Archive for the ‘Finance 101’ Category

To Refi or Not to Refi – Does This Help?

There are a lot of reasons to refinance a home, and a lot of reasons (probably the same number) NOT to do so.  Mortgages Unzipped has provided a good number of analyses recently, including really good ones from Evan Vanderwey and Ken Cook. This post isn’t meant to explore all of the reasons, just to offer one possible calculation for those out there that are hesitant to refinance because doing so 1) resets your mortgage to 30 years again and 2) sticks another dollop of closing costs onto the loan.  Maybe it’s because I do lending in Utah, but it seems that for many people these days, their fondest dream is not to have a mortgage at all.  That’s fine, and I encourage my clients to think that way.  That does not mean, however, that you shouldn’t refinance.

Instead of looking at your loan as a new set of requirements, look at how to fit your new loan into your current requirements.  Stay with me here.  This is going to require you to do some actual forward planning.  But it won’t hurt much, I promise.

First, figure out when you want your home paid off.  Yes, put an actual date on it.  If your 30-year mortgage closing was in October of 2009, that means that you’ll pay the loan off more or less in October of 2039.  Sound like forever?  Okay then, shorten the time.  Put that date anywhere you like.  At this point, it doesn’t matter.

Second, now that we have a date, we have to figure out what payment pays the loan off on that date.  Alternatively, we have to figure out what lump sums at what points will pay the loan off on that date.  The earlier additional funds are paid on the principal balance, the greater the impact those funds will have.  There are excellent calculators out there that can help you do this math.  For instance, on a $200,000 loan, if you want to cut your 30-year, 5% loan down to 18 years, you pay an additional $316/mo, and there you go.  You can accomplish the same thing by putting $3500 down every year in a lump, plus $5000 right at the beginning.  And so on.

NOTE: You’re thinking this is backward.  You’re thinking that what you should do is figure out how much money you can put toward your mortgage, then see how fast it will be paid off.  And of course you can do that, but I wouldn’t.  This is not how savvy people do this calculation.  They know that if they have a target to hit, they’ll move Heaven and earth to hit it.  So they set a date, then they figure out how to arrange things to make that date.  This process makes it much more likely that the plan will work.

Third, now that we have the payoff date set and the payment calculated, let’s find out if the refi gets us to that date faster, or with less cash expended.  Using the same scenario above, the current loan already has a low interest rate, and it has already been paid for 11 months.  That’s an advantage for the current loan.  However, what happens if you refinance it to the current rate, say, 4.5%?  The principal balance after one year is about $197,000.  We’re going to add $5000 in closing costs to that, making it $202,000.  Since you’re looking to pay off, not to drop your payment, we’re going to take the payment you skip (all refinances have a payment skip built in) and pay it as a principal reduction on the new loan.  That drops our principal to $200,900.  Then we have monthly payment savings of $56/mo (from reducing the interest rate).  Doesn’t sound like much.  But over time, it is the difference-maker.  If you target your 18-year payoff, as above, you can pay $30 less per month and still hit it.  If you keep the payments at the same level, the refinanced loan pays off one year sooner and saves you $10k in interest.

And that means (in this case) that you should refinance, if your goal is to get to zero in the shortest time, with the least cash expended.

Now, you can do these calculations yourself, but I wouldn’t.  Your mortgage professional – you do have one of those, right? – can do those numbers in seconds, while you’re doing what you do for a living.

If you need to lower your payment, then this calc won’t help you.  But for those that are aggressively seeking zero, as we say, this is a handy way to figure out how best to get there.

Maybe I’ll Just Go Out on My Own…

Economic times are tough.  There are layoffs and threatened branch closings, all sorts of unrest in the labor markets.  The “recovery” hasn’t shown up at your door yet, and you’re considering going to work with your brother and opening that new office selling the supercool widgets he makes.

It might be a great idea.  Can I offer one thing, as a lender in Utah (and the rules are the same everywhere), for you to think about before you go?

If you’re going to refinance or buy a house, do it before you leave your job – before you even mention to anyone that you’re thinking of doing so.  Underwriters are unkind to the self-employed (and even more unkind to those whose verifications of employment come back with “we don’t think he’s staying here very much longer”).  There are no more stated-income loans (well, essentially), so you’re going to have to document all your income, and not with bank statements, either.  It will be tax returns. And those will be verified by an IRS transcript.

You’re going to want to have a long chat with your accountant.  She’ll probably have some suggestions for ways that you can minimize your tax liability while maximizing your adjusted gross income (AGI), and you definitely want to do that.  Underwriting is going to look hard at your AGI, and there are also add-backs for depreciation and amortization, so you can get some tax relief there without hurting your qualifying income.

