Mortgage on Upcoming Home Purchase

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goaztecsfight
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Mortgage on Upcoming Home Purchase

Post by goaztecsfight »

Hello... I am going to be taking out a loan of roughly 380K for a home purchase. The lender is offering 4.5% fixed on a 30 year mortgage but 1% ( 3800 ) is due at closing. The other option is for 4.625 % with no closing costs. What is the preferred option ? Also I am selling my home and coming away with 360K after fee's. Should I wrap all of the proceeds into the home to keep the payment lower ? I am having a hard time deciding because my retirment accounts are fairly underfunded and I have always had low savings balances. I'm 38 wife is 36 and we are largely debt free.
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deanbrew
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Re: Mortgage on Upcoming Home Purchase

Post by deanbrew »

P&I on a $380k mortgage at 4.5% is $1,925 per month. P&I on a $380k mortgage at 4.625% is $1,954 per month. So, the break-even point is 131 months, or 10.9 years, without considering that you have to cough up $3,800 up front and lose the chance to earn interest/returns on that money. I would choose the slightly higher payment and not pay the upfront fee.

As for "Should I wrap all of the proceeds into the home to keep the payment lower ?", that is a topic that is debated very regularly here in Bogleland. It depends on a lot of things, and you can look up a huge number of previous threads to help make that decision. Hint: there is no right or wrong answer, so long as you save/invest and don't just spend all of the money you get from selling your current house.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson
sterlingcooper05
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Re: Mortgage on Upcoming Home Purchase

Post by sterlingcooper05 »

I'm assuming you're putting enough down to avoid PMI. If not, I would at least do that. Have you considered a 15 year mortgage? I was in a similar position last year and put enough down to keep my payment affordable on a 15 mortgage with a lower interest rate. The interest savings is significant. With the tax law change, I'm not going to deduct mortgage interest anyway. Putting SOME of the sale proceeds into the new house while investing the rest makes sense to me.
mak1277
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Re: Mortgage on Upcoming Home Purchase

Post by mak1277 »

No closing costs for me thanks.
soccerrules
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Re: Mortgage on Upcoming Home Purchase

Post by soccerrules »

Hard to really answer without more info.
How much do you have in 401k,403B, IRA's now ?
How much in Taxable Account ?
Emergency Fund amount ?

How much are you automatically saving in these accounts each month/year ?
Will your savings amounts change with new house ? (bigger house cost more to maintain, utilities, taxes, insurance, furnishings)

What is New Worth ?
How much would house represent of Net Worth if you used all proceeds in new house transaction?

What are your plans for retirement ? (FIRE ? )
Kids ? (college for kids?)

In general most people don;t recommend having bulk on NW in your house. You could make the case to use some of the proceeds for the house to help bring down cost and some into savings -- how much ?
I have also read that is it typically not a good financial move to "pay for points" on a loan -- but someone else can probably show you the numbers.
Don't let your outflow exceed your income or your upkeep will be your downfall.
delamer
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Re: Mortgage on Upcoming Home Purchase

Post by delamer »

soccerrules wrote: Tue Jul 24, 2018 10:54 am Hard to really answer without more info.
How much do you have in 401k,403B, IRA's now ?
How much in Taxable Account ?
Emergency Fund amount ?

How much are you automatically saving in these accounts each month/year ?
Will your savings amounts change with new house ? (bigger house cost more to maintain, utilities, taxes, insurance, furnishings)

What is New Worth ?
How much would house represent of Net Worth if you used all proceeds in new house transaction?

What are your plans for retirement ? (FIRE ? )
Kids ? (college for kids?)

In general most people don;t recommend having bulk on NW in your house. You could make the case to use some of the proceeds for the house to help bring down cost and some into savings -- how much ?
I have also read that is it typically not a good financial move to "pay for points" on a loan -- but someone else can probably show you the numbers.

I agree with all of the above.

The bottom line is that you don’t want to tie up too much of your net worth into an illiquid asset like your house.

Think of it like this — in the event that you lost your job, would you rather have $50,000 in a savings account to make a $2,000/month mortgage payment or $0 in the bank (because the $50,000 went to increase your downpayment) to make a $1,700/month mortgage payment?

The number are made up, but you get the drift.

