Everything You Need to Know About Mortgages!

hey money guy family you probably have questions about mortgages this is an important decision we've got a best of series that's going to hook you up and likely it's connected to the largest purchase that you will ever make so you want to make sure that you do it right it's brian preston the money guy i get it when you go read books like chris hogan has a great book everyday millionaires he shows that the average millionaire pays their house off in 10 years you see that that's a headline and you're like wow so a 15-year mortgage is going to be probably what i need to do i need to get out of debt as fast as possible if you go read the detail or go listen to interviews of what chris hogan has talked about he has he has shared that that was not this person's first house this was typically the millionaire realizes in their 40s or 50s so this is probably their second or even third house and yes that is probably i resemble a lot of that and it is true i will have my current house paid off within 10 years but this is not your first house exactly because realize there's a lot of 25 year olds there's a lot of 30 year olds there's a lot of 35 year olds that are watching this show and you're being financially shamed in the fact that because you have so many talking heads they'll say this is the way you should do mortgages you should do 20 down and finance them over 15 years and you're seeing that you're like i live and the cost of living is going up in my community the cost of housing is going up i feel like i'm on a treadmill where i can never catch up and you know who can put down 20 on a 15-year mortgage rich people that's right and we're trying to get you to rich people's status but a lot of us don't start at rich people's status we have to kind of build the blocks to get there so i want to kind of give one more reason why i think you can give yourself a little more breathing room without disrespecting how much you should spend on housing to the rest of your financial life so realize money guy rule that we talk about housing should be 25 of your gross income that's your top line you can't go over that if you go over that perhaps you're buying more house than you can afford so how you spend that 25 we're going to give you a lot of flexibility and freedom and i'm also we've confessed this before and i know we take a little flack but i like to be very transparent with you guys my first house i put down five percent bo's first house three and a half percent so and we went around and interviewed a lot of our staff and i think only two of our employees put down 20 on their first house i think it was carter it might only be one it might have been eric but there was only two employees because even carol surprised me because she is miss cpa mrs cpa super conservative great with her money she even confessed she was just like me she didn't put down a full 20 and we get it when you're young and you're you're trying to to do all the things you're trying to do financially with the kids the family the job saving for retirement life is kicking you in the rear end your wallet is just not gushing with overflow so you're trying to make sure every dollar has a purpose and you're doing it so that's why i want to give you that breathing room to be real with you so i don't just look like a successful guy that's now shaming you because you're not putting down 20 and doing a 15-year mortgage because also think about every house decision you make you got to raise the kids there so if you're raising the kids let's talk about if you only have a certain pot of money it's at 25 of income let's look at some of the realities of how that actually plays out too yeah so again in true money guy fashion why not let's do another case study so let's assume that you have a family that in the household they make a hundred thousand dollars a year uh we know that housing costs can only go up to 25 of your gross income so that's 2083 dollars a month is what your housing costs can be but we also know that when you buy a house there are other things that come along with it it's not just principal that's exactly right they're gonna spend about 600 a month on utilities taxes and insurance so what that really means is when they look at their mortgage payment that leaves about one thousand four hundred and eighty three dollars a month that they can spend so the question then becomes if one thousand four hundred eighty three dollars a month is what i can spend how much house can i afford how much house should i buy with that so let's let's look at this because i thought this was a very important thing in america right now we know that the average size of a house in america is between 2600 to 20 800 square feet and we also know now people in new york people in california go laugh at this next number i tell you because i try i just had to choose a number because it depends upon where you build a house or where you buy a house cost per square foot i just landed on a hundred and thirty dollars a square foot now even here in nashville we're laughing about that number because that's super low but in other parts of the country like georgia where we came from you could buy a house for a hundred dollars a square foot so i just landed on 130 so that way i know i'm gonna get laughed at by the coast and we'll get laughed at it places like in nashville but it at least gives us a conversation point because it's low on purpose to be conservative so if we know that housing is a hundred and thirty dollars a square foot how much house can you afford to buy if you know what that 1400 a month housing payment can buy so here's what we figured out if you're looking at a 15-year mortgage you can afford a mortgage of 207 000 and at 130 dollars a square foot again this is assuming after 10 down payment you can buy a house that has about 1 769 square feet and i think you even had the number brian this isn't a house that's equivalent to 230 000 exactly right so okay that is an idea so for a young family starting out 15-year mortgage 230 000 house 1769 square feet without changing your cash flow without spending more money without having more cash without going outside of your 25 realm we said well what if instead of doing a 15-year mortgage we decided to do a 30-year mortgage how much house could we afford on our 1 483 a month mortgage payment wow look at that that's a that's a dramatic difference now you can afford a 367 000 house probably around 2 800 square feet so that you know that the kids you get a you get enough house that it's not so big that it's going to be a mess to maintain but it's big enough that you don't feel like every time you walk you're stepping on a lego and tripping and hurting yourself i mean i think that this is a big part and here's something that i like to always close with an exclamation point on this issue a 30-year mortgage can very easily especially when you're at interest rates as low as we currently are a 30-year mortgage can actually be a five-year mortgage a 30-year mortgage can be a 10-year mortgage it can be a 15-year mortgage it can be a 20-year mortgage they don't have prepayment penalties so all you have to do you have maximum flexibility that all you have to do is pull out your nerdy financial calculator change your maturity date that you want to have the loan paid off and start increasing your monthly payment guess what your 30-year mortgage magically just like a transformer has converted itself into a 10 or 15-year mortgage now reverse that you go ahead and you do the 15-year mortgage and you look at it and maybe you decide because i'll tell you my personal story 15-year mortgage i learned remember wisdom is created through experience did a 