But the big thing is that if you are self-employed, you have to have two years of tax returns showing this before you can be qualified for a loan under FNMA/FHLMC (Fannie/Freddie) guidelines.  So it’s going to be at least 24 months, and possibly longer, before you’ll qualify, once you leave.  And don’t try to claim that you’re not self-employed just because you get a W2.  If you own more than 25% of the business, you’re self-employed no matter how you get paid.

I’m not saying you shouldn’t do it.  I love self-employment.  I’ve been self-employed for a decade.  Small businesses are the heartbeat of the economy.  But before you go, get your house in order.  Literally.

Where ARE the Buyers and Borrowers?

Freddie Mac is reporting that mortgage rates have hit a low for the year.  This news is being met with commentary about how borrowers and buyers seem unaffected.  Housing starts are down, purchases fell off a cliff the last 4 weeks…if rates are so great, where are the borrowers?

Here are a couple of clues.

First, and perhaps most importantly, it is really, really hard to sell a house when you owe more on it than you can sell it for.  If you short sell, or send in the keys, your credit will not permit you to become a buyer for a good long while.  There are some million plus people that ordinarily would be prime candidates for purchase that are in this group.  There are tens of millions – some estimates have up to 25% of the homeowners in the US – that are unwilling to trash their credit and therefore cannot sell their homes.  Not all of those people (me, for instance) are interested in moving, but a lot of them are.  That takes some ten million more people out of the market.

But if it were only that, I think the low rates would be having a significant impact.  Unfortunately, there’s something worse happening.

This is the second problem.  Let me use an analogy here.  Getting a mortgage loan is like running.  Once upon a time, say, 2006, getting a loan was a lot like running a 100-yard dash.  Practically anyone can do this.  They might not be very fast, but it is likely that all but the very most obese would be able to run 100 yards without stopping.  Roll out of bed, go to the track, run 100 yards.  Roll out of bed, go to a loan officer, get a loan for a home.  Pretty much, that was that we had four years back.

Fast forward to 2010.  Lenders are terrified.  Foreclosures are everywhere.  10% of the workforce is officially unemployed, with another 10% or more practically so.  The only hiring going on is being done by the US Census.  Homes are underwater.  It’s not a good lending environment.

Add to this something we forget, and that is that low rates are good for BORROWERS, but they suck for LENDERS.  If you’re getting 10% on your money, a higher foreclosure rate won’t kill you.  When you get 4.5%, it does.  So let’s just sum up with “lenders are skittish”.  When they get skittish, they lock down on qualifying.

Roll out of bed.  Go to the track.  Run a 10k.


Most people cannot do this.  The average Joe and Jane are unable to run 6 miles without stopping.  There is a segment of the population that can, of course.  You know which ones those are, because they are actively running, and quite regularly.  But out of the next 100 people you meet, how many could run 6 consecutive miles?  10? 5?  Not many.  Many people, say another 35-40, could be able to run a 10k in 90 days or so.  They’d have to train, but no major lifestyle changes would be necessary.  The other 50?  They would have to significantly alter their diets, start getting some limited exercise, and train up.  It would take a while.  Six months.  For some, a year.  For some, it would never be possible, whether for health reasons or sheer unwillingness to change.

And that’s where we are with mortgage loans.  There is a segment of the population that can qualify just by showing up.  It’s a small segment now, and it’s the segment that is financially savvy, very careful, saves money, made a sizable down payment and/or bought their house several years ago and never cashed out of it.  That’s 10-15% of the population.  Then there’s another 35% or so that might be able to qualify if they worked at it.  They’d have to pay down some debt, fix up the house, sell a car.  Save some money (this one is the kicker).  Many of these people have credit issues that need fixing.  But a little guidance and they can get there.

Problem is, they don’t get the guidance.  It’s hard to train for a 10k.  It hurts.  You try to do it yourself, you’ll find its quite difficult to do.  If you have a coach, someone that can tell you that those shin splints you’re getting are not going to go away without rest, and “shake it off” is not going to work, then you’re far, far more likely to get where you need to be to run your 6 miles, get your loan.