Liquidity is more important than most people understand, until they need it and don’t have it.
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jimb_fromATL
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Re: Mortgage on Upcoming Home Purchase

Post by jimb_fromATL »

goaztecsfight wrote: Tue Jul 24, 2018 9:48 am Hello... I am going to be taking out a loan of roughly 380K for a home purchase. The lender is offering 4.5% fixed on a 30 year mortgage but 1% ( 3800 ) is due at closing. The other option is for 4.625 % with no closing costs. What is the preferred option ?
The "no closing cost" loan will cost several thousand dollars more. And there's virtually no place you can invest the $3800 that will give you as good a return as paying it to get the lower rate mortgage -- with no risk at all. Essentially the "no cost" loan would be financing the whole $380K at a higher rate, and financing the $3800 at the higher rate too.
deanbrew wrote: Tue Jul 24, 2018 10:13 am P&I on a $380k mortgage at 4.5% is $1,925 per month. P&I on a $380k mortgage at 4.625% is $1,954 per month. So, the break-even point is 131 months, or 10.9 years, without considering that you have to cough up $3,800 up front and lose the chance to earn interest/returns on that money. I would choose the slightly higher payment and not pay the upfront fee.
There is no break-even point for the borrower. Your own numbers illustrate that the "no closing cost" loan will cost more. You just didn't go quite far enough with your calculations.

If you pay $3800 up front and finance $380,000 at 4.5% for 360 months (30 years) the payment for P&I is indeed $1925.40 per month. The total cost will be 3800 + (1925.40 x 360) = $696,946 with $313,146 interest on the loan.

If you pay $0 up front and finance $380,000 at 4.625% for 360 months (30 years) the payment for P&I is $1953.73 per month. The total cost will be 0 up front + (1953.73 x 360) = $703,343 with $323,343 interest.

Notice that the total is $6,397 more for the "no cost" loan to avoid paying $3800 out of pocket up front.
Also I am selling my home and coming away with 360K after fee's. Should I wrap all of the proceeds into the home to keep the payment lower ? I am having a hard time deciding because my retirment accounts are fairly underfunded and I have always had low savings balances. I'm 38 wife is 36 and we are largely debt free.
Need more information about your age, tax brackets, savings for emergencies, anticipated income and sources of income in retirement, and how much you're contributing to retirement now.

As the market now stands, there is no place you can invest that $360K in after-tax, taxable accounts that can give you as good a return on your money as just paying down the mortgage, with no risk to the principal. However, depending on the information asked about above, it might be a good idea to keep some of it for emergencies.

Personally I'd want to have at least 6 months to a year of living expenses -- including the mortgage payment, property taxes, insurance, etc. along with all other month-to-month living expenses before I tied up the remainder of the money in home equity. You cannot beat the absolutely guaranteed rate of return on the money for paying down the mortgage, but it's somewhat like buying a CD or bond that you cannot easily cash out until its maturity date -- which could be many years down the road.

Another possibility -- depending on the above factors -- is that if you're not contributing the max to any available tax deferred retirement accounts because of previously having a mortgage payment that was too high, you could actually come out better by paying a big chunk -- maybe half or more -- of the proceeds of your old home to buy the new home, keep some of it for an emergency fund, and use some of it to pay bills IF that is necessary to be able to invest more to a 401(k).

So ...

How old are you?
When do you plan to retire?
How much would you need in savings to be able to go 6 months to a year without income if you were to lose your job?
Do you have a 401(k) or other plan available, and are you contributing the max allowed to it?
What are your top tax brackets for federal and state?
How much do you have saved for retirement in tax deferred or tax-advantaged accounts like 401(k)s and IRAs?
Will you have a pension or other income for retirement ... in addition to social security?

Incidentally, I mentioned that you will come out better by paying the $3800 closing up front out of pocket. However, it's not clear to me whether you'll have the $360K in time to use a bunch of it for the down payment too. If you won't have the money until after you close the new mortgage, it would be worthwhile to seek a lender who will include a low cost one-time "recast" option in the contract.

The way this works is once you get the loan, for a small fee you can make a large extra payment to reduce the unpaid balance, then "recast" to a smaller minimum payment -- still at the same rate. You can still continue making the higher payment of the original schedule, but you will have the option to drop back to the lower payment if you were to fall on financial hard times, or if it would be necessary in order to be able to afford to invest more -- up to the max -- in your 401(k) or other retirement account.

Here's how a recast might work if you haven't sold your old home yet:
  • We showed that if you borrow the $380,000 at 4.5% for 30 years. The payment would be $1925.40 per month. The total interest would be $313,146.

