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If you're wondering if I'm truly going to get into the weeds about mortgages right now... you're correct. We'll only take a few steps into the thicket.

(I'm not a financial advisor so, you know, be careful when listening to me about this stuff.)

(This post was excerpted from a longer Dev Chat newsletter.)

My wife and I have been going through the refinancing process for a couple of weeks now ("refinancing" is literally just "getting a different mortgage"). I've found it difficult to reason about. There are a lot of variables moving at once and so it's hard to know what choices to make.

In general, for a mortgage you'll be choosing the term (e.g. 15, 20, or 30 years), how much to pay up front, whether or not you want to pay "points" (pay now to decrease your interest rate), get paid "credits" (the bank pays you now to increase your interest rate), and some other factors. Some of those choices are made for you by your circumstances (how much you can afford to pay upfront, and per month, etc).

In looking at my options, it seemed obvious that the shortest term and the lowest interest rate would always be best. Shorter terms cost more per month, but in the end a lot less goes to the bank. So... the shortest term for which I could afford the monthly payments, right?

And then someone told me that, well, if I instead went with the longest term to get the lowest monthly payments, then I could invest the difference every month. Compound interest is an incredibly powerful thing, so even though I'd give the bank a lot more money over the term I'd potentially still come out ahead.

But that's assuming I did make those investments, and otherwise wouldn't have, and that I'd be doing so over the entire duration of the loan...

Anyway, the point still stood: it's all about opportunity cost. The question isn't how much money can you avoid giving to the bank, it's what are all the things you could do with the money being discussed?

This is all to say that the right move depends incredibly strongly on your circumstances, in particular how long you'll be in a home before selling and then getting another mortgage.

I won't go into all the wild spreadsheeting I've been doing to figure out how compound and amortized interest interact, but there was one realization I had that helped clarify how to approach this problem in general:

Mortgages aren't about home ownership.

A mortgage is a financial tool that:

  • Lets you live more cheaply (renting adds a middle-man). You get more home for your dollar, or the same amount of home and fewer dollars.
  • Lets you keep part of your already-cheaper monthly housing costs. Part of your monthly mortgage payment goes into equity in your home. That's still yours.
  • Lets you capture the upside if you sell. The bank doesn't own your home. They've given you a loan, with your home as collateral. If you sell your home for $10k more than you got it, all of that is yours. (But you also capture the downside if it sells for less!)

When I stopped thinking that the goal of getting a mortgage was to pay it off, and instead that it was a financial tool to reduce the cost of housing in order to free up money for other purposes (like investments) it all got a lot easier to reason about.

It was still super hard though. Compound and amortized interest are like oil and water. My spreadsheets are complicated.

(Note that this way of thinking about mortgages also helps underline the idea that "poverty is expensive". Being able to afford a mortgage makes housing cheaper, which in turn frees up money for other purposes. In particular, when that freed-up money is allowed to grow with compound interest the gulf becomes enormous (generational wealth).)