[AN ASIDE: why did the $8000 tax credit make such a difference?  Because the hardest thing for people to do is to save money.  They cannot come up with a down payment.  Inasmuch as there are only two kinds of 100% loans anymore - USDA Rural (currently out of money with 6 months left to go in the fiscal year) and VA - the $8000 credit allowed a lot of people to get a "gift" from mom and dad (or, let's face it, from Visa), put the cash down on the house, then use Uncle Sam's largesse to pay it back.  PRESTO!  100% financing.  That's gone now, and the pool of buyers is shrinking fast.  It's like having a rabid dog chase you while you're running.  Amazing what you can do in that circumstance.  But it's a short-term thing, and it has negative consequences that show up later.]

Then there are the remainder, the 50% that really need to change radically.  Those people will almost NEVER get there without help.  They need radical credit surgery, a draconian budget, major lifestyle changes.  Without a coach that really cares, and will take the time to design a program that they can stick to, then help them stick to it, they will not be able to qualify in six months to a year.  They will not ever be able to qualify.  That’s HALF of the population.

You want to know where the borrowers are?  They’re stuck in their homes that they wish they could sell.  They’re unable to qualify for loans.

So woe is me, all of us in real estate are doomed.  Or are we?  I have outlined the problem.  There is a solution.  Want to hear it?  It’s really quite simple.

Unfortunately, I have to go do some mortgage work now.  But during Mexico/South Africa tomorrow, I’ll post the answer.

A Primer on Federal Tax Credits

Many people have been asking recently how the Federal tax credit works for home purchases.  Here is the straight dope:

If you:

  1. Have not owned a home in the last 3 years (this means you have not been on the title of a primary residence)
  2. Have income less than $250,000 last year
  3. Are purchasing a home less than $720,000 in value
  4. Have your new home under contract (this means a written agreement signed by both parties) by April 30
  5. Close the purchase (this means sign the documents, fund the loan, and transfer the title into our name) by June 30

then you qualify for an $8000 tax credit on your federal taxes.  The credit is fully-refundable, meaning that you get it even if you owe no tax.  You may file it on your 2009 taxes.  You may also file your taxes now, close later, and file an amendment claiming the credit.  The rumor is that the IRS will audit everyone that takes this credit* (seems unlikely, but that’s the rumor), so be forewarned.

For the long-time homeowner tax credit:

If you:

  1. Have owned your primary residence for at least 5 years
  2. Have occupied that home as your primary residence for four consecutive years of the five
  3. Purchase a new home (new to you, it does not have to be new new)
  4. Get the new home under contract (see above) by April 30
  5. Close the purchase (see above) by June 30

then you qualify for a $6500 federal tax credit.  Same terms apply as those above, except that there is actually a way to document your qualifications, and you should expect to have to.  Ask for a copy of the title report on your current home; your mortgage lender should be happy to provide that.  We are, anyway.

*It being impossible to prove a negative – how, exactly, can you prove that you have NOT been on title on a home in the last three years? – I don’t know how the IRS will be able to dispute this.  They will surely ask for a credit report, and it would be a really good thing if there were no active mortgages on it in the last three years.  But if you own a home outright, it’s going to be complicated for the IRS to prove that, especially if you have some sort of rent that you claim on your taxes.  Not encouraging anyone to cheat, here; I’m just sayin’.

Utah Appraisal Value Warning!

Specifically, Utah County.  Our latest batch of appraisals in the Utah County area have come in about 10% lower than projected.  Since we run all of our appraisals through the best AMC on earth, 1st Choice AMS, we know these are not appraiser-specific values.  These are across the board, almost all properties, all appraisers and all loan types.

This is a warning for those of you that do business in Utah County.  Expect your values to be low.  We have not noted this problem in Salt Lake County, so at the moment we think it’s a phenomenon restricted to Utah County and southern environs.

Here’s our take on why this is: everyone knows that the $8000 first-time homebuyer credit is expiring in 90 days.  In Utah County, with its two large universities spewing forth about 10,000 graduates a year, there is an abnormally large population of first-time homebuyers.  That means that for the next little bit, that cohort, being especially active, is going to have disproportionate impact on home values.  When shopping for the thousands of properties out there, which is going to be most attractive to you: $198,000 or $204,000?  It’s human nature.  If the houses are even reasonably similar, the lower price is going to win, but here you also have the famous $1.99 effect working against you.

One of our most recent appraisals reaffirms this rather directly.  The house appraised for $203,000.  There were two comps in the low $200k range, each had been on the market for 300 days or longer.  There were 2 comps in the high $190k range, and their time on market was 42 days and SEVEN days.  The stuff that’s selling, people, is the stuff right under the K, at $295k and $195k, so if your house wants to appraise at $310k or at $210k, you might find that you’re in trouble.

Just a word to the wise.