    After 6 months, the balance would be $376,969.

    if you sold your old home and used some of the proceeds to pay $180,000 on the principal, the new balance would be $196,969.
    Recasting the payment for $196,969 at 4.5% for the remaining 354 months would reduce the payment to $1006 per month.
    If you made the smaller payment, you would pay 1006.04 x 354 = $356,138 more with $159,168 interest. That's a total of $167,690 interest, for a savings of $145,456 compared to the original $313,146 interest.

    If you were to continue paying the original $1925 payment the new lower balance of $196,969 would be paid off in 129.28 months -- a total of $248,920 more payments and $60,473 more interest.

    This way, the total time to pay off the mortgage is 135.28 months (11.27 years) with $60,473 interest. That saves a total of 225 months and $252,673 interest compared to the original $380,000 mortgage for 30 years.
jimb
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deanbrew
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Re: Mortgage on Upcoming Home Purchase

Post by deanbrew »

The no closing costs loan will cost more only if the borrower keeps the loan for more than 11 years, or longer if you consider the opportunity cost of forking over $3,800 up front. I am not a fan of buying down interest rates with upfront money, which is effectively what is happening. That is a pretty long time to not move, refinance or pay down the loan.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson
JGoneRiding
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Re: Mortgage on Upcoming Home Purchase

Post by JGoneRiding »

deanbrew wrote: Tue Jul 24, 2018 9:02 pm The no closing costs loan will cost more only if the borrower keeps the loan for more than 11 years, or longer if you consider the opportunity cost of forking over $3,800 up front. I am not a fan of buying down interest rates with upfront money, which is effectively what is happening. That is a pretty long time to not move, refinance or pay down the loan.
I believe the average rate of time to keep a loan is 7 years. I have one I will keep long term but I have owned it for 11 years and refied at 3. Yr. The rate is 3.875% I don't expect to see that number again.
g2morrow
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Re: Mortgage on Upcoming Home Purchase

Post by g2morrow »

deanbrew wrote: Tue Jul 24, 2018 9:02 pm The no closing costs loan will cost more only if the borrower keeps the loan for more than 11 years, or longer if you consider the opportunity cost of forking over $3,800 up front. I am not a fan of buying down interest rates with upfront money, which is effectively what is happening. That is a pretty long time to not move, refinance or pay down the loan.
+1
Admiral
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Re: Mortgage on Upcoming Home Purchase

Post by Admiral »

If you cleared over $300k on your existing home sale, I would not be stressing over $3800. What I WOULD do is pay more down so the new loan is a) lower and the interest is b) less. If you do that then all the math in the world won't make a difference about your $3800...you'll be saving money.

W/o knowing your full financial picture it's hard to say how much more you should put down, but you've just gotten a windfall. I would immediately start maxing out all pre-tax retirement space; earmark some of the home sale money for your living expenses if you cannot afford to max both you and your spouse's retirement contribs and still pay the bills. You can map out how much/how long you can afford to do this, but the effect is using non-taxed money (the home sale profit) while also getting a large tax deduction (maxing out retirement space). You should also open Roths and fund them.
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goaztecsfight
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Re: Mortgage on Upcoming Home Purchase

Post by goaztecsfight »

Thanks for all the replies and insight. I'm leaning toward putting 40% ( 270k ) and making sure to fill up tax advantaged space this year. Im also leaning toward not buying down the rate. The rest I'm planning on keeping in a good 12 month CD or high yield savings. Either repeating next year or maybe buying a rental property..? Real estate is golden in the Monterey Bay area. My wife and I have retirement accounts but they are very low for our age. Combined 20k range. Emergency funds are solid and job stability are very solid, as I work for my family's business and expect to get significant raises going forward. My problem is that cost of living is very high in the bay area and I got started late in investing (38 and 36 ) and the contributions have been sporadic. Essentially most of my net worth is in real estate and it seems right to diversify somewhat.
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jimb_fromATL
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Re: Mortgage on Upcoming Home Purchase

Post by jimb_fromATL »

g2morrow wrote: Thu Jul 26, 2018 7:23 am
deanbrew wrote: Tue Jul 24, 2018 9:02 pm The no closing costs loan will cost more only if the borrower keeps the loan for more than 11 years, or longer if you consider the opportunity cost of forking over $3,800 up front. I am not a fan of buying down interest rates with upfront money, which is effectively what is happening. That is a pretty long time to not move, refinance or pay down the loan.
+1
Seems to me that the borrower paying discount points in advance to get a lower interest rate is almost exactly the opposite of having the lender advance the closing costs and getting their money back in a higher interest rate.

