Apr 16

I’d always thought, and advised others, that to retire, one should have their mortgage paid in full. And that was always my own plan. But, anyone who knows finance knows that you can’t plan on an exact stock market return, you can’t plan on your own health being excellent, nor your marriage outlasting your mortgage. In our case, these things actually all are going pretty well, thank-you. What changed was our income which I posted about a few months back. While we were working, we saved, over 20% per year on average. We topped off the 401(k)s and IRAs, and put aside money for our daughter’s college tuition. In hindsight, we could have saved a bit less, and aggressively paid off the mortgage, and I know there are people who are in the Dave Ramsey “debt is evil” camp who will agree, but I have no regrets. I’m a numbers guy and as rates fell, I was a serial refinancer. We entered our retirement phase with a fresh 15 year 3.5% mortgage.

When we lost our jobs, the balance was $265K, and I did the math to see what it would have taken to have no loan on that day. Our average interest rate was 6.0% over the prior 15 years. An extra $935 per month for that time and we’d have no loan. Keep in mind, the market was interesting during that 15 year stretch from 1998-2012. A 3 year slo-mo crash with a cumulative 38% market loss. A 2008 loss of 37%. The compound growth during this stretch was 4.4%. But didn’t I just say my average loan rate was 6%? Yes. The difference was going into our retirement accounts. Not the matched portion, although that would certain tip the numbers in my favor. Just the regular pretax savings. And even with that disparity between my mortgage rate and the low market return, the 401(k) had $349K extra vs our $265K mortgage. What’s interesting to note here is that the money went into our retirement account at a marginal 28% tax bracket most years. But now, the withdrawals are at 15%. At a current rate of 3.5%, the mortgage payment is $1966, and if you do the math, it takes $2313 from the 401(k) to make this payment.

Two years have since passed, and the market in 2013 and 14 was very rewarding. A gain of over 50%. We ended 2014 with the mortgage at $233K and the calculated 401(k) extra funds at $453K. The interest deduction wasn’t part of my math, although it helps my numbers a bit. Instead of the whole payment being subject to the 15%, the first $8,000 is interest and, with some good planning, keeps us from hitting the 25% bracket.. No one should keep a mortgage “for the deduction” of course, paying a dollar to save 25 cents makes no sense. From where I sit, it simply means my 3.5% mortgage is actually 2.6%.

The fact that we hit our number while taking the mortgage payment into account, and not counting on social security which is still quite a few years away, is what lets me really sleep at night. Right now, I can’t say whether the mortgage will be paid off before we decide to move. Either way is fine by me. Paid off, our number drops, freeing up our savings for other endeavors.  A move would drop our cost of living, as we’re currently in one of the higher expense parts of the country.

The bottom line? 2 crashes over a 15 year span and the results are still in my favor. The key thing was that the difference was put into savings, not just absorbed into the spending portion of our budget. No regrets.

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Nov 14

I had an experience I was planning to share and after writing about Student Loans and Your First Mortgage, today is the day to do it. In that article, I wrote that a couple earning $100K could afford a house worth as much as $465K if they had a 20% down payment saved up. I actually think this is on the high side, but given how low rates are today, the numbers work.

If you’ve not read the article earlier this week, I used two ratios, 28% of monthly income to go towards housing cost, and 36% to total debt servicing. This is how responsible banks qualified borrowers before the mid-2000 bubble that nearly destroyed the economy.

On a personal note, I am taking the state mandated 40 hour class that will let me sit for the real estate salesperson exam. (Note – the word Realtor is trademarked, one has to have the license to become a Realtor, but not all real estate agents are Realtors.) That said, the class is offered over 4 consecutive Saturdays, a long day, 10 hours of stuff we’ll never use after taking the test. We were honored to have a guest speaker join us, a Mortgage Broker who talked a bit about her business. When she got to the qualifying ratios, it wasn’t 28/36, but 43/50. To compare to my numbers from the prior article, 43% is just about 1.5 times 28%, so this broker is saying this couple can borrow not the $372K I calculated, but rather, $558K. She was also pushing loans with as little as 3% down.

