Rates Take A Slight Shift

While rates are still relatively the same there was a slight decline. This is a great time to take advantage of interest rates being this low. Due in part to the fact that China's growth rate dipped below 7%, there is speculation the Fed might even wait to raise rate until next year but here is no sure way to tell how long they will stay this way!

Here are this week's rates:

30-yr Fixed

Conventional:  3.625%*                 FHA/VA:  3.250%*

15-yr Fixed

Conventional:  2.875%*                 FHA/VA:  2.875%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Financing Home Improvements

With a few exceptions, using a mortgage to pay for home improvements carries a double-benefit: it increases the value of your home and improves your quality of life.  This is common purpose for a cash-out refinance (where you use some of the equity in your home to pay for the home improvements) and there are several ways to accomplish it.

Key point: Determining how much equity you can use

Equity, or the difference between the value of your home and the amount you still own on your mortgage, is a crucial determining factor.  Unless you are getting a VA loan, you can’t borrower 100% of the value of your home.  You’re normally going to be capped at 80% (for a conventional loan) or 85% (for an FHA loan). 

We’ll use 80% in this example:  If I have a home value of $200,000, the maximum mortgage I can have (for a cash-out refinance) is $160,000 ($200,000 x 0.80 = $160,000).  If I have an existing mortgage of $125,000, then I can access up to $35,000 in equity for home improvements ($160,000 - $125,000 = $35,000).

Easiest Option:  You already have enough equity with your current home value

If, in our previous example, $35,000 is enough to accomplish the home improvements you have planned, then the process is fairly straightforward.  An appraisal is ordered to determine the value of your home, your income/credit/debts are considered, etc.  It’s important to get an idea of how much your home is worth before you get too far into the process.  Zillow provides a starting point, but it’s good to get “comps” as well (we provide those!) beforehand to see if you can safely predict how much equity you will have to work with.  Remember that an FHA loan will let you borrower 5% more (an extra $10,000 in our previous example), but does carry mortgage insurance (but much of that is offset by the lower rates FHA offers).  A VA loan will give a whole lot more, but you have to be careful how often you are using your VA loan benefit (we can help you determine if it’s a wise move).

Other Option:  The home value you need depends on the improvements you are considering

Let’s return to the previous example and say you want to upgrade your kitchen and add a room, for a total estimated cost of $50,000.  The current appraised value of your home ($200,000) only gives you $35,000 to work with.  But, once the repairs are done, your home will likely appraise for $240,000.  If you could use the future value of your home as the appraised value, then you would be able to access the full $50,000 needed ([$240,000 x 0.80] - $125,000 = $67,000.  There are several ways to accomplish this:

·         An FHA 203K Loan:  In brief summary, this loan allows you to borrow based on the future appraised value for permitted upgrades.  It requires architectural plans, inspections, general contractors, etc.  It is an involved process, but if the upgrades are substantial, this is the best way to go.

·         A Home Equity Line of Credit (HELOC):  This is essentially a 2nd mortgage.  If your credit is great and you are solidly qualified, you can often get a HELOC for 90% or more of the current value of your home.  In our previous example, that extra 10% would be an extra $20,000, which would give you $55,000 to work with.  HELOCs are not the best long-term plan (they are variable and after the interest-only period is over, the payments can sometimes triple or more), but once you’ve completed the work and have the higher value (we estimated $240,000 in our ongoing example), you can then refinance and combine the existing first mortgage and the HELOC into one fixed-rate loan (in this example, a new 1st mortgage of $190,000).

·         Self-Financing:  This isn’t an option for everyone, but you could essentially pay for the repairs with cash-on-hand or other means.  Once the work is done and the home appraises for the higher value (as a result of the repairs), you can then do a cash-out refinance and get your money back.

Tips/Notes

·         Consider the scope of the project(s) – If a refinance is not going to get you a lower rate or better terms, or pay off any other debts, then it may not be the best idea to do a full refinance if the project is minimal (I would say under $5000).  If the terms of your new mortgage are going to be “worse”, then make sure the size of your project or it’s intended impact are worth it.

·         Be careful in estimating your future home value – Putting $30,000 into your kitchen does not necessarily mean your home will then appraise for $30,000 more.  There are many factors to consider and it’s best to consult with someone who knows the market/industry before committing yourself.

Evergreen Mortgage has helped a lot of its clients beautify their homes and increase their net worth.  If you’re considering some home improvements, give us a call and we’ll go through your options

Rates Expected to Rise

For the past few months the rates have change a little. Although it is expected that rates are to rise in the near future we are not yet seeing anything to confirm that projection.  

Here are this week's rates:

30-yr Fixed

Conventional:  3.750%*                 FHA/VA:  3.000%*

15-yr Fixed

Conventional:  3.250%*                 FHA/VA:  3.000%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Mortgage Rate Advertising – Truth in Advertising…Often Stretched

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The other day, I drove from Orem to Salt Lake City (Utah) and counted 6 billboards advertising specific mortgage interest rates.  During the same time (approximately a 45 minute drive), I heard 4 advertisements on the radio quoting even more rates.  I lost count of the Pandora mortgage rate advertisements I heard during the rest of my afternoon back at the office.

