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Mortgage Q&A: Borrowing for refi is one solution

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One of my customers settled on his refinance today. In fact, he is an avid reader of this column and the Friday Home Guide. After I had reviewed his settlement statement with him, he reminded me that I had told him his situation would be a good story for this column. Here it is:

John and Sandy Smith own a home in the D.C. suburbs. They, like thousands of other homeowners around the country, purchased at the peak of the market and have a mortgage for roughly $40,000 more than the home's current market value.

For various reasons, they were not eligible for the oft-touted Home Affordable Refinance Program (HARP). If you have read my previous columns, you will know that HARP is riddled with bureaucratic rules that eliminate most of the folks the program is designed to help, including the Smiths. But that's a subject for a different column.

Anyway, these folks have a $450,000 mortgage with a rate of 6.50 percent. They have excellent jobs with the federal government, good savings and a sizable balance in their Thrift Savings Plan (TSP) retirement account.

Alas, they can't refinance to today's low rates because they're underwater in their home to the tune of about $40,000. John and I get on the horn and brainstorm. Here's what we came up with.

John and Sandy applied for a loan equal to 90 percent of the home's current value. The property appraised for $415,000, which means they needed to bring $80,000 to the settlement table. Though this may sound like a drastic move, the Smiths made a very good financial decision.

Instead of using up all their liquid savings or withdrawing from the Thrift Savings Plan with a large penalty, they borrowed against their TSP at a rate of 1.875 percent. I locked their 30-year fixed-rate loan at 4.375 percent with no closing costs or private mortgage insurance.

The calculations prove their decision to be a smart move.

First, the TSP loan carries a rock-bottom interest rate. Because the loan is to be paid off within five years, the repayment terms required a high, but affordable, payment. Second, the interest saved by refinancing from 6.50 percent to 4.375 percent is more than significant. Simple interest calculations, which are not entirely accurate but are close enough for this column, show that the Smiths are saving roughly $7,936 in interest in the first year by dropping their interest rate by 2.125 percentage points.

The interest paid on the TSP loan in the first year amounts to $1,483. Deduct the $1,483 interest cost from the $7,936 interest savings, and they have a net savings of $6,453.

Divide the $6,453 into the $80,000 equity investment and the Smiths discover that the $80,000 actually earns an annual return of 8.06 percent in the first year.

Where can you find a guaranteed return of more than 8 percent these days? It's not easy.

At the end of five years, their TSP loan will be paid to zero and their mortgage rate will be 4.375 percent instead of 6.50 percent.

A smart move.

• Send email to henrysavage@pmcmortgage.com.

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