Blog Moved to StartwiththeHouse.com

Hello, and thanks for visiting my Blog. I've moved all my new posts over to my new website, www.StartwiththeHouse.com. Please click through to there to stay up to date with the latest mortgage strategies and news. When you "StartwiththeHouse" you can succeed financially.

Regards,
Tom Tousignant CMPS

How long will it take to recoup your closing costs

I read an article in the paper this week from a home finance ‘expert’. She closed with the comment, “be sure your refinancing costs can be covered in about six months”. Great, meaningless, advice.

Where does the ’six months’ rule of thumb come from? (Hint: thin air.) If you are going to move in six months, that is great advice. If, however, you plan on staying in your home for more than a year or so, what difference does the time to recoup closing costs make? If you spend less money on interest over time, does it really matter if it takes you six months, or six years to recoup your refinancing costs?

The real number you need to know

What will be your total cost of financing over the period of time you expect to have your mortgage? A good loan agent should be able to calculate this for you. It’s a pretty simple calculation, but, unfortunately the vast majority of loan agents are never taught how to do this. Their training is ’sales based’ training. That is, they are trained to prospect, present, close, answer objections, and close again. That is why so many loan agents came from other industries, and so many more are now leaving the mortgage business to go back to other sales jobs.
The Total Cost of financing your house is the sum of the closing costs plus the interest you will pay on the mortgage. By knowing the Total Cost, you can make an informed loan decision. As an example, consider the case of Fred and Nicole. They are going to live in their house for at least ten more years. If they can refinance their current two year old mortgage from a current rate of 6.875% to 5.875%, they will save $274 per month. However, with the lender fees, appraisal, and legal fees, they need to spend almost $6,000 to do so. Our newspaper reporter mentioned above would simply divide the $6,000 by 274 and say, “That’s 22 months to recoup your costs, so that’s too long a time period. Don’t refinance and continue paying the bank an extra $274 each month”.

However, using some good mortgage software, or by looking at the amortization schedule, we showed Fred & Nicole that over the next 10 years, a refinance would have them spending $32,850 less on interest. Add back the $6,000 in closing costs, and refinancing now would save Fred and Nicole $26,850 in 10 years.

What to do with the savings

Using the priorities I spell out at StartwiththeHouse.com, the real benefit may not be the $274 per month or $26,850 in 10 years. More important that the Total Cost, may be “What will you do with the savings?” For Fred and Nicole, they had an adequate emergency fund (Step One), carried no credit card or “bad” debt (Step Two), had adequate protection for their house (Step Three), so they were in a position to choose what the best way to deploy the monthly savings was. (Step Four). Fred and Nicole decided, with advice from their Financial Planner, that the best use of that money for them was to continue making the same mortgage payment as before, but now more of their payment would go towards principal and less towards interest. In 10 years, they would have $41,500 more equity in their house by refinancing with a plan.
What this means for you:

• Forget outdated rules of thumb, like the one that prompted this article. If Fred & Nicole needed to recoup their closing costs in an artificially low time frame, they never would have refinanced, and would have a much larger mortgage balance at the end of their 10 year time frame.
  
• Make sure your loan agent can show you the real numbers. Remember, his training may only be in how to close the sale, so if he/she can’t answer your questions, find a mortgage professional who can. www.CMPSInstitute.org is a great place to find a local mortgage planner.
  
• Know the Total Cost of home ownership. Your refinance decision is not about interest rates or closing costs. It’s about the amount of money you will spend to finance your house. Closing costs are irrelevant if you save more money over time with a lower rate. Conversely, the lowest rate with very high closing costs will be very expensive if you need to sell your house in 1-2 years.
  
• (Commercial) If you can’t find someone who can show you the true “Total Cost’ of home ownership, give me a call - that’s what I do.

For most of my clients, their mortgage payment is usually the largest check they write each month. I’ve found that when I assist someone with their mortgage, that if they look at their mortgage in the context of their overall financial picture, they make better mortgage decisions, and better financial decisions.
If the Mortgage is the largest monthly expense, and after time, home equity becomes many families’ largest asset, then isn’t it reasonable to assume that if your financial planning starts with your house, that you have a better chance of reaching your financial goals and succeeding financially?
The idea is to start with the house, and answer questions like these, when you are thinking of buying a house, or if you already own a house, make sure you have answers to these types of questions.