With points to reduce the rate, you pay all the extra interest up front. (Historically, points typically have been calculated to break even for the lender in about 5 years.) So if you don't keep the loan long enough to reach that break even point, the lender wins. The longer you keep it after the break-even point, the more you win, because you have a lower interest rate for the rest of the life of the loan.

With a "'no closing cost" mortgage, the lender is effectively loaning you the money up front without adding it to the balance, and planning to get it all back in extra interest because of the higher rate. Once the lender breaks even in getting their money back, then the longer you keep the mortgage after that the more they win and you lose because you're paying a higher interest rate.

You cannot count on beating the lender at their own game by paying off the mortgage early before they break even, either. The fine print usually states something to the effect that the credit will only be waived IF you keep the loan at least 3 years or so; else an early payoff penalty is imposed to reimburse them. (Lender-paid PMI and cash back rebates at closing are usually that way, too.)

However ... I have observed that the waiver or early payoff penalty period is not always long enough for the lender to recoup all of their up-front costs. I'd guess that actuarially, they figure that the loans which do go longer (plus the loans that they may get away from competitors with this shiny lure) probably pay enough extra interest to make up for the ones that are paid off after the penalty period but before the full costs are recouped.

So ... there could possibly be a narrow window of opportunity for a borrower to come out ahead if they pay off the loan after the penalty period but before the lender has actually recouped all their costs in the higher rate.

Not sure what kind of crystal ball would be necessary to predict whether that might ever be practical. But for someone who has the money to spare now it makes no sense to me to gamble on saving few bucks if you sell early compared to paying a lot more interest if you decide to keep it longer. And if there's any question at all of how long you might keep it, you'd be more likely to win by rolling the costs into the mortgage balance and keeping the lower rate.


As for breaking even, I still don't think you went far enough with the math. Here's why:
  • It look like you came up with 11 years for "break even" using the difference in payments, which is $28.33. Dividing 3800/28.33 = 134.15 months (11.18 years). It is true that the total paid is the same on either loan at that time. But you are not "breaking even".

    Looking at the two amortization schedules ( by using the FV (FutureValue) math library function to walk through the amortization schedules for us) :

    =FV(4.5%/12,134.15, 1925.40,-380000) … returns $292,965
    =FV(4.625%/12,134.15, 1953.73,-380000) … returns $294,282

    After 134.15 months (11.18 years) on the 4.5% loan with the $1925 payment, you will have paid 3800 + (134.15 x 1925.40) = $262,098 with $87,035 principal and $171,262 interest, along with the $3800 up front. The lender has pocketed $175,062. You will still owe $292,965 on the loan.

    After 134.15 months (11.18 years) on the 4.625% loan with the $1954 payment, you will have paid 134.15 x 1953.73 = $262,098 with $85,718 principal and $176,380 interest. The lender has pocketed $176,380. You will still owe $294,282 on the loan.

    You have indeed paid $0 difference out of pocket, but you have paid $5118 more interest on the loan to avoid paying $3800 up front. You will have paid $1318 more as costs to the lender, and owe $1318 more on the balance. The lender is up by $1318.

It is not "breaking even" when you owe more on the debt after paying exactly the same money out of pocket to the lender.

IMO it's not really an apples to apples comparison anyway. To be fair, you'd need to compare paying the same money out of pocket at closing AND the same monthly payment on both loans. Otherwise you're speculating on whether you can earn as much on the $3800 somewhere else as you can avoid by paying it on the mortgage. The same goes for paying the higher payment on the lower rate mortgage.

jimb


PS: Here's where the lender breaks even on this particular loan:
  • After 98.1 months (8.17 years) on the 4.5% loan with the $1925 payment, you will have paid 3800 + (98.1 x 1925.40) = $192,681 with $59,203 principal and $129,678 interest, along with the $3800 up front. The lender has pocketed $133,478. You will still owe $320,797 on the loan.

    After 98.1 months (8.17 years) on the 4.625% loan with the $1954 payment, you will have paid 98.1 x 1953.73 = $191,660 with $58,182 principal and $133,478 interest. The lender has pocketed $133,478. You will still owe $321,818 on the loan.

    So ... the lender is even. Your extra interest has made up the $3800 difference. You have paid $1021 less out of pocket, but owe $1021 more on the balance.

jimb
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