I would only know this by being in the industry, but each ad that quoted a specific interest rate was exceptionally misleading.  Without knowing key information about the borrower and the transaction, quoting rates really is a shot in the dark.  With this post, I’ll set forth (simply) how mortgage rates are determined, how to decipher advertising, and where to go for reliable information regarding mortgage interest rates.

How Rates are Determined

There are 2 main drivers with mortgage interest rates (aside from the market).  The first is Costs/Fees and the second is Risk Factors.  

• Costs/Fees - Mortgage lenders make money either by charging the borrower origination fees or by being paid by the investors that will eventually purchase the loan.  Investors (like Wells Fargo, Provident, PennyMac, etc., whoever ends up with your loan after you close) pay more money for higher interest rates, so if a lender wants to make money but not charge you an origination fee, he will give you a higher mortgage rate so that he is compensated by the investor.  The same can be done for other fees (like processing fees, administration fees, etc.): either you pay for it and get a lower rate (keep in mind that it is often just added to the loan), or the lender pays it you get a higher rate.  Lower Rate = Higher Costs, and vis versa.  Below is an example of how costs can affect your interest rate (assuming a $100,000 loan).

                   You Compensate the Lender        The Investor Compensates the Lender

Costs (out of pocket or added to the loan)

                                                       $2500                                             $0

Interest rate

                                                       3.625%                                        4.000%

• Risk Factors – Credit score, how much you’re borrowing (compared to the value of your home), the type of property, etc. are just a few examples of risk factors.  The riskier the loan, the more likely that the borrower will default on the loan.  That requires a higher interest rate, because investors need to be compensated (by higher interest rates) for lending money in the presence of those risks.  Returning to our example, here is how just credit score will affect your interest rate (assuming Lender-paid compensation, it’s a purchase, and the borrower is putting down 5%).

                                           740 Credit Score                           640 Credit Score

Interest rate                           4.000%                                           4.625%                                        

How Lenders Quote Misleading Interest Rates

Simply put, lenders often mislead potential clients in their advertising by presenting rates for scenarios that are possible, but not probable (or that are exceptionally rare).  They do this by using unlikely assumptions regarding the Costs/Fees and Risk Factors.

• Tactic #1:  Quoting rates as if they would do the loan for free – Every lender/loan officer has the option of doing a loan for free, or at least extremely cheaply.  Because that is possible, they can advertise rates that reflect that.  But lenders don’t work for free (and they shouldn’t), so you will soon find once you start signing documents that the lender is not working for free and, consequently, your rate is much higher than advertised.
• Tactic #2:  Quoting rates with no Risk Factors – A billboard knows nothing about you or the financing you’re looking for.  It’s possible that you have a 800 credit score and a 50% down payment (though quite unlikely, at least in regards to the down payment), so they can advertise a rate that reflects those unlikely assumptions.  However, once they pull your credit, appraise the home, etc., your rate will be significantly higher once all of the Risk Factors are accounted for.

Lenders often combine these two tactics.  An average client of mine has a 700 credit score, an 80% LTV, and is refinancing to take out some cash to pay off credit cards (those are the risk factors).  Below is a final example of how this rate could be advertised and what it would actually be:

Advertised (working for free, no risk factors) Interest Rate

3.625%

Actual Interest rate

4.500%

About APR

APR (Annual Percentage Rate) is often cited in advertising.  APR is meant to allow borrowers to compare interest rates and costs; a note rate that has a significantly higher APR means that you will be paying significant fees/costs to get that rate.  So, if Lender A advertises a 4.00% interest rate with an APR of 4.125% while Lender B advertises a 4.00% interest rate with an APR of 4.750%, Lender A has the better offer.  The APR is required to be quoted in certain advertising instances as it is meant to force lenders to be more truthful in their advertising, but it doesn’t work, because it doesn’t keep lenders from quoting “work for free” loans and rates that don’t include risk factors. 

What to Do

Here’s a little secret about the mortgage world: due to compensation regulations and the fact that all mortgage lenders are selling their loans to most of the same investors, rates don’t vary much from lender to lender.  That doesn’t mean that lenders won’t reduce their commissions to be competitive in some instances, but that is the only power they have, and it doesn’t happen very often (i.e. most lenders are earning about the same on their loans/rates). 

Some tips:

• If you’ve been given a quote from a lender you trust (who has actually learned about your situation, pulled your credit, etc.) and you get a quote from another that is substantially lower, don’t trust it.
• Take billboard/radio/TV advertised rates with a boulder of salt.  To be safe, add a 0.5% - 1% to what their advertising as a more accurate representation of what your rate would be.

Rates Hold Steady

Last week the Fed decided to keep interest rates instead of raise them. While home mortgage rates are still holding relatively steady, they have decreased slightly. If you are thinking about refinancing, now may be a good time before the rates rise instead of decrease. 

Here are this week's rates:

30-yr Fixed

Conventional:  3.750%*                 FHA/VA:  3.250%*

15-yr Fixed

Conventional:  3.000%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Rentals: An Excellent Investment if You Know What to Expect

If you’ve ever been a renter, you may at some point declared “dang, our landlord is making a killing on us!” and concluded that being a landlord is the key to wealth and power.  While it may not be as glamorous as it is sometimes made to seem on infomercials and seminars, owning a home as a rental can be a significant portion of your wealth late in life, and more importantly, an excellent source of retirement income.

