The Investment Scientist

Bad Mortgage Refi Could Cost You an Arm and a Leg

Posted on: June 18, 2012

Is Refinancing Right for You?

A recent doctor client of mine told me that he just did a refi through one of his patients who happened to be a mortgage broker.

I asked him what the rate was and he answered: 5% for an 8-year mortgage. This immediately raised a red flag: currently a 15-year mortgage is 3.02%, and a 5-year ARM is even lower at 2.67%. If anything, an 8-year mortgage should have a rate less than 3%.

So every year, he will pay 2% extra in mortgage interest. With a loan of $500k, that’s $10k extra a year. How would you feel if someone stole $10k from you every year?

But somehow the mortgage broker was able to show the doctor that he will save $20k with the refi. What gives?

It’s actually not too hard to understand. The good doctor originally had a 15-year mortgage. By shortening the term to 8 years, the broker was able to create the illusion of savings.

If you still don’t see it, imagine you owe me $100, payable in 10 years. I offer you a deal: if you pay me $98 now, I will cancel the debt and you will save $2. Would you take my offer?

In reality, $100 ten years from now is worth a lot less than $98 now. If the interest rate is 3%, $100 ten years from now is worth about $74 now. By offering you $98, I give you an illusionary saving of $2, while actually stealing $24 from you. That is effectively what the mortgage broker did to my client.

When a prospective client approaches me, the first thing I do is to do a discovery meeting to uncover all the costly hidden problems. Now that this doctor is my client, I will not let things like that ever happen to him again.

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2 Responses to "Bad Mortgage Refi Could Cost You an Arm and a Leg"

This mortgage refinance deal is like offering to sell a new Honda Fit for $30,000 when the MSRP is in the $18,000 range. You don’t have to be super-savvy to figure out it is a bad deal, just conscious and able to look up the current rates, e.g. on the front page of money.cnn.com. This broker must be a slick fast-talker to have gotten away with this deal.

Jerry, 95% of doctors are not financially savvy. Checking prevailing rates is very rudimentary, but there are still a lot of very smart people who don’t know how to do that.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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