15-year mortgage on my second home so proud of that it was at four and three quarters which was a steal on a 15-year mortgage at the time but then we decided we were going to be moving all of a sudden i'm kind of regretting that 15-year mortgage because i knew that there was a period especially moving to tennessee i might have two houses for a little period of time and believe me having the squeeze of a 15-year mortgage then plus a new 30-year mortgage it would have been a lot better if this was a 30-year mortgage and this was a 30-year mortgage so that i could have the flexibility the same thing happens to you guys when you do a 15-year mortgage can it become a 20-year mortgage bow nope can it become a 25-year mortgage not without refinancing it sure can't become a 30-year mortgage and i found that out so if you want maximum flexibility i will tell you there's nothing wrong with still having the intention of paying your mortgage off in 15 years but doing a 30-year mortgage because there's no prepayment penalty go ahead knock it out of the park get yourself the flexibility it also allows you because here's the other great thing i like about money guy family members we all start somewhere yeah i mean my first salary right out of colleges 28 000 a year can't afford a lot of house at 28 000 a year but the good news is is just like a lot of you guys you're on the i mean we start at the bottom but now we're moving up to here so you know your income is going like this do the do the mortgage financing so that you have maximum flexibility so that when your pay raises come you will have the flexibility you can always accelerate those payments but let's go over some money got teachable tips yeah i was going to say so what what is our recommendation in terms of how you approach more mortgages than paying off mortgages and brian i i don't know i don't remember when this happened but one day i think you just woke up and you came up with a number but it's just such a good number you you finally said look there's a dividing line if you're on this side of the line doing one thing if you're on this side of the line do something different and it's all it's all driven by the fact of compounding growth for your retirement assets and you know what you can expect but also try not to take too much risk that you don't run the whole enterprise into the ditch so there's a balance there and i think anybody under 45 you're really kind of it doesn't make sense especially an interest rate environment like right now where you can get a three and a half to a four and a quarter percent interest rate you don't there's no reason to go pre-pay all that stuff while you could have growing assets that you'll need for retirement but then when you get over 45 i think that it's okay you want to simplify your life is changing the compounding growth effect is not as powerful as it was when you're 25 years old why not get out of debt completely and look i had this discussion just a few days ago somebody said why would you ever pay your mortgage off and i was like it's not a numbers point at that point there is a point where you're going to cross over was from a psychological standpoint from a peace of mind standpoint that's why you want to own your life at retirement is because the word encumbrance which debt is does not go at all with financial independence how are you independent when you have something that is encumbering and creating an obligation for you you know and i think sometimes brian i get caught in this trap of uh so stuff that's common sense to me i recognize it's not always common sense the people that i'm around i've had this conversation four times in the last month talking with young folks who've had a desire to pre-pay their mortgage and i say i think it's great if you want to get out of debt and do that but by putting the money on the mortgage and and satisfying the mortgage you may not be doing yourself any favors because you still have the ability if you say you know what i want to pay off my mortgage in 10 years you could still save that money outside of paying off the mortgage build up an after tax account and then if you so chose 10 years from now you could just write a check and pay off the mortgage what it does is it leaves maximum flexibility in your corner because every once that dollar goes into the mortgage we just saw what happened to you in 2000 it's hard to get that dollar back out especially there's some sort of downtrodden i want to go a little deeper because if i had a house i showed an example earlier if you're watching a highlight and so the full show if you go watch the full show i showed that my house at the end of 2006 back in georgia was worth 510 000 but just four short years later less than four years was like three and a half years it was worth 270 000 so all that equity kind of evaporated so think about this in terms of if you were prepaying your mortgage if you're 25 or 30 year old or 35 year old who's just dumping money to get debt free you don't really get the benefit of flexibility of saving that monthly payment until it's completely debt free that's right if something if it's going to take you 10 years to hyper aggressively pay off that mortgage but you lose your job in year six it's not easy to go pull all that six years of aggressive payment back out you'd probably be better served from a flexibility if you had that money in something liquid like an investment account and if it's a diversified investment account you probably wouldn't have to go yank all of it from equities that are down you might be able to go pull some of it from from conservative assets to bridge getting over the life stuff that just happens yep people need to understand we love you paying down your mortgage i don't want you to mishear me i do want you to be completely debt free as you approach retirement but you have to understand the power of compounding interest there's about 20 years that you need to maximize all the opportunities plus all the craziness that happens in the messy middle today we want to do a case study that kind of proved our point a little bit further and we're going to walk through some common misnomers because we keep hearing for you guys which we love we love hearing your feedback we love hearing you guys leaning in saying no no guys you forgot about this oh well what about this oh well what about this well we didn't actually forget about those things we're going to address them front and center today as we kind of walk you through what we think are the pitfalls of paying off your home early so of course we couldn't start this show without having an fte daniel case study and i thought it was interesting we changed the name from dave to paul because a lot of people thought and that was truly that was the last time we did this we didn't do dave it was totally freudian dave at all so we changed the name to paul and melissa now we chose 33 years of age here's why we did this this is what i said daniel go find me what the average age for first-time home purchasers are and it was 33 years of age so that's the age we've made both paul and melissa i found that so interesting because you were you weren't 33 when you bought your first house were you 20 25 and i was 21 when i bought my first house maybe 24. so when i heard 33 that just seemed but it makes sense you know you hear me a lot of houses are a nickel here in in georgia well not in tennessee but well not in nashville in georgia houses were a nickel so it was it was a lot easier to buy a house when you're 24 years old whether they're cheap i just thought that was really interesting but we said okay so we want to stack the deck here and actually look at these two savers all right so we're going to look