The Basics

The economic gains in being a landlord stem from appreciation and cash-flow.

• Appreciation:  A home appreciates when it increases in value.  Historically, real estate appreciates (short term cycles may see dips, but the overall trend is upward).  Some areas see more appreciation than others, but the 100-yr average is 3.5% appreciation per year (just a bit more than inflation).  That may not seem like much, considering that stocks have returned an average of 8%+ over the last 60 years, but the key is that because you can finance the investment with a mortgage (at a relatively low rate), you realize the appreciation of the entire property/house, even though you only have a fraction of your own money invested.  This is called return on investment (or return on equity, depending on how you look at it).  As an example, I could pay $24,000 (as a down payment) to purchase a $120,000 home today, and in 30 years (when the mortgage is paid off) it would be worth $336,000.  That’s a return on investment of 9.2% (on your original $24,000).

• Cash-flow:  Cash-flow is the rent money left over after each month after the mortgage and other expenses are paid AND THE RESERVES ARE SET ASIDE (more on that later).  Unless you get a killer deal on the home, don’t count on a lot of cash-flow in the beginning, especially if you have a mortgage (if you don’t have a mortgage, you will have more cash flow, but you’re return on investment from appreciation will be lousy).  But, once the mortgage is paid off (close to when you retire), then your cash-flow will be significant.  Your cash flow is heavily dependent on the rent market (which will fluctuate over time), but let’s say the $120,000 home mentioned before yielded rents of $825/month.  Your mortgage payment, taxes, insurance, and reserves would total about $675/month, leaving you cash flow of $150/month for the first 30 years.  Once the mortgage is paid off (assuming a 30-yr mortgage), your monthly cash flow would increase to $575/month.  Even before the mortgage is paid off, your cash flow is $1800/year, or a cash return on investment of 7.5% ($1800/$24,000).

Combine the returns from the appreciation and the cash-flow and you’ve got a pretty good investment.  You’ll be entering your retirement years with a $336,000 asset that pays you $575/month.  That’s not bad…and it’s just one rental.

How it’s Done

“Great,” you may be thinking facetiously, “all I need is $24,000.  Great advice, Kjell.”  Buying an investment property/rental that is not your primary residence requires at least a 20% down payment and the underwriting requirements are significantly more stringent.  Most of us don’t have that type of disposable income (at least starting out), but the most common way of acquiring rentals- at least in the beginning- is a form of “house hopping”.

The mortgage down payments for primary residences are far less than 20% (3%-5%).  Once you’ve lived in the home for at least a year (I would plan on at least 2), then you can purchase another primary residence and move from your former home (now a rental).  The down payment for your new house is still 3%-5%, since it will be your primary residence.  You would need to save for that new down payment, but 3%-5% is a lot better than 20%.  Many families will do this 2 or 3 times, building up a nice “portfolio” of rentals in the process without having to pony up 20% down payments for each one.

Warnings

This has seemed like a sales pitch up to this point.  Now it’s time to temper expectations and point out some common misconceptions.

• Are you ready to be a landlord?  You will need to vet applicants, manage tenants, keep up on maintenance repairs, deal with the legalities/taxes, and even occasionally evict people.  There are smart ways to be a landlord that can reduce the amount of time required/stress required, and perhaps a property management company is the best solution (though they will take 8-10% of your monthly rent, which could be most of your cash-flow, in the beginning), but there is no way to escape at least some level of involvement.

• Buy the right property.  The better deal you can get, the better your returns (in both appreciation and cash flow).  The type of property is important as well.  Large single-family-residences can be easier to resell (and have somewhat more reliable appreciation), but can also be higher to rent out.  Condos are easier to rent and provide solid cash-flow, but sometimes have resale issues/complications.  Neither are bad, but you have to consider all factors.  Homes that have a lot of deferred maintenance and will require more money in the long run.  You also want to have a long term plan.  Know what income/down payment you will need to show long before you start looking for another home.

• Have the discipline to keep RESERVES!  One of the most common problems new landlords have is not sufficiently identifying future repairs and maintenance costs and not setting aside the necessary reserved funds to cover those costs.  It may seem silly to set aside 15% of your gross rent when everything seems to be functioning, but eventually the fridge WILL break and the carpet WILL need to be replaced.  Plan ahead and be disciplined.

• Don’t buy into the Hype.  Unfortunately, most real estate investment scams prey on those enamored by the idea of being a real estate tycoon.  Don’t buy properties unseen, don’t buy them with credit cards, (just to name a few ill-advised practices) and be a sceptic.  If it sounds too good to be true, it almost always is, especially when it comes to investing in real estate, no matter how good you’ve been made to feel.

This is just a snippet of the tome that could be written regarding rentals.  If you think you might be up for it, let us know and we’ll run through your options.  I (Kjell McCord) have significant first-hand experience with rentals and can vouch for their upside, as long as you practice prudence.

Rates Slowly Rise

While home mortgage rates are still holding relatively steady, they are continuing to slowly rise week after week. If you are thinking about refinancing, now may be a good time before the rates get any higher. 

