $543.11 in 2047 dollars, which is only $113.12 in 2007 dollars. But isn’t $113.12 over four times more than $25? Yes, but that’s $113.12 you don’t pay today, you pay that in 40 years… the time value of money makes $113.12 in 40 years worth only $23.56 today (given the same 4% rate used for inflation). So you get more money and you pay less tax in the future, not bad!

I bet you didn’t think calculating post-tax 401(k) contribution costs could be that involved huh?

(Someone please check my math, I don’t make a habit of calculating 401(k) numbers so I could’ve gotten something wrong)

My friend received a flyer in the mail the other day from Hawkins Electric Service, Inc. about a product that could save him “up to 25% on [his] electricity bill without changing [his] lifestyle.” Apparently, all American homes poorly handle inductive loads and thus lose much of it without even using it. Inductive load is required on anything that runs on a motor and those motors require an amount of non-working reactive power to create an electromagnetic field to operate. Your electric company delivers this reactive power to your home without much knowledge of how much you’ll need and then your motor-equipped appliances draws on what it needs to operate. The excess is sent back to your box and is lost as heat, this loss is called I2R loss or line loss. The idea is that you’re paying for this I2R/line loss when you could’ve installed the Power-Save 1200 (the product that can save you up to 25%) and have it capture this power for later use.

My friend and I are both skeptical about the $300 product because neither one of us really buys the fact that we lose that much electricity in the form of line loss (I would agree that some loss occurs, but 25% of my electricity disappears as heat? I’m not sure). In a pretty exhaustive search online, I couldn’t really find much information discussing the recapture of unused load (there was a lot of other information about recapturing energy, but nothing on electricity in the home).

Phantom power drain: One interesting thing I did find was that a study by the Energy and Resources Group at UC Berkeley and the Energy Analysis Department at Lawrence Berkeley National Laboratory showed that in a study of ten California homes (yes, it’s a small data set, but what can you do), the total standby power used by each home ranged from 14W to 169W, the average being 67W. This corresponds to 5-26% of a home’s annual energy use. This power use is generally called phantom power drain and seems like an easier target for a savings of “up to 25%” than a $300 unit attached to your power box.

Lastly, somewhat related to this topic is the idea of energy saver systems for the induction motors themselves, because as they operate they lose a bit of the energy as heat depending on their efficiency. I discovered this extremely technical analysis on energy saver systems for induction motors that covers the marketing idea of making a particular induction motor driven item more efficient. Ultimately I believe the article is saying that they’re not worth it.

Anyone do any research on this idea of recapturing unused electrical load?

A few years ago, it was a seller markets. In the Baltimore area, a home would list on Friday and a contract would be signed on a Monday. At the latest, it took until a Tuesday until it was finalized as buyers would compete with each other to get the house. List prices were the starting point, not the ending point, and if you really wanted a home you’d have to pay top dollar. The home I now own was listed at $270,000, I paid $295,000, and a competing buyer offered as much as $330,000 for the home*.

Today it’s totally different. I believe that right now, and for the next six months, you’re seeing the lowest point for sellers from a psychological perspective. Whether or not the housing market is actually at the bottom of the valley remains to be seen but I think we’re at the lowest possible point a seller can be and still keep their home on the market. If the market gets any worse, you’ll probably see any optional sellers, those that don’t have to make a move, pulling their homes off the market if they haven’t already. Homes that have languished on the market for months will probably slide a few renters in to tread some water and those foreclosures? Scooped up by opportunists or just left sitting on a bank’s balance sheet.

Why do I believe that we’re at the low? The stats don’t lie and there are only so many punches you can take. Home prices take the largest tumble in 25 years? Homeowners and builders offering all sorts of freebies like leases on cars and free appliances. I mean it’s so bad that the government is stepping in and thinking about freezing ARMs in order to stop the bleeding. Oh, and to pile on even more, it’s now winter which has historically been the slowest season for home sales.

If I were in the market, I’d probably turn to new constructions first because builders need to move inventory. They aren’t like regular sellers where they can opt to just live in the house a little while longer, they need to free up the capital they’ve invested so they move onto other opportunities. They are also more likely to offer up huge incentives for buyers because of this need to rid themselves of inventory. If new constructions are out of your league, I’m sure there is plenty of inventory in most of the US so pick your spots and you’re likely to find yourself a great deal.

What do you all think? Things will get worse? Much worse? Things will get better?