at paul and we're going to look at melissa and we're going to assume that they both buy a home they're going to purchase the home for 300 000 uh they're going to be responsible put 20 down so they both are going to take out a loan of 240 000 all right so we have equivalent purchases equivalent consumption here so if we look at paul he says you know what i want to be debt free as early as possible and i've listened to all kinds of shows and i follow all the financial stuff and i know that a 15-year mortgage is the best way to do that so i'm going to go out and get a 15-year mortgage but melissa says you know what i listen to the money guy show and i've heard about this thing with this army of dollar bills and so i am just going to do a normal 30-year mortgage well because paul opted for the 15-year he actually gets a better rate he has a two and a half percent interest rate on his mortgage where melissa has to take a little premium on the 30-year she's actually going to pay 3.25 percent interest so if you amortize those two loans paul's minimum monthly payment is sixteen hundred dollars a month right look at principal and interest his minimum monthly payment is sixteen for 15 years for 15 years well if we look at melissa her minimum payment because she gets to stretch it over 30 years is actually gonna be a thousand and forty four dollars so it's roughly five hundred and fifty dollars less than pause but again we wanted to set this up to be an equivalent illustration so this is what we assumed paul's going to pay off his mortgage over that first 15 years and then starting in year 16 he's going to invest all sixteen hundred dollars right because that's the argument that we have people say you know what if i pay off my mortgage early i'm gonna have more money to invest sooner exactly right if you're someone making that argument in your head right now pay attention to the illustration and also realize because everybody always says are you guys including the interest yes yes we are totally including the interest as you'll notice we even give paul the benefit of since he's taking a shorter loan we give him a lower interest rate at two and a half percent melissa's three and a quarter that creates a headwind for melissa addition initially because realize they both start off with 240 000. melissa is paying more interest than paul is so we could have skewed this if we were just trying to prove our point for the sake of it we could have manipulated the data but we tried to make this as honest and true as possible so you guys can really see how this thing flows through so again remember we're trying to set up equivalent examples so we assume that in addition to melissa's 1044 dollar minimum mortgage payment she's going to invest an extra 556 dollars per month so what that means is both paul and melissa have sixteen hundred dollars flowing out every month it's the exact same number sixteen hundred one of them just has it all going to the mortgage the other has it going to mortgage and then investing and then once melissa has her mortgage paid off in 30 years she's going to begin investing the full 1600. so if you're one of those people saying well i'm gonna be paul because i can invest more sooner that's true he can't invest 1500 1600 earlier than melissa can but there's more to the story well yeah because melissa is going to have a huge head start on him she's going to start saving 556 a month right from day one she's 33 years of age we know that that is a great multiplier when you're that age so show them the rest of this bo and then i want to talk about what if things don't go like paul and melissa anticipate when they hit the age of 43 which is 10 years after they bought this house so what we can see is that if you again if you're out there uh listening to this make sure you go out to youtube so you can actually see the visual here they both start with the same mortgage amount they both start with a mortgage of two hundred and forty thousand dollars well paul is going to pay all of his mortgage down by the time he gets to age 48 and then at age 48 he is going to start building up his investment assets melissa is going to start from day one building her investment assets and also satisfying her mortgage but she's going to satisfy the mortgage at a slower pace than paul is going to so we said just like what you mentioned brian if we look out 10 years how do they stand or where do they stand well after a 10-year period when they're both 43 years old paul still has an outstanding mortgage of just over 90 thousand dollars and he has no investment dollars built up he's not begun saving yet he's paid off a lot of debt he has a lot of equity in his home melissa has double that mortgage amount she has a hundred and eighty four thousand dollars of outstanding mortgage but because she started adding to her army of dollar bills she has built up almost a hundred and two thousand dollars of investable assets so why did we choose 43 to show this because this is a point that i see in our comments section on youtube and i'm like guys you're missing the big point and there's two stories i have to share on this first i think i've told you guys from my sunday school class i had a widow come up to me and said please please please make sure you share on your show that paying off all the debt is not always the greatest thing because she her husband passed away she still had kids in the house she everybody told her go pay off your mortgage so you'll be you know you'll at least own the house and everything's okay well the problem is she did that and then she didn't have money to cover a lot of the education needs a lot of the other stuff she said was some of the worst advice she was given but everybody was well intentioned saying get out of debt as soon as possible well i see this and i think about i immediately thought about my childhood and but we even have an article to pull up this you can see this is june of 1988 my world changed in life okay and what happened was my dad started working for this um mckesson back right out of college and he did that for 20 plus years and then at age 43 mckesson decided to get out of that division and he was out of a job and i mean life was completely different we lost company cars we were living off my mom's teacher's salary now here's the here's what's crazy now i can't imagine being a parent us kids we thought these were the this was the greatest summer there was because dad was home he was home he was home for that period while he was finding another job but it showed me and this is one of the reasons why i always want to be self-employed this is one of the reasons why i realize you have to be careful if you give 20 years to a company that doesn't really give you a path forward you could get yourself in a pickle of a situation but it goes even further what if paul and melissa 10 years into this mortgage their their dream house they loving where they are but all of a sudden they realize oh my goodness i've still got to pay the mortgage on this house even paul who's five years from the house being paid off only owes ninety thousand dollars he still owes ninety thousand dollars it's not like the mortgage company goes man you've done a great job behalf of building up equity so we're gonna be in this with you and protect you they're gonna be like hot diggity dog this guy's about to lose the house look at all the equity we're going to take down that's what the bank is thinking i hate to be mean like that whereas at least melissa will have liquid investment assets that she can use to pay mortgages used to pay her grocery bill used to pay utilities melissa's going to have options because she has liquidity behind her name even though we might think it's great to pay off this mortgage debt as soon as possible there's a time and a place and that's why i always ask you are you 45 and over if you're not goodness gracious get that army of dollar bills working for you take advantage of the compounding because remember 88 times over happens when you're 20. 