mortgagebroker

She was quick to point out that Real Estate Agents are not supposed to offer financial advice to clients, and that since she knew more than everyone in the room, we should just send our customers her way. (She literally said, “I know more about mortgages than any of you.” I decided it would be pointless to challenge her. We all just wanted her to leave so we could get through the material.)  It’s interesting for me to see that these mortgages are even available, the bubble and crash aren’t even 10 years behind us. I can understand the downpayment is tough, and if a buyer with good income can qualify for a mortgage with a decent debt to income ratio, that’s fine. But the thought of selling someone a mortgage that will put their debt service to 50% of their gross income should be criminal, in my opinion.

I’ll leave you with one final thought. Say this $100K couple gets in too deep, and for 30 years skips the 401(k) matched deposit of 5%. $10K each year for 30 years will grow to $1.1 million at an 8% rate of return. I know, it’s not that simple, but when people get in too deep, something has to give. Would you be comfortable if the Mortgage Broker told you not to worry about having half your gross pay going to service your debt? I don’t think I’ll ever refer anyone her way.

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Nov 12

Is it wise to have no debt at all when you are planning a mortgage in the not-too-distant future? That’s what I was pondering after a blogger I follow was considering wiping out her student loan.

stephloan

If you’ve not read Stephanie’s blog, Graduated Learning, you might give it a try. The tag line is “I got my degree, I got a job…now what?” Not just any degree, Stephanie is an MIT graduate. Now, to her shared thought bubble above. Here’s what we know, she has a 2.75% student loan, enough cash to pay it off, and an engagement ring on her finger. No high interest debt, else that would surely be the priority for payment. Let’s look at how paying off the student loan might impact the size house she and her new hubby can buy.

We’ll make some assumptions, to offer a general idea of why you should or shouldn’t kill that last bit of debt before buying your first house. We’ll keep the math simple and start with a $100K salary. Engineering grads are starting higher than $50K, but $100K makes it easy for you to scale up or down to your our salary. When applying for a mortgage, the old ratios used to be 28/36. This means that monthly housing debt can be up to 28% of monthly income and total debt, 36%. In this example, 28% is $2333 per month. Let’s set aside $500 of this for property tax, and look at an $1833/mo mortgage payment. The 30 year fixed rate is just under 4.25% right now, so my trusty TI35 calculator tells me the new couple can afford a $372,600 mortgage. With 20% down, this is a house purchase of $465,750, and the down payment is $93,150. For most people, it’s not the mortgage that’s the deal breaker, it’s the down payment. The money she might wish to use to pay off the student loan will be very precious when she and Mr Blogger are house hunting.

Paying off the debt won’t put them in a better position, either. You recall that I mentioned that total debt service can be 36%? That 8% gap from 28 to 36 is $667/mo. Enough to support payment on a 10 year student loan of nearly $70K. You see how this works? The payment toward the loan isn’t impacting their ability to get a mortgage, and paying it off wont enable them to get a higher mortgage. But the ability to put 20% is pretty important. Imagine finding the right house, all is perfect, location, size, price, etc. But having paid off that student loan, they are a bit short on the down payment, and need to wait 6 months to save up again. Better to pay the 2.75% loan’s minimum payments, and in a year or two, after they are settled in the house, see if the emergency fund is topped off. And the retirement accounts are funded at least to the match. After that, if they wish to get rid of that low interest debt, no problem.

Last – the area we live in, not far from Boston, isn’t near the US average. Home prices can easily exceed $500K without living in a McMansion. And living too far from one’s job can result in 3 hours of daily commuting time. But again, these numbers are just an example to illustrate the need for that down payment and how the 28/36% gap can work to your benefit.

 

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Jun 26

You knew that, of course. If you’ve searched for personal loans at sites such as http://www.cbonline.co.uk/personal/loans  you’ll discover competitive rates, but if you own a home in the US and have a mortgage, hopefully you’ve looked at the rates as they dropped and acted by refinancing to a lower rate. But, as I expected, the low rates were not going to last forever and we’ve recently seen the move back up.