Here are this week's rates:

30-yr Fixed

Conventional:  3.875%*                 FHA/VA:  3.375%*

15-yr Fixed

Conventional:  3.125%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Despite Economy, Rates Look Good

Home mortgage rates are still holding fairly steady, despite economic volatility.  The Fed has likely pushed back from a September rate rise, but we can almost certainly expect one come December of this year.  If you're waiting to refinance, remember to act quickly.

Here are this week's rates:

30-yr Fixed

Conventional:  3.750%*                 FHA/VA:  3.250%*

15-yr Fixed

Conventional:  3.125%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

The Opportunity and Costs of Building Your Dream Home

You might not think it from seeing some of the newer neighborhoods around here, but new construction housing is in a bit of a slump (at least for single-family homes.  As you can see there is no shortage of newly constructed apartment buildings!).  The construction industry still hasn’t fully recovered from the financial crisis.  A shortage of available houses for sale at the moment can leave prospective homeowners frustrated by their options.  These factors (and others, such as low interest rates) could be cause to consider building a home as opposed to purchasing one already available.  If done correctly and with the right expectations, a construction loan can be the best way to your dream home and/or possibly save some money.  Here are the basics and the pros/cons of construction loans.

The Basics

As the name implies, a construction loan covers the costs of construction and sometimes the land required.  There a quite a few steps to the process:

·         Preparation:  Before ground is broken, architects, contractors, city officials, the lender, and the buyers need to be on the same page.  Building plans, site surveys, permits, licenses, insurance, inspections, material lists, contracts, receipts, etc. are all needed before determining the loan amount.  The underwriters must also decide if the borrower qualifies for this loan amount, once it is determined.

·         Getting the money:  With a traditional loan, the funds are dispersed all at once.  With a construction loan, the money is disbursed in “advances,” which are portions of the loan intended to pay the costs as construction progresses.  The lender is significantly involved in this process, as they have to be sure that the costs do not exceed the final appraised value of the home (or 90% of it).  If costs are getting out of hand, the lender may feel it necessary to restructure the loan or may stop giving advances altogether.

·         The terms:  Since construction loans are meant to be short term (they are usually replaced with normal, fixed-rate loans once construction is complete), the rates are often variable and somewhat higher than traditional fixed-rate mortgages.  This gives the lender a small amount of “up-side” should things fall apart before the process is complete, permitting them to assume the risk of offering the loan in the first place.  Borrowers are generally only required to pay interest on construction loans before they are converted to fixed-rate loans.  A down payment of at least 10% (often 20%) is usually required and the borrower is normally required to show and keep significant amounts of cash on hand as well.  Construction loans that automatically convert to fixed rate loans are fairly common as well, but carry their own requirements.

The Pros

Here is why people often build their own homes with a construction loan:

·         Dream Home:  This is pretty much the only way to get a home that meets your exact requirements.  Remodeling can only go so far, and is sometimes more expensive than just building something from scratch.

·         Potential Savings:  Builders charge a premium for going through the construction process/costs (that’s how they make money).  By overseeing this process themselves, borrowers can often see a savings (i.e. more equity) by avoiding that premium.

·         More Flexibility in the Process:  Because lenders are more personally involved in the process and don’t want the loan to fail (it’s hard to sell a half-finished house), they are often willing to make sensible adjustments to see that things get done on time and within budget.

The Cons

This list is going to appear longer than the “pros”, which doesn’t mean it’s a bad idea, it just means there are aspects that need to be pointed out.

·         Larger Down Payments:  Buying a pre-existing home normally requires a down payment of only 3-5% (and often nothing).  Construction loans will require at least 10%, if not more.  This can sometimes come from equity in the land, but you have to own the land first.

·         Borrowers need to be well-qualified:  Higher credit scores and more income in relation to debt payments are often required.

·         It’s not for the impatient or weak-stomached:  The vast majority of the time, the project will take longer and will cost more than anticipated (if it’s a truly custom home).  You’ll have many stressful conversations with contractors, architects, lenders, etc.  You also have to make sure the city signs off on everything, and a well-managed city will scrutinize.

·         You may save money, but won’t save time:  You may not pay the premium that a developer will charge, but you’ll put in a lot more time and energy than you would otherwise.  Make sure that you are ready to make that trade-off.

·         You usually need to go big:  Building a single custom home is kind of a pain for builders (compared to building 5 track homes that are the exact same).  In a tight market (like now), builders (by builders, I mean contractors, architects, and all other involved in the process) are going to need an incentive to take on the project.  That means it needs to be relatively big and “expensive”.

Recommendations

Here is my advice in regards to construction loans:

·         It’s not for most first-time homebuyers:  Unless you have cash to burn, I advise that your starter home not be a custom home built with a construction loan.  You need to figure out what you really want in a home, which requires you to live in one first.  Most first-time homebuyers won’t have the down payment and other financial requirements to qualify for a construction loan, although it doesn’t hurt to check.

·         Consider a remodel:  Will a remodel meet your needs?  If you have some equity, it’s far easier to get cash for improvements with a normal refinance than with a construction loan.  There are also “rehab” loans that allow for extensive work and are based on the future value of the home. 

·         Consider a builder’s existing models:  Many builders have a selection of models that allow for some customization (cabinets, paint, kitchens, etc.).  Because the builders have the process “down” for these models, there is less chance for running over budget or over time.  Builders will often fund the construction costs during the building phase, requiring you to only worry about the final fixed rate loan at the end.