23 times over happens when you're 30 by the time you're 40 years of age that drops down to seven so you can quickly see 20 30. those are the years where you're getting maximum compounding growth for your army of dollar bills don't take those years for granted yeah i think and we see this riddled all through our comments people say you know what no no it's gonna be safer it's gonna be better if i pay off my house sooner because then if i lose my job if da da da da da remember paul has actually saddled himself with a sixteen hundred dollar a month payment if he loses his job just like you said it doesn't matter how much equity he has built up he has to make sure that next month he can come up with that 1600 and if he doesn't get another job the next month the next month and the next month so the question we asked is if you were these two individuals and 10 years into your mortgage you ran into a dire situation or an uncomfortable circumstance would you rather be paul who has 210 000 of equity in his home but no liquidity or would you rather be melissa who she doesn't have as much equity in her home yet but she has a hundred and two thousand dollars of liquid investments that she can help bridge the gap on realize when we talk about housing equity real estate's awesome but it's considered non-liquid it takes think about all the different steps that require to get your money out of your house and a lot of you're like well just go get a home equity line no remember i've fallen into that trap i've shared with you guys when we went through the great recession i had six figures of home equity in my house down in georgia had zero cash because i was like why would i need cash i have a checkbook i have all this equity i have six figures of equity until the day you don't because the bank very quickly can send you a letter saying hey that access to equity you thought you had we're shutting it down it no longer exists and i think we even heard somewhere in the chat room somebody had mentioned that they were starting to freeze home equipment as equity lines and other things so bad things tend to happen at one together it's so there's a chance you'll lose your job but also real estate market will be struggling so you can't go sell it and turn that money into liquidity so it's good to have options so we actually because we're nerdy enough we said let's run the numbers we can get full-time equivalent daniel to run the numbers on this so that people who are just so sick of paying the minimum can know maybe there's a better strategy that still lets me respect what brian and bo are sharing on don't pre get crazy and carried away on p prepaying the low interest mortgage debt but still lets me check the box to know there's a better way of prepaying debt and here's what we wanted to do we wanted to make it fairly simple for you guys we didn't once you have to break out an amortization schedule and do all kinds of calculations so we wanted to look at three common strategies for paying off your mortgage or how you should approach it so strategy number one is just pay the normal monthly payment whatever the mortgage company says based on your amortization schedule need to pay just pay the normal monthly payment that's not going to prepay at all it's going to pay it over the term of your mortgage you know 15 year 30 year depending on your mortgage and just do what they set out for you option number two is okay well why don't i just pay a little bit extra i'm gonna round up to the nearest hundred so if my mortgage payment is 958 a month i'm just going to pay a thousand dollars a month and i'm going to let that be the way that i pay off the mortgage or the third one and this one's kind of clever i like this rather than paying your mortgage payment monthly so having 12 payments per year you say i want to pay bi-weekly well if you pay every other week you'd actually make 26 payments in the course of a year well 26 payments is two more half payments than 24. so you're actually paying one extra monthly payment per year hey i do want to give a catch on three okay just because we're going to show the numbers and i want to nerd out with you but i want to tell you to be careful some mortgage companies i'm going to let you send half this week and then another half you know in two weeks so you need to pay attention to what your mortgage company requires and actually allows don't use a third party company i don't want you paying 300 set up fee plus an ongoing maintenance because you might get yourself into something you can't get out of but it is worth a phone call call your mortgage company and say hey do y'all have a bi-weekly payment plan that's just a value-add service and a lot of them will do now if they don't no big deal we're gonna tell you how to do this in a do-it-yourself type methodology but it is one of those things you need to make sure you do it the way your mortgage company because they're the ones that are doing the accounting they're the ones run the amortization table and we want to make sure we keep them happy yeah so the real easy math is if you're someone who your mortgage company doesn't make available bi-weekly just take your monthly mortgage payment divide it by 12 and add the principal payment onto each month right and so that way essentially over the course the full year you will have made one extra payment over that 12-month period so let's get in the math let's nerd out on this thing bro go ahead and show them where we're at so here's what we want to say let's assume that we're going to do a 30-year mortgage so everything we're looking at is 30 years let's assume that right now mortgage interest rates are 4 and we're going to buy a 250 000 house we're going to put 20 down so that means that we're actually borrowing or financing 200 000 well if you choose to go with strategy number one which is just normal monthly payments your monthly payment is going to be 954.83 a month well because you are borrowing some money you got to pay interest so over that 30-year period you will pay 143 739 dollars in interest so the actual cost of your house you know as a 250 000 house what you actually paid for it was 343 739 and it took you 30 years to pay that so that's kind of our baseline that's where we're starting so now let's look at strategy number two we're just gonna round up so instead of paying 954.83 cents per month we're just going to pay a thousand dollars per month well if we pay a thousand dollars per month we're going to pay total interest of just under 123 dollars that's going to take the total cost of our 250 000 house to just under 323 000 and that means we're going to have the house paid off in 25.2 years wow so just by rounding up a little more than 40 bucks per month we knock five whole years off of the mortgage pretty powerful it's insane so let's look at strategy number three which is instead of paying monthly we're going to pay bi-weekly well what that means we're going to do is we're going to pay 1038 dollars of cash flow out per month the total interest we're going to pay is going to be just over 120 thousand dollars the total amount that we're going to pay for the 250 000 house is actually just over twenty thousand dollars and this one actually pays off even a little bit quicker pays off in 25 years even so we have a payoff slot and this is if you're not if you're you know looking on youtube i want you to this is what i like is that we actually put