Free Money Finance regularly posts questions that are e-mailed to him by his readers, with the intent of having other readers offer advice. Recently a reader asked about refinancing a mortgage that is currently under water (meaning that more is owed than the house is currently worth). Here's the skinny:
- $225,000 is owed against a house that is currently worth $200,000 to $208,000.
- The current mortgage is at 6.75%, a couple of percent higher than current rates for equivalent mortgages.
- The savings per month would be about $350, which they plan to use to maintain and improve the house.
- The refinance process would wipe out their savings cushion almost entirely.
- They characterize their jobs as “very stable” and do not know how long they'll be in the house.
Not easy, is it?
Two percent is a big enough difference that it is usually a good idea to look into mortgage refinancing, but is it worth wiping out $25,000+ from their high-interest savings account? There were a number of different takes, as you might imagine. Financial Samurai recommended going full steam ahead with the refinance:
$350 divided by $30,000 = a 11% yearly return on your investment. Pay down your mortgage and refi, it's a NO BRAINER. Where else can you get a 11% yearly return guaranteed?
His calculations, admittedly, assume pretty liberal definitions of principal and return, but that's not the main issue. He sees no emergency fund as being no problem. Saving that much per month is cushion in itself, perhaps. The readers' jobs could be really, really stable, in which case they could go on without an emergency fund without any issue at all, or build it up slowly.
Money Crush takes the other side of the fence:
Based on what you're said here, I wouldn't refinance. Mainly because you're going to be wiping out your savings and emergency fund, with no plans to replace it. If it were just wiping out savings (and not the emergency fund too, I might consider it.) Lots of people lose their “stable jobs”.
The last sentence is key. Lots of people do lose their stable jobs. I tend to side with Money Crush on this one (if there are no other options for handling the situation available — there might be). There are times to pay down debt aggressively, and there are times to build up emergency funds aggressively. Now is a time to build up, and maintain, emergency funds and cash savings. Why? Because cash buys you time if something bad happens, and a lot of bad things can happen. No cash, no time. Time to carry balances on the credit cards!
An underwater mortgage isn't a problem unless it's made to be a problem. Refinancing an underwater mortgage makes it a problem. The bank won't take the house back just because it's underwater. The bank will take the house back (eventually) if you can't make the payments. Voluntarily wiping out your emergency fund increases the risk that this bad outcome will happen.
Everything you say makes sense. Refinance if you can pay down the difference without losing the emergency fund.
Rates will be low for a while, so it might be in this person’s best interest to go on a spending diet for a while if they want to proceed on a refinance later.
I’m kind of going through the same thing. We wouldn’t wipe out our emergency fund but would wipe out most of our non-retirement investments if we were to do this. The investments, like the stock market, have pretty much been flat since I made them (they’ve gone up, down, up again) so for me, it’s a matter of deciding whether I can get a better return in the stock market or the guaranteed return of the lower payment. Not sure yet but keeping an eye on things while rates are low.
I personally think that no emergency fund IS a problem. A couple of problems and you’re suddenly in credit-card debt.
For example, my sister and her husband experienced a year that they recalled as “the revolt of the appliances.” The fridge died. The stove died. The washing machine died.
They were able to pay cash for new ones. Not happily, mind you. But had they not had an EF, they’d have been even less happy.
It doesn’t even have to be a big-ticket item — just a series of smaller ones. Car repairs, broken eyeglasses, minor illness + high deductible…
And yeah, plenty of people never expected to hear “Clear out your desk.” But they heard it anyway.