* The reason I got the house was because I was willing to rent it back to the seller for two months as they bought their new house. The competing buyer wasn’t willing to do that, so I lucked out big time.

This morning I did a bit of an apples to oranges comparison of a 401(k) and a high yield savings account, showing that the two would meet two years and two months out given a set of probably unreasonable assumptions. It was apples to oranges because the risk involved in investing in the stock market simply isn’t anywhere near the risk involved in saving money in a high yield savings account. So, I took Anne’s suggestion and compared a pre-tax account, in this case the 401(k) again, and a post-tax account.

Results? 401(k) never catches up. Despite starting with more money, $133 vs $100, 401(k) can never get over 25% the marginal tax rate + 10% penalty hit that it takes when you extract funds from it (not a loan, a straight up withdrawal). If you plan on pulling out your 401(k) funds to buy a house, don’t put them in there in the first place. Make the minimum contribution to get your match, then put the rest somewhere else.

Assumptions

• Better is defined as the approach that ends up with the most amount of gain.
• You are in the 25% marginal tax bracket.
• Both accounts return 11% a year, or 0.8735% each month, compounded monthly.
• There is no 401(k) contribution match by your employer. An employer match will bring in the breakeven point and raise the value of the 401(k).

Pretty Charts!

The chart below plots the growth of the brokerage account versus the 401(k) account. The value shown is the final extracted value, but growth is based on the non-extracted value. For example, with the 401(k), it’s the pre-tax dollar amount that is being compounded but the graph is showing that value reduced by 35% (25% tax, 10% penalty). The brokerage account line is growing based on its unrealized gains but the value shown is the realized gain, minus long term or short term capital gains. If you’ll notice the little hitch in the purple line at around month 12, that’s because the brokerage account tax rate fell from 25% (short term capital gains) to 15% (long term capital gains).

If you’re interested in the Excel spreadsheet I played with to reach these simplistic conclusions, I’ve made them available here. Please check it out and let me know if you see any mistakes I may have made.

When it comes to saving for a house, is it better to contribute pre-tax into a 401(k) and withdrawing it (taking the 10% penalty) or contribute it post-tax into a high yield savings account? The trade off is that a 401(k) will grow more, start with a bigger pot, but take an extra 10% hit on the way out. A high yield savings account starts with a smaller balance, takes an earnings tax each year, but doesn’t face a 10% penalty at the end. According to my analysis, after three years of growth, contributing to a 401(k) comes out 6% ahead compared to a high yield savings account (my assumptions and an explanation of my analysis to follow). The break-even point is at around two years and two months.

What does this mean? If your sole concern is saving and earning the most to put down towards a house, with no consideration towards retirement, then contribute to your 401(k) if your target date is at least two years and two months into the future. I believe that to be short-sighted because retirement is far more important than whether you own or rent, but that’s a decision you have to make. *One other option to consider is that you can contribute to a 401(k) and then borrow from it at prime + 1-2%, so these are by no means the only two options you have.

Assumptions

• Better is defined as the approach that ends up with the most amount of short term gain, this analysis gives no consideration towards retirement goals, which I believe is far more important than buying a home.
• You are in the 25% marginal tax bracket.
• The 401(k) would return 11% a year, or 0.8735% each month, compounded monthly.
• The High Yield Savings would return 4.75% a year, or 0.3875% each month, compounded monthly.
• There is no 401(k) contribution match by your employer. An employer match will bring in the breakeven point and raise the value of the 401(k).

Explanation of Approach & Spreadsheet

I assumed that you would contribute $100 in the beginning of January (once) to your high yield savings account and you would contribute $133.33 to your 401(k), that’s the pre-tax equivalent of $100 if you are in the 25% marginal tax bracket.

Pretty Charts!

The chart below compares the growth between the high yield savings account and the 401(k). You’ll notice the dips at the end of each year in the HYS, that’s when income tax is levied on the interest earnings. The 401(k) line reflects the post-tax value of the 401(k) balance, that is after a 25%+10% reduction (25% marginal tax rate, 10% penalty). The 401(k) growth is calculated using its pre-tax value but the chart is charting it’s post-tax and post-penalty value. You can see that the lines intersect around the 2 year, 2 month point (X-axis 25 or 26), when income tax is levied on the HYS.

If you’re interested in the Excel spreadsheet I played with to reach these simplistic conclusions, I’ve made them available here. Please check it out and let me know if you see any mistakes I may have made.