everything into different columns and rows so you can actually do a comparison now coincidentally daniel chose an amount with 200 000 that it worked out to be almost the same whether you're rounding up a hundred dollars and that makes sense if you look at what the monthly payment is this could actually become a bigger or smaller difference depending upon how big your mortgage actually is on looking up the rounding up or bi-weekly but it's still a powerful concept and this is where i'm going to give you guys permission because i think it is powerful that just rounding up you know like you said bo to a thousand dollars from 9.55 you know or to a thousand and 40 or 38 dollars a month i mean it's just it's not that much money but it can make a dramatic difference so i'm gonna give you guys permission i still stand by the fact that if you are under 45 i want you focusing your army of dollar bills on saving for the future but i'm going to give you a little bit of grace that if you want to round up or if you want to do a bi-weekly payment plan because paying the minimum is absolutely driving you crazy i think it's okay now don't misread this we could have gone a completely different direction and showed you how every bit of that 45 dollars on the roundup or even the the 70 close to 80 bucks a month on the bi-weekly payments and if we invested that and earned 9 or 10 percent it would have still been better to invest that money so do not miss here that saving that five years is now superior to investing it's not it's just that i do agree with the fact that i think you can chew gum and walk at the same time so it is one of those things that if you are serious and that's why we give you the goal of saving 20 to 25 towards the future if you have checked that box in your financial order of operations then it is no problem to also be rounding up or viewing bi-weekly i think those things can actually happen at the exact same time and you're going to end up in a much better place yeah brian so it's interesting right now we are and have been in this remarkable low interest rate environment and while we talk all the time about how that's like really negative for savers you know folks in retirement folks living on cash there is one really really really bright spot that we see that's a great financial planning opportunity that folks can and have been asking us if they should take advantage of and that thing is possibly refinancing well here's how this show comes about one of our principals here at abound wealth carter is building a house yep and he comes in and goes guys i just locked in because he's moving into his house first week of june because locked in 30-year mortgage 3 i was like get out of here 3 on a 30-year mortgage you'll never ever ever be able to move because you'll never ever ever get a price that low again you know it really ticks me off about that i just closed on my house back in january i didn't get three percent i didn't stick the landing i didn't i mean so it is one of those things so when i hear that you can get three percent on a 30-year mortgage i'm like we got to do some content on that but we also need to make sure the money guy family knows how to do this properly because it's like most things when you're dealing with the dangerous instrument of debt and leverage so much of our consumer society is doing it completely wrong how you can take something that's good like the idea here's here's how simple this is if i could just refinance and i'm going to let you get the definition sure to refinance this but i can just lower my interest rate that i pay on my mortgage that's a good thing for me how could this go wrong i'm going to show you that most people do mortgage is completely wrong and we're going to show you how to avoid those traps so at the very basis level you may be seen as saying okay i don't i've never i've heard people say that but i don't even know what a refinance is all a refinance on a mortgage is is it means you're taking your current mortgage and you are adjusting some of the terms from your original contract you're essentially closing out one loan with a certain amount of terms and you are replacing it with another loan with different terms whether that be length of time or interest rate we'll kind of talk about that but you're essentially adjusting the terms of the more of the money that you've bought to pay for a house and why shouldn't you be able to do this because think about mortgage lenders have no problem changing the rules on you and the fact that you could close with your local bank down the street but you're going to find that they assign your mortgage essentially sell your mortgage to somebody else so you might as well take advantage of this too and see if while interest rates are low are there ways i can improve my financial situation so we started thinking brian about all the different terms that you sign on whenever you sign a mortgage whenever you go to borrow money what are the things you're committing to and we started really thinking about all right what are the reasons that people do refinance and we were able to really distill them down to five we think there are five main reasons that people refinance and the number one reason and you already alluded to this is to decrease the interest rate and that's great and that that's a great opportunity lower that interest rate lower how much interest you're paying save that money in your back pocket hopefully even accelerate how you're paying it down and that leads to number two is how great would it be if we could decrease our monthly payment that's exactly right a lot of folks say you know what i'm a little strapped or i have whatever going on maybe i want to refinance to give myself a little more breathing room in my month-to-month cash flow a refinance will certainly solve that problem for you and even i mean a lot of times yes you can go through your existing mortgage company but if you've lived in the house for a while a refinance might let you do a twofer where you get lower interest rates and you get rid of pmi so if you didn't put down a full 20 yep this is a time to do that as as part of one and two in combination with each other and then number three is maybe this is an opportunity and this is one yet to be very very careful with this is a measure twice cut once because i don't want you to make a bad financial decision but maybe you're refinancing to get cash out of your home yeah brian the third reason that people generally we see do a cash out refinance now sometimes this is good sometimes bad but they do it to consolidate debt maybe they have some outstanding credit card debt or they have auto loans or fill in the blank they recognize that uh home might have a tax advantaged really low interest rate so perhaps they want to refinance and consolidate some of that debt into it i would just caution anybody because debt is one of those dangerous instruments it's one of those very fearful things you should use in your financial toolbox that if you are going to use this for consolidating debt that this is something you really internalize hard measure twice cut once on because i do worry too many people hit this button too often just because your house naturally appreciates when you find out people are doing cash out refinances every few years you never actually own your house and that that's something that people need to be very aware of number four increase or decrease mortgage period man this is a big one we've actually gotten a lot of views when we talk about this and we will by the way be ringing that bell again when we talk about 15-year 30-year mortgages lots of chances there a lot of times look we get it when you're younger you might need that longer