·         Do your homework:  Inform yourself as much as possible about the process, make sure you can afford it (not just from the lender’s perspective, but considering your own budget as well), and have the right expectations.  Then, make the decision.

In conclusion, building a new custom home can be a great option.  There are aspects of construction that can be more difficult or taxing on you as a builder than if you simply bought a home outright, but the current market is right for building a new home, and there is the possibility of saving you some money (while getting exactly what you want in a house).  If, after learning the basics, you think a construction loan might be right for you, we would be happy to go over your options with you.

Rates Ready to Rise

Not much has changed with rates in the last couple of weeks.  Rate levels have held steady and low for a while now.  However, there are strong indicators that the Fed will suggest a rate hike next month.  If you've been waiting to refinance, you might not want to wait any longer.  It is possible this rate hike won't occur until December, and when it does happen, it will probably be a gradual and cautious rise, but acting sooner rather than later would definitely be in your best interest.

Here are this week's rates:

30-yr Fixed

Conventional:  3.875%*                 FHA/VA:  3.375%*

15-yr Fixed

Conventional:  3.125%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Refinancing to Consolidate Debt

A common—and generally wise—purpose for refinancing a mortgage is to consolidate other debts.  The new mortgage not only pays off the old one, but also pays off other debts, usually at a lower interest rate and better terms. 

Here’s a simple example:

John’s home is worth $220,000 and his current mortgage balance is $130,000, giving him $90,000 in equity ($220K - $130K = $90K).  His mortgage payment (not including taxes and insurance), is $810/month.  John also has $30,000 in credit card debt with a total payment of $500/month.  His monthly debt payments total $1310.  He refinances with a new mortgage that pays off the $130,000 mortgage and the $30,000 in credit cards, yielding a new mortgage of $160,000, with a new total payment of $764/month, which is his new monthly total debt payment.  He’s now saving $546/month.

Key Benefits

A debt consolidation refinance carries some significant benefits, namely:

·         Lower Overall Interest Rate – The average interest rate for a 30-yr conventional mortgage as of 8/5/15 is about 4.00% (FHA and VA loans are lower).  The average interest rate for a credit card is 15.00%.  Kind of a no-brainer.  But, let’s say that your existing mortgage interest rate is fairly low to start with.  Would you still get a better rate by refinancing?  Returning to our example, if John’s existing mortgage interest rate was already 4.00% and he refinances to another 4.00% interest rate, it may seem as if the benefit is limited, but if we consider his overall interest rate (i.e. the weighted average of the interest rates of all of his debt), he is over 6% (6.1%, in fact).

·         Lower Payments – The lower payments are achieved both by a lower interest rate for the consolidated debt, but also from lower payment requirements compared to the debt.  Most credit card companies require payments of 1.5-2% of the balance (with a minimum of, say, $25/month).  Mortgage amortization does not require such high payments, even though the interest rate is much lower.

·         Simplicity – If John had 3 credit cards (totaling $30,000) plus his mortgage payment, he was making 4 separate payments each month, each with potentially different due dates, late fee arrangements, etc.  A debt consolidation refinance consolidates the payments as well as the debt balances, making it so that John just makes 1 payment each month.

·         Tax Benefits – Mortgage interest is usually tax deductible, but credit card interest is not.  By paying off credit cards (or other debts) with a mortgage, the interest paid associated with that debt can now be deducted from one’s taxable income, saving them even more money.

Note that I am using credit cards as a primary example, but a debt consolidation refinance can be used to pay off anything.  Common debts paid with this type of refinance are credit cards, lines of credit and personal/signature loans, car loans, medical bills, collection accounts and judgments, taxes, money owed to ex-spouses, other mortgages, student loans, 401K loans, etc.  If you borrowed it, chances are it can be paid off in a debt consolidation refinance.

Maddening Misunderstandings

Despite the significant advantages of a debt consolidation refinance, there are several common misconceptions about the process and its consequences-

·         Misconception #1:  “By rolling the debt into my mortgage, there is greater risk that I could lose my house if I can’t make the payments.” – If your monthly payments are reduced as a result of a debt consolidation refinance, are you now more or less likely to struggle making the payments?  Less likely, of course.  Plus, unless you plan on declaring bankruptcy, you have to pay all of your debts.  Would you rather do that at 15% or 4%?  Finally, in the event that you do have trouble and declare bankruptcy, 9.9 times out of ten, your home is exempt.  In truth, a debt consolidation refinance that reduces your payments actually REDUCES the risk that you could lose your home.

·         Misconception #2:  “If I refinance, it will take me longer to pay off my debts.” – If you have less than 30 years left on your mortgage and refinance with a new 30-yr loan, then yes, you will have extended your payoff date.  BUT, if you don’t want to extend the pay-off date, then just set the term to whatever it was before.  Returning to our example, if John had 25 years left on his original mortgage and still wanted to get out of debt in 25 years (instead of 30), he could just get a 25-yr mortgage instead.  In that case, his payment would be $844/month…still $466 less than what he would be paying if he didn’t refinance.  Additionally, if you just make the minimum payment on your credit card (as most everyone does), it will take about 33 years to pay it off…and you’ll do so at 15% interest.  If monthly savings isn’t as important to you and you just want to pay off your debts faster, a debt consolidation refinance is still a good idea, since the interest rate is lower.  Let’s say that John is comfortable with his $1310 monthly payment but wants his debts to be paid off faster.  If he proceeded with the refinance but kept paying $1310/month, he would be out of debt in just 13 years.  That’s 12 years faster and $135,000 cheaper than not refinancing.