RateHistory

This chart only goes back a year. If we went back 5 years, we’d see rates at 6%. Go back to the 80’s and the 30 year fixed rate was 18%. But I digress. The 30 year rate recently hugged 3.4% for a time, and has now risen nearly a full percent from that low.

mortratesHave I mentioned my love of spreadsheets? You know how there are rules of thumb that suggest you can afford X times you income on your house purchase? Those rules are tied to the interest rate, because as rates change, the payment you can afford gets lower as rates rise. I wanted to look at this with numbers that are reasonable to my readers, so I started with a $60K per year income. This is a bit over median income, and offered just as an example. A well qualified mortgage will permit you to use 28% of your monthly income for the mortgage, property tax and insurance, so I use 23% for the mortgage payment only, that’s $1150 per month. Strictly from an affordability perspective, you can see that at 3.5%, an earner just over median family income would be able to pay for a $256K mortgage. Since this is an 80% loan to value, the home price is $320K, twice the median home price. It was actually a great time to be a buyer. Now that rates are nearly a percent higher, we are close to 4.5%, with that same payment of $1150 only supporting a mortgage of $227, nearly $30K less just a few months ago. This chart gives you a good look at how the borrow power of that payment drops as rates rise. The real question is whether this will put downward pressure on home prices as well. I suspect housing wont drop to meet the new value supported by the payment, but there is a risk that home prices drop a bit from their current levels. This also prompts the question whether rates in the UK will rise and is now the time to check out the rates at http://www.cbonline.co.uk/personal/loans/personal/loans before they head up.

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Jun 20

The housing market is still at almost record lows. Though the rates have been steadily rising the past year or so, they are still far below the rates that they had before the market fell. These days, even people who are sitting comfortably in their mortgages are debating refinance due to the extremely low rates that are available on home loans. You can use the money on anything you wish, from working on your yard to consolidating your existing debt. There are a few things to consider, however, when you are thinking of refinancing your home.

Value of Home

One of the reasons that it has become so easy to get a low home loan is the value of housing has dropped considerably in the past few years. There are many private residences that have dropped over 40% of their value in just a few years.

The reason that you can get loans so cheaply against these homes is that they haven’t proven to have a steady worth. Basically, your house isn’t a proven asset in today’s market. Banks make money on high risk loans. So when you are looking at a mortgage refinance, remember that the bank may consider you a risk.

How Long Will You Live There?

If you’re not going to live in your primary residence for more than five years, it is not a good idea for you to go in for a refinance. The reason for this is that the first five years on a home loan are not really paying against your loan. Instead, what you are paying on is mostly the interest and the fees that are associated with your loan. The loan itself is not going to be paid back or have a dent made on it for at least five years. If you’re thinking about refinance, then it’s important to figure out how long you intend to remain there. If you are not at the level of income that you can afford to take a major loss on your refinancing, then don’t obtain one unless you’re certain you’ll remain in one place for more than five years.

Other Loan Rates

What are your goals? Do you want to landscape or do something to increase the value of your home like hardwood flooring? Do you want to save money for college or purchase a vehicle? Is your final goal a debt consolidation where you can lump your major debts under one umbrella? Depending on what your final goal is, your main bank may have a better option available to you than a home refinance. Check with loan managers at your bank to make sure you’re going with the best option before you proceed with a home loan. There are times where debt consolidation loans can be acquired for less risk and lower rates than home loan refinances.

Regardless of what your final choice is for your lending needs, a home loan may be in your immediate future. However, it’s important to remember that this avenue isn’t the right one for every borrower. If you’re not going to remain in your home for an extended period of time, then you don’t want to be tied to that home via another line of credit. Even if you are going to remain in the home for an extended period of time, you may not get the best deal or rate from your home refinance. In the end, your best course of action is to discuss the issue with your bank’s lending agents to figure out what sort of refinance or loan is best for you.

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