amortization period so you have more flexibility because you're trying to not only pay for the kiddos you're paying for saving for retirement but you're also trying to make sure you have a house a shelter over your head um but you're gonna get to a point where maybe you get a little older and you want to bring that down to a 15-year 10-year 20-year you know you have options so that's another reason to refinance and then by the last one is let's talk about this one move between a variable and fixed interest rate yeah it's not uncommon for someone when you buy a house maybe some set of circumstances that caused you to have an adjustable rate mortgage well now interest rates are super low you may want to refinance and lock in that long term very low rate so a lot of people refinance just to go from an adjustable to fixed or sometimes from a fixed to an adjustable rate uh the question i always have because traditionally if you're somebody because realize you're talking to a guy my highest mortgage rate now i did a little dance after i got it was six and three quarters and i was so excited about it like six months i know but that to compared to my i'm sure my parents could tell the stories that you know double digit mortgage rates but i've often wondered because typically you tell people if you're only gonna be in a house for two or three years look at a variable rate because you're gonna save some bucks when rates are three percent on a 30-year mortgage i almost wonder if yes maybe even the variable's a little bit lower but why not do the fix just in case life throws you some curveballs and you're there a little bit longer than you thought you know historically brian we've we've actually counseled folks hey maybe you should look at a 5-1 jumbo or a 7-1 jumbo or a 7-1 arm or 5-1 arm we haven't been saying that a whole lot lately it's really been looking at fixed-rate mortgages so it's that is one of the reasons people write refinance it's just not right now they're not they're not looking at a bunch of adjustments so i will tell you i think if you're a young person and you're and you're maybe on your first home and you're trying to figure out should i do variable fixed guys this is a chance of a lifetime here with low interest rates don't blow it because i'm not so sure 10 years from now 15 years from now we're not going to look back at this golden age of low interest rates so pay attention to those fixed income rates so fixed rates so we've talked about some of the reasons why people do that but it's not all sunshine and rainbows there are some dangers that are associated with financing that we ought to talk about there are some some negatives or some downsides that we want to look at only in america can we turn something positive like refinancing to get lower rates is it actually becomes a dangerous financial gain for you so let's jump into these but first of all it can actually be expensive yeah i was surprised by this and i think i don't know if it was you or full-time equivalent daniel that found this but the average closing cost nationally is almost five thousand dollars so to close on a new refund could cost as much as 5 000 bucks that's that's expensive that's not a small amount of money and it ranges from two to five percent you're like that's a huge range why would it be so such a broad range between two percent or five percent on closing costs the reason is realize every time you refinance your local government has recording fees has state stamps they have all these they got their hand in your cookie jar you have title insurance you have all these things so depend upon how your state looks at mortgages taxes mortgages you can see a big variance in what the closing cost is in your state the other big risk brian you said this kind of earlier on and we'll kind of revisit is that you never actually own the property if all you ever do is refinance if you keep recasting recasting recasting it makes it real hard to actually ever build equity in that home and actually own the piece of earth at your house you create a carousel of um resetting amortization tables so your 30-year mortgage could very easily turn into a 45-year mortgage and i think those are the risk you run and then we put this part in there because this is where it can get dangerous with refinancing also is you can actually cost you more money over the long term even with a lower interest rate what do we mean by that is look you're extending the term i talked about that with the carousel of amorization rates resetting um the tables resetting but you also every time you refinance a lot of times that your mortgage lender will say okay you either can take a premium on the interest rate or you can just roll the cost in and a lot of people will say well just roll the cost in it'll be okay so you're actually increasing the amount you're financing and then we've already talked about this as well a lot of people take cash out when they refinance as well so all those things in combination are actually dangers right because you might not actually be working towards owning your house so we thought uh in true money guy fashion perhaps it would make sense to look at a case study right just kind of walk through an example of how most people go about refinancing so we said all right let's assume that you have a house that you bought 10 years ago so you have now been in the house for 10 of your 30 years let's assume that you still owe a hundred thousand dollars on the outstanding mortgage your current interest rate on your mortgage is five percent and you recognize that rates are low and so you want to refinance the one percent so you're gonna save one percent on the mortgage rate and let's just assume the cost to refinance this house is about two percent of the loan amount or two thousand dollars sure sure so okay let's talk about the original loan first if you look at an amateurization schedule and basically that just shows a list of all of the payments so if it's a 30-year mortgage they're gonna be 360 total payments you have your payment and every payment is composed of two pieces there's an interest component and there's a principal component right and the way that amortizing loans work is you pay more interest early on and then it slowly decreases through time you pay very little principle early on and it increases to through time that's the way that the payment changes so if you find yourself in this situation after 10 years you're looking at month 121 you've been in there in 10 months if you were to stay in your current mortgage you would continue to pay 660 dollars a month right that's your monthly payment so what most folks say is okay i want to do this new mortgage i'm going to go refinance i'm going to go from 5 down to 4 and i'm going to do a new 30-year mortgage well the great news is as your payment actually decreases you go from 660 dollars a month to 477 more money in your pocket and not only that because the interest rate went from five percent down to four percent you're paying less in interest you went from four hundred and sixteen dollars in interest starting in the month in the first month did only 333 dollars in interest before you hit the button i already see something that gives me a little bit of a red flag look at the principle on the chart is old amorization it's 243 dollars of your 670 i mean 660 is going towards principal look at the new amortization table i see principal yes interest is lower but principal is only 144 that's almost 100 a month didn't go to principal that's right what happened well it's that that part that you took off that part that you're saving you're saving some interest but you're also resetting the principle so what actually happens with this loan