• How expensive a house should we buy?
• How big a mortgage payment should we accept, even if we can qualify for more?
• How should the loan be repaid?
• How should the actual closing costs of a new mortgage be paid
• How important are the income tax consequences of our mortgage decision and how should we maximize our tax savings?
• How can we protect our equity?
• How can our mortgage help us create wealth?

It’s my belief that better decisions and better results come from asking a lot of questions – the fewer questions asked, the more likely that the result will not be as good as it could be. For example, if the only question asked is, “What is the current rate today?” a home buyer could end up with the wrong loan program, an inability to repay the loan, or find themselves unprepared to handle one of the curve balls that life can throw occasionally.
If you are thinking of buying, or thinking about your financial future, I encourage you to “Start With The House” and make sure that your mortgage and your house are helping you succeed financially. Spend some time at my new website, www.startwiththehouse.com and see if you recognize any gaps in your plan. Let me know if I can help.

How Important is Cash in the Bank?

One of the first things I ask people to consider when building their mortgage plan is how much liquid cash they have on hand and how much do they need. In fact, of all the considerations, liquid cash is probably most important. A lot of people learned the hard way that equity in the house in not the same as money in the bank - only money in the bank is like money in the bank.
As you start to build your mortgage plan, you need to ask, "What could happen, good or bad, and does the mortgage / house equity help or hurt me?"
When you look at the threats to your wealth and financial safety, almost everything turns out better if you have $10,000 more cash in a liquid account. Conversely, almost everything turns out worse if you have $10,000 more equity in your house rather than in a bank account. Let's play a few rounds of the game: "Would you Rather":

1. If you lose your job, would you rather have an extra $10,000 in your savings account or a mortgage that is $10,000 lower($10,000 more equity in your house) in order to reduce your mortgage payment by $60 per month?
2. An ice storm hits, knocks out power for a week, and drops a tree limb onto your car. Would you rather have $10,000 cash in the bank, or $10,000 more equity in your house.
3. A friend's co-worker needs cash in a hurry and is willing to sell you his car $5,000 below blue book trace in. Would you rather have $10,000 available to you, or $10,000 home equity that can't be accessed to buy the car?

As you can see, good or bad, having extra cash in the bank is the cheapest and most versatile insurance you can buy - in fact, it's pretty much free. Having some liquid cash available is the first step to creating a mortgage plan that works for you.

I will often recommend people choose to put less money down on their house, or to take money out when they refinance, in order to make sure they have a start on their emergency fund. Most experts will tell you that you need 3-6 months' living expenses in a liquid emergency fund. What I've found is that a lot of people can't see themselves saving that much money all at once, so they never get started. They then develop a habit of not having enough liquid savings and have to turn to credit cards to bail them out of mostly minor problems. Then the credit card interest payments make saving even tougher.

When you put a lot of money in motion, like when you buy a house or refinance your house, it's a great opportunity to start a new habit as a saver and keep some of that money aside to start building that emergency fund if you haven't already. This is one habit you can live with!

If you don't have the ability to create a quick chunk of your emergency fund when you buy or refinance your house, make that the first priority - play another few rounds of 'Would you Rather' and discover for yourself how important is is to get some of your money in your bank account. Choose to build up your savings before you choose to pay extra on your mortgage, buy a new toy, or even pay off credit card bills - just ask yourself which would you rather have as you go through the next year.

Will you ever see your downpayment again?

I was thinking of titling this post, "Why I no longer hate PMI, and maybe you shouldn't either". I was doing some math the other day for a presentation I made at a local Chamber of Commerce luncheon and it struck me - mush of a downpayment on a house will never be seen again by the owner! As an example, assume a buyer puts 20% down on a house purchase to avoid PMI (Private Mortgage Insurance). Some time later, they have a need to access the wealth they chose to store in the house. There are only three ways to get to your equity:

1. Open a Home Equity Line of Credit (HELOC)
2. Refinance the mortgage to get cash out
3. Sell the house.

With each option, a substantial amount of equity must be left behind. For the HELOC option, most of the money will be inaccessible, as the best HELOC's today only allow the owner to get up to 90% of the current value of the house. Several banks limit HELOC's to just 80% of the house value, so that leaves most or all of the equity trapped.

