by Karl Denninger, Market Ticker:

The stupid, it burns.

The screamers are out again telling people to refinance — and apparently, plenty of people are doing exactly that with their mortgages.

Folks, a significant percentage of the time this is bone-headed stupid.  Sorry, it just is.

The reason is that when you refinance you are resetting the amortization clock and your first payments go back to being nearly all interest.

Now if you are buying now anyway then this is a nice opportunity to get a lower rate on something you were already going to do.  If you have purchased in the last couple of years then likewise, this might be a decent opportunity.

But if not the penalty for resetting the amortization clock can be enormous.  In that case it only makes sense if you refinance into a loan that has the same duration as that remaining on your existing mortgage.  This is especially true if you’re 10 or 15 years into an existing note.

Remember that your interest cost in the present month on an existing amortized loan is based on the remaining balance.  Anything you do that resets that outstanding amount higher will appear to be cheaper for you on a monthly basis but in fact it frequently is not.

The key point to remember is that every dollar of mortgage payment you make that goes to principle is a dollar that becomes yours in the form of equity (in other words, you are paying yourself) while all interest dollars go to the bank and thus really are SPENT and GONE.

That is, the key item in any refinance is this: Only the interest amount paid in a given month matters, provided you can make the payments, and the lower that amount is the better, both monthly and in total between now and when the loan matures.

In addition, and this is very important, extending a mortgage beyond the date you expect to either (1) stop working (e.g. retire), (2) believe your job will be outsourced, destroyed or otherwise force a reduction of your income is really dangerous — and thus you should never, ever do that unless you are willing to immediately sell that house, possible under duress (which will impact the amount of money you get for it, obviously.)

Every dollar you pay on an amortized loan that goes to principle is a dollar you take out of your left pocket and immediately place in your right pocket when it comes to your net worth.  It is true that you are impounding that value (in your house) but it is still yours, and you had to do that anyway (if you default you get kicked out of the house, natch.)

Therefore the total payment amount is immaterial so long as you can make the cash flow.  In fact, increasing consumption at the expense of impounded investment, even forced investment, reduces your margin of safety materially in terms of your personal financial situation.

What matters in the end, over time, is how much you give someone else.

Let’s say that you start with a $200,000 mortgage @ 4% interest.  It’s five years in and you now owe $180,543.  Your current payment to someone else is $603 a month, decreasing monthly.

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