is as you move through time rather than having your house paid off in 360 months or three years it actually took you 480 months or 40 years to pay off this home loan wow this is this is the this is what i love about math is because we have shown how you can take something very positive in the fact that you saved a if you take an interest rate from five percent to four percent guys that's a huge dramatic drop you have essentially cut that rate by a fifth which is a great cost savings measure but somehow and i know you're going to show this we're going to figure out how we can pay more interest as well as take longer to pay off put that into numbers so here's the rest of the story if you compare what you would have done originally versus where you were after you refinanced you actually paid an additional thirteen thousand four hundred eighty dollars in interest and it actually took you 10 extra years to own your home so i would argue in this case refinancing was not an advantageous strategy yeah it was done the wrong way by the way we have all the components here for this to be an actual happy ending and a good story and we're going to try to show you how you turn that frown upside down so you do refinancing the right way before we get you know because what you're going to do you'll get a lot of people excited when you start talking about refinance you're going to get all the mortgage lenders you get your local affiliate your government because remember there's recording fees there's all kind of stuff that's going on title insurance when you refinance it is a big legal transaction is there a way that we can still end up with the net benefit we want which is lower interest rates without having to go through all the rigmarole yes and it's called this simple step we call this the lazy way a rate modification now you may be wondering hey what is a rate modification mean oh that's just simply a process where they modify your rate it's exactly what it sounds like you call your current mortgage lender the person who currently holds you more you say hey i know that interest rates are dropping i could go refinance and you could lose this loan and i'm happy to pay someone else for the next 30 years but would you consider just modifying my rate and dropping it to be more in line with market now look i'll be honest when you call with this you do need to tell them i'm considering moving and refinancing they're probably going to be like all right but you need to ask again be like look i specifically want to know and the process is called this do y'all offer a rate modification process and look they don't do this for charity they if they do allow this and i know a lot of the credit unions we've done mortgages with they've been the easiest ones to deal with you'll call them up reach out and they will have a fee they will call it a modification fee it'll be a few hundred bucks and they will just that easily there's not a new closing it's basically just you are agreeing with your lender to change the terms so that you don't walk and vote with your feet and go refinance and the thing is that's beautiful about these we just said the average cost of a closing is like five thousand dollars these things at least in our experience a couple hundred bucks so it's much less cost prohibitive than working through an official refinance but let's say that you call and they say okay no way we're not going to do a rate modification the next thing you move to is okay i want to refinance how do i figure out if it makes sense well you first need to do you know it's just like i think most of us we tell you you don't need a financial advisor to get to four to five hundred thousand dollars in assets so a lot of your financial plans are done essentially i call them napkin financial plans or we've done 30 minute financial plans where you can go to the website download the content on that well a lot of times you're probably looking for just an easy calculation is there a back of the napkin calculation where i can figure out if refinancing makes sense and we think there is an easy way but welcome through the two steps that are needed to to do this and then you can figure out if you want to go even deeper into the process that's right so the easy way is pretty simple mathematics you take your old rate minus the new rate that you could receive multiply times your outstanding loan amount that's going to give you about your annual interest savings this year so in the example we had five percent minus four percent times a hundred thousand dollar loan it's a thousand bucks yeah now look this is simple math remember amortization schedules work differently we'll talk about that in a second well if you know that it cost you about two thousand dollars to refinance and you know that you save about a thousand dollars in interest in year one you could come to the conclusion that you will break even at about two years so so long as you're going to be in the house longer than two years it probably makes sense to refinance so i would think about this in terms of you know if you know you'll be in the house for the next six or seven years and your math is that simple two years you can probably just know this is what i'm going to do now we're going to show you in the next the the money guy way things you need to take into consideration but it probably is going to make sense now if you're somebody who knows you're going to be moving in 18 months three years and you do this you still probably need to go a little deeper into the process because it's not going to be as black and white on the decision making so let's kind of transition now to what we call the money guy way so again let's lay out a few assumptions uh you bought your house 10 years ago so you're on a 30-year mortgage you've been in there for 10 years you still owe a hundred thousand dollars on your loan your current interest rate is five percent and you have an option to refinance to four percent and your closing costs are going to be about two thousand dollars we've already laid out for you the standard amortization schedule remember it was going to be a annual pay a monthly payment of 660 dollars roughly a month you're going to pay that every month for 360 months until your loan is paid off well we showed you you could refinance to a 30-year mortgage and pay on that thing for 40 years or rather than allowing your monthly payment to decrease you say you know what i could afford 660 dollars i'm just gonna keep paying six hundred and sixty dollars a month so i'm gonna make the minimum required payment of 477 but every single month i'm going to pay an additional principal payment of 182 to keep my monthly payment the same but this looks exactly like the wrong way illustration with one big behavioral modification is that we have done the same refinance same closing costs same structure but it's that additional column over there called additional principal and you nailed it you pay the exact same that you're paying on the old mortgage 660 dollars a month you don't take the new required payment you actually goose it and pay a little bit more and look it's just amazing when you add the principal plus the additional principle now i mean you are vanquishing dragons if you compare that to the original principal payment and there's a lot of savings that are going to come and it's going to really talking about give you make your heart dance is when you see how much faster you're paying down the mortgage so here's what i think is beautiful if you continue on this path you actually have the house paid off in 332 months you would have saved over the course of owning your home seventeen thousand eight hundred and twenty eight dollars that is real money that's actual