·         Misconception #3:  “If I pay off other debts with a mortgage, I won’t have as much equity and that’s somehow bad.” – This one has always surprised me.  It’s as if equity is somehow more sacred than other assets, like cash.  What you should be most concerned about is your net worth, which is your assets minus your liabilities (debts).  In John’s case, his home is worth $220,000 (his asset) and he owes $130,000 on his mortgage and $30,000 on his credit cards (his liabilities), so his net worth is $60,000 ($220k-$130k-$30k = $60k).  If he refinances and consolidates his credit cards, his mortgage is now higher ($160K), but his net worth is still the same ($220k-$160k = $60k).  So his net worth hasn’t changed and he’s saving over $500/month.  His circumstances have only improved.  Also, equity comes and goes.  How many homeowners saw their home values fall in the last 7 years, wiping away trillions of dollars of equity?  If you are diversified (i.e. you have your assets in other forms like cash or other investments, as well as equity), then you don’t lose everything when there’s a downturn in real estate.

On a final note, while my opinion about debt consolidation refinances is obviously positive (and biased), I must point out that it is not a cure-all for financial woes.  No strategy or scheme can overcome poor money habits and lack of self-mastery.  Anything can be misused, even a pay increase or winning the lottery.  If you racked up your credit cards at the mall or Wendover, a debt consolidation refinance will most likely improve your situation, but will it keep you from ending up in that same boat later?  A debt consolidation refinance is a powerful and valuable tool for a better future and achieving your financial goals; but you need to make sure you're doing your part to achieve those goals as well.

Keep an Eye on Rates

Despite slight fluctuations, rates continue at mostly the same level as past weeks.  The economy is improving, but the global market outlook keeps rates lower despite it.  The Fed meets next week, so we could expect a rate hike after that time, if they suggest one.  Now is a good time to keep an eye on rates, as we could soon see some bigger changes.

Here are this week's rates:

30-yr Fixed

Conventional:  3.875%*                 FHA/VA:  3.375%*

15-yr Fixed

Conventional:  3.250%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Expect Rates to Rise

Rates continue to hover in a similar area as before.  As a warning, however, it is unusual for rates to remain so low with other aspects of the economy recovering.  Though the Fed has suggested a rate hike near the end of summer, the economy is a better gauge of where rates are headed, so be aware of the economic climate.  For more info on what makes rates change, you can check out our previous blog post on the topic here.

Here are this week's rates:

30-yr Fixed

Conventional:  4.000%*                 FHA/VA:  3.500%*

15-yr Fixed

Conventional:  3.250%*                 FHA/VA:  3.125%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

How Much Home Should I Buy?

In a previous post, we addressed how to determine your maximum allowed mortgage payment and to how much of a mortgage that corresponded.  It may have surprised you to learn that the government and quasi-government entities that set the “rules” for most mortgages allow for some pretty high payments in comparison to your income.  FHA will allow for a mortgage payment that is 47% of your gross income; if you account for the fact that taxes are taken out of your paycheck, your mortgage payment would be over 62% of your take-home pay.  That’s a lot.

The Conventional Wisdom

A perusal of several money sites shows that most money bloggers offer close to the same recommendations.  In summary, they state that your total housing payment should be no more than 25%-28% of your income.  That means if you make $48,000/yr ($4000/month), your total housing payment should be no more than $1000/month.  For an FHA loan, that’s a purchase price of about $165,000.

If I had to give a simple thumbs-up-or-down to this advice, I would say thumbs up.  In my experience, that size of a payment is well-suited to that income.

And overall, with a few reservations (such as the fact that they state that the 25% figure should include home maintenance, which is extremely subjective), I tend to agree with this advice.  An informal survey of the clients we worked with recently showed that 70% of homeowners have a mortgage payment that is less than 25% of their gross income.

Other Considerations

That being said, I do think it is perfectly acceptable to go beyond that, and even times when your payment should be less.  Here are some additional considerations:

• Budget First – Setting a percentage of income as your housing payment benchmark kind of puts the cart before the horse.  If you are not managing your finances otherwise, you could still end up in a bad situation.  It’s more important to set wise priorities and budget for those.  Expenses that should be budgeted for before- or at least simultaneously- determining your ideal housing payment are (these are just a few):

o   Adequate Retirement Savings – I stress ADEQUATE (many people are saving far less than they'll need)

o   Emergency Savings – This keeps you from having to turn to debt in the case of an emergency

o   All-but-Guaranteed Future Expenses – It’s impossible to determine everything, but you know that cars will have to be replaced, student loans paid, etc.

Once you've determined and accounted for your most important priorities, then figure out how much you want to spend on everything else.  Let's say that traveling and eating out is more important to you than the size of your home.  In that case, the 25% figure may be too high.  Or perhaps you really don't spend much otherwise and would really enjoy a bigger or nicer home.  In that case, going beyond 25% makes perfect sense.  The bottom line is this: as long as everything else is "in order," spend whatever you want on housing!