With a cash out refinance, rules changes with Fannie Mae, Freddie Mac and FHA guidelines limit the cash out amount to 85% of the appraised value of the house, leaving 15% of the wealth trapped inside the house.

To sell the house, you, as the seller, could expect to pay 5-6% in real estate commissions and anywhere from 1-3% in state taxes, and likely will not be able to sell the house for the full asking price. in the case of a sale, 6% to 10% could easily be lost in transaction costs, and the time to get access to the wealth could be as long as 6 months or more.

So, if you are thinking of putting 20% down on a home purchase to avoid PMI, maybe you need to run some numbers and scenarios and ask yourself, what if I need my money back? Might you be better off with a smaller downpayment, say 5-10%, even if you had to pay PMI? If you ever really needed the money and then find out the answer is, "you can't have your money back", due to declining property values, loan guideline changes, or a change in your ability to borrow, then suddenly PMI looks really cheap.

What if you only put 5% down, and then your home declines in value by 10% and you are now "upside down"? My first response is, "Who says your house declined in value?" If you aren't selling your house, it doesn't matter what someone says you house is worth, does it? You still have the same square footage, number of bedrooms, location, etc, so if you aren't moving, the alleged value of your house is really meaningless to you.

Your home's value does matter if you need to get some equity from it, and, forces beyond your control, namely property values and loan guideline changes, could make your equity inaccessible to you.

The lesson here - you might be better off with a larger monthly mortgage payment that includes PMI in order to have your money where you can access it rather that blindly following the advice of 'do anything to avoid PMI' and then finding out your wealth is gone.

What to do with an Inheritance, Part two

In may last post, I discussed a case of a family that inherited some money and wanted to pay off their mortgage. The second homeowner I spoke to recently had also inherited money, this time as a result of her spouse's early passing and receiving life insurance proceeds. Her financial advisor is advising her to let him manage the money as he can earn more with it than if it is just sitting in the house. With four children, she is receiving enough social security survivor benefits to pay a mortgage and raise her children. The good news in this story, financially, is that the mortgage balance is much less than the insurance proceeds, so paying off the mortgage won't drain all her savings. Also, her husband had bought the life insurance so that she could pay off the house if anything ever happened to him.

In this case, paying off the mortgage with the inheritance seems like a smart idea: It was her husband's wish, she has more assets left over, other financial needs are covered. (for her, the primary concerns were daily living expenses and education for the four children). Since she will still have her assets diversified between the equity in the house and other savings, she has the structured, regular social security payments for monthly needs, paying off the mortgage doesn't put her financial priorities out of whack.

Most important of all, she and her husband are to be commended for thinking through the unthinkable, coming up with a plan and then funding it properly so that the family can be OK financially during this tough time.

Does your mortgage plan covers the "what if's" in life that could cause real hardship to important people in your life?

Inheritance: Pay off your mortgage?

I've been asked twice in the past few weeks if a person should pay off their mortgage since they just inherited some money. As is most often the case, the answer is, "It depends".
In the first case, this family hated the thought of paying a mortgage for 30 years. The inheritance was just a little larger than the mortgage balance they had, so they could easily use that money to eliminate mortgage payments forever. When we reviewed the financial priorities for this family, we looked at the mortgage, financial protection (insurance), education for their children, and retirement. In each case, the family agreed that the other priorities they had were more important, on paper, than the peace of not having a mortgage. It boils down, as it often does, to the emotional pleasure of not having a mortgage, versus the logic of taking care of more important priorities first, and then paying off the mortgage. For this family, they decided to use some of the money to pay the mortgage balance down while refinancing to a shorter term mortgage. They are putting the rest of the money into retirement and college savings, so they are making progress on three financial goals with this inheritance, rather than putting it all into the house.
Have you been faced with this decision, or if you had this opportunity, what would you do?