savings of going from five percent down to four percent and you will have actually paid your mortgage off in two point three years faster without changing your monthly outflow still paying the exact same mortgage payment you just were able to put an extra almost eighteen thousand dollars in your pocket and all you have to remember is you take your old payment but you have a new rate you just keep paying like it's your old mortgage so you effectively lock in the benefit of that lower interest rate now a lot of you are going to try to recreate this you go say amortization tables you know yeah i think i have excel or i have sheets i have google sheets i can use there's an easier way guys if you'll just go just type in on google or whatever bank rate yep you know mortgage amortization calculator bank rate actually has a pretty good one if you are somebody who's comfortable with spreadsheets i know both sheets as well as microsoft excel have great templates that are right there you just go under new templates amortization charts one of the first things you can go to you want to use those tools if you want to go do a deeper dive into the process let's kind of pivot and i want to talk about the cost of refinancing bo and how we kind of handle that because a lot of people you've decided yes there is a cost savings here i should definitely do a refinance to lower the mortgage to to give me more flexibility but then you're like okay now i have a decision because the lender is telling me i can do a no closing cost that sounds great because you know they say on average it costs like five grand i don't have five grand sitting around but man i really want to refinance so what's the catch when somebody tells you you can do a no-cost closing you're like there has to be a catch to that and what they're typically doing is realize lenders when they price mortgage rates to you they can actually give you a higher interest rate and take uh they essentially get a subsidy from the mortgage companies where a portion of that money gets kicked back out to cover the closing cost so you can take a premium on the interest rate or you can just pay the closing costs yep so just like in all the other examples we've laid out there's some mathematics you can do pretty easily to figure out okay should i pay the closing costs or should i take the premium so let's assume that you could do exactly what we said earlier you could pay the closing costs you could get a four percent rate or if you wanted to not have the closing cost you just have to take a quarter of a percent premium you want to have a 4.25 percent rate well what we find is that the mortgage payment's going to be the same in this example it's going to be 659 dollars per month but as you go through time payment stays the same goes all the way down mortgage is still paid off in the same amount of time but what happens is you want to calculate your interest savings on a running schedule so like in this example in month one the four percent rate would have saved you 21 dollars over the 4.25 percent rate you want to add up your monthly savings every single month and in the month that your monthly savings crosses over the amount you would have paid to close that's how long it takes for you to break even that tells you if you're going to be in the house for less time whether you should refinance or if you're in the house for more time whether you should pay the closing costs so just to kind of clarify what this is showing on this illustrations remember your 10 years already into your mortgage so that's why you're in month 121. so when we see it takes 217 to reach breakeven that's really 96 months right from the refinance event so if you think about it in those terms in this illustration a quarter of a percent it's gonna take eight years to recoup the the two thousand dollars of closing costs you have to ask yourself now in reality i will tell you because quarter percent's pretty tight we've we've seen things where you this is why it is important that you understand this concept is that there's pricing you can get into some weird arbitrage situations where maybe your savings on a refinance is so big that you can actually recoup closing costs easily within three years i've even seen that happen i've seen them even faster than that the only reason this is taking eight years is because it's a quarter of a percent difference that's just not a big spread on interest rates so it's but it is one of those things you need to understand this will help you understand whether you should pay closing costs or do a no cost and take a premium on the interest rate it's simple math where is the break-even point and that we're trying to give you the tools so you can understand that the reason we want you guys to know this and understand this is there used to be a common rule of thumb that okay if i can save 100 basis points if i can save one percent of my rate then it probably makes sense for me to refinance and that's a decent rule of thumb but that's all it is is a rule of thumb we think if you're going to analyze for your personal situation you have to actually break out the numbers and look at it because so many variables can affect whether or not it makes sense for you well and we're talking about this show specifically is on refinances but i think that we uh it'd be crazy in money guy fashion if i didn't go a step further and tell you a lot of you might be buying that first new house and you're gonna get asked when you buy that first new house do you want to buy down the rate do you want to pay points that's all and by the way it's the exact same calculation you're going to want to go see what they're charging you for those the lower interest rate because you can actually buy down the interest rate go see what they're going to charge you to buy down the interest rate on this on this house and see when the breakeven point now here's something from a taxability standpoint you guys need to understand when you're buying a brand new house those points you pay are deductible in the year of purchase when you refinance a house if you're paying any type of points or any type of closing costs on the refinance if you roll it in or you even pay it out of pocket you can recoup that from a tax standpoint but it's going to be amortized over the length of the loan so if you do a 15-year mortgage it's going to be divided by 15. if you do a 30-year mortgage it's going to be divided by 30. now the good news is if you refinance six years into this new mortgage the government lets you recoup all those closing costs when you do the refinance but i feel like it's important to understand new purchases meaning a new home to you is fully deductible in the year purchase a refinance is going to be amateurized why does this matter to you guys obviously what we're trying to teach with the money guy show is how to stretch your dollars five ten fifteen percent further than your peers you could be someone who goes out there and you just buy a house and you pay on it for 30 years and you get it paid off and that's fine but we want you to be those financial mutants that when there are opportunities like right now when interest rates are super super low you know and understand how you can take advantage of those opportunities to take your personal finances to the next level

Channel: The Money Guy Show

Views: 32,088

Rating: 4.9216785 out of 5

Keywords: money guy show, debt, budget, cash, real estate, insurance, how to make money, save, credit card, compound interest, buying house, buy stock, success, personal finance, mortgage, real estate investing, mortgages 101, mortgage basics, home financing

Id: 6FvGi17b0jM

Length: 58min 26sec (3506 seconds)

Published: Fri Oct 15 2021