• Your First Home Will Often Require More – Housing price growth has been outpacing wage growth for a while, and when you buy your first home, you likely will be far from your peak earning years.  Expect to pay more for housing as a percentage of your income, but this is also the point where you start to build equity.  This makes it so that you can put down more on your next home, making that purchase proportionally smaller.
• It’s the Other Debts That Will Get You – I’ve rarely come across a struggling client where a high mortgage payment was the bulk of their financial woes.  It’s the credit cards, the cars, the boats, etc.  These payments often add up to more than their mortgage payment, and at much higher interest.  Plus, they’re depreciating (decreasing in value), as opposed to appreciating, as homes do, historically.  If you’ve got little other debt- and have the self-control to keep it that way- then you can definitely go beyond the 25% housing payment benchmark.

In summary, the question of how much home you "should" buy is a very subjective one.  The key is to practice financial responsibility; set and budget for your priorities, be careful with other debts, but understand the investment advantages of homeownership (it may be worth the higher payment).  Once you've nailed that, picking the right "number" for your ideal housing payment is the easy part.

Momentarily Low Rates

Today's rates show a little bounce back to those lower rates we like to see.  Rates are not expected to stay low, however, so take advantage while you can.

Here are this week's rates:

30-yr Fixed

Conventional:  3.875%*                 FHA/VA:  3.375%*

15-yr Fixed

Conventional:  3.125%*                 FHA/VA:  3.125%*

Rates Hold Steady

Rates have remained much the same over the last couple of weeks.  Remember, though, that we expect to see rates rise again in a few months.

Here are this week's rates:

30-yr Fixed

Conventional:  4.000%*                 FHA/VA:  3.625%*

15-yr Fixed

Conventional:  3.250%*                 FHA/VA:  3.250%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Can't Qualify For a Traditional Mortgage? Consider Alt-A Financing

Some of you may recall the financing options available in the few years leading up to the housing bust.  If you could fog a mirror, you got a loan!  For example, you could get 100% financing on an interest-only mortgage, even if you were just 1 day out of bankruptcy.  Needless to say, such lax requirements led, in large part, to the historic housing collapse, and credit has been reined in considerably.  That being said, there is a place for non-traditional mortgages, although it is a highly misunderstood niche.

Traditional vs Non-Traditional Financing, In Summary

When we say “traditional” financing, we normally refer to Conventional, FHA, VA, and USDA loans.  These types of loans are overseen in some way by government institutions (or quasi- government institutions!) to ensure that borrowers meet certain criteria.  These criteria cover how much can be borrowed, the amount of the down-payment (or equity that needs to be in the home), credit scores, income, etc., but they also cover how this criteria is documented.  You may be a self-employed borrower that makes plenty of money, but you don’t show much on your tax returns.  Non-traditional financing is not overseen or regulated in the same ways and therefore has more flexibility in setting guidelines and requirements.  The trade-off is the interest rates for non-traditional financing are often higher and they may have some non-traditional requirements (because they assume more risk).  Non-traditional financing usually comes from groups of investors that are willing to lend in riskier situations, in return for higher returns (interest rates).  It’s more fluid than traditional mortgage lending; it’s like borrowing money from a rich aunt instead of the bank.  She can make exceptions that a bank can’t, but she may have some different requirements. 

Benefits of Non-Traditional Financing

Non-traditional financing has many names, but it’s very commonly referred to as “Alt-A”, so that’s what I’ll use moving forward.  There are all sorts of Alt-A lenders serving different “niches”, but here some common uses/benefits of/for Alt-A loans:

·         Non-documentable Income – Alt-A is an option for borrowers that don’t or can’t show much income.  As previously mentioned, self-employed borrowers often have this problem.  Or, if perhaps you work on a cash basis, you can use your bank accounts to offset what you don’t have in income (how it is counted varies).  You often don’t need to provide tax returns or paystubs and retirement accounts can even be used (with restrictions).

·         Recent Major Credit Problems – Traditional mortgages all require significant waiting periods if you’ve had a bankruptcy, foreclosure, or short-sale.  Many Alt-A lenders will let you get a loan one day out of these events, which can be a huge advantage if you want the benefits of not renting for 3+ years.

·         Non-warrantable Condos – Some PUDs (condos/townhomes) can’t get financing from traditional loans because they are non-warrantable (usually because there are too many renters).  This is a very common occurrence, unless the HOA is on the ball.  Many Alt-A lenders will lend against these non-warrantable properties.

Cons of Non-Traditional Financing

Before you jump into an Alt-A mortgage application while the ink on your bankruptcy paperwork is still drying, you’ve got to know the flipside of Alt-A loans.

·         The rates are higher – Traditional mortgages will yield an interest rate (as of this blog post) of about 4.00% (for a 30-yr fixed, conventional).  Comparable Alt-A loans will have interest rates of around 6.50%.  For a $200,000 loan, that’s a payment difference of about $300/month.

·         They require substantial down payments/equity – The smallest down payment requirement I’ve seen for Alt-A loans is 25% (a 75% loan-to-value ratio).  The average is about 33% down and can be as high as 50% down (for people that are 1 day out of foreclosure).  That’s just not an option for most people (especially if you just foreclosed!).

·         They have larger loan requirements – Many Alt-A lenders won’t consider you if your loan is under $200,000.  Traditional mortgage lenders often have incentives for larger loans, but Alt-A lenders often only do larger loans.

When Would You Use an Alt-A loan?

You may have seen a theme here: Alt-A loans are meant for people that get big loans, can put down large down payments (or have lots of equity), and/or have padded bank accounts.  But, there are applications for those of more average means.

·         Getting a good deal on a house – Even though you’ll pay more in interest, if you can get a good deal on a house, the equity you gain can often offset the extra you’ll pay in interest.  You can also refinance out of the Alt-A loan when you can better qualify for traditional financing.

·         Buying an investment property – If you have the cash (even in a retirement account, which sometimes can be used without tax penalties) but can’t show the income, an Alt-A loan can be a good way of picking up a rental or other investment property.

·         Not having other options – As we have tirelessly tried to emphasize, owning is almost always better than renting, even at a higher interest rate.  Some of you may remember when 6.50% was a deal, it’s still lower than the historic average of 30-yr mortgage rates.

As a mortgage broker, we can offer Alt-A loans from a multitude of lenders in addition to our extensive portfolio of traditional lenders.  We often find that there are indeed traditional financing options available for you (which are preferable) instead of the initial intention of getting an Alt-A.  We’re happy to talk about your situation and options with you and find the best way to achieve your goals.

Good Rates, Considering Outlook

While the June rate hike anticipated by the Fed hasn't happened, the economy is improving, and with some soft inflation, rates are continuing to move up.  The Fed has pushed the expected rate hike to September, so these rates are still good compared to what we can expect to see in coming months.

Here are this week's rates:

30-yr Fixed

Conventional:  4.000%*                 FHA/VA:  3.625%*

15-yr Fixed

Conventional:  3.250%*                 FHA/VA:  3.000%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

Rates Still Creeping Up

Conventional rates are continuing to slowly creep back up, while FHA/VA remain about the same as last week, for now.

Here are this week's rates:

30-yr Fixed

Conventional:  3.875%*                 FHA/VA:  3.375%*

15-yr Fixed

Conventional:  3.125%*                 FHA/VA:  2.875%*

*These are the closest “par” rates for the different types of mortgages.  They assume very good credit, sufficient equity, and the absence of other negative risk factors (e.g. property use, cash-out or not, loan amount, etc.).  Different specific risk factors will affect interest rates.

4 Signs You're Ready to Buy a House (And a Few Signs You're Not)

Buying a home is, for most people, the logical “next step” in life, but it is also a major financial commitment.  How do you know you're ready to buy a house?

1.  Your mortgage payment would be comparable to your rent for the same approximate home size/style/condition.  Sometimes rent will be cheaper than a loan payment and vice versa—it depends on the housing market at the time, and how good of a deal you get on either a purchase or rental contract.  You need to consider comparative size and accommodations—if you rent a 1-bedroom condo, your rent is going to be significantly less than a loan payment on a 3-bedroom single family house.  You should also remember that, considering the upsides of homeownership, it’s okay to pay a bit more to own instead of rent.

2.  Your budget is ready.  A good way to determine if you’re ready to be a homeowner is to see if your budget can handle it.  Make sure that you’re able to afford not just the mortgage payment (including the insurance(s) and property taxes), but also the utilities, HOA fees (if applicable), and upkeep/repairs of the home.   If your budget can handle it while comfortably paying for everything else, you’re good to go.  If you’re finding it’s tighter than you’re comfortable with, you might not be ready yet, or you may want to consider a lower-priced home (or one without HOA fees).

3.  You can get pre-approved.  We can help you with this one!  If your credit is at least fair, you have a reliable income, and your other debts are not outrageous, you should have some solid mortgage options.  The best rates are for scores of 740 or higher, but there are great options for scores of at least 600 as well (we can go even lower than that, but your options are limited).  Even if you’re not quite ready, we can help you put together a plan that helps you to be ready to purchase a home as soon as is prudent.

4.  You’re prepared to stay in one place for a while.  As mentioned in a previous post, you normally only need to own a home for a minimum of 18 months in order to make a worthwhile investment (if the market is in your favor), but the more time you can give yourself, the less chance you’ll have of losing money.  Giving yourself a 2-year minimum window may be safest.  If you’re planning on renting out the home, then you can stay in the home for even less time.

 Now that you’ve seen some signs you might be ready to buy a house, consider also the following signs you might not be ready to buy a house:

1.   You aren’t sure how long you’ll be around.  Again, there’s sort of an 18-24 month benchmark to make homeownership worth it, unless you think you can rent the property (and are prepared to be a landlord) if you move before then.

2.   Your income is potentially unstable.  You need to be sure you’ll be able to continue making your payments and keep up with your expenses.  If your income situation fluctuates or you have a temporary source of income, homeownership might not be the best idea right now.

3.   You’re trying to keep up with the Joneses.  Are you better off renting but feeling pressure to buy because your peers are doing it?  Peer pressure isn’t bad if it makes you consider your situation, but if it doesn’t seem right after an honest analysis, don’t buy a house just to be cool.

 If you think you may be ready to buy, contact us so we can get you pre-approved!