1 The Home Decision II: Answers to Questions (Updated 2014/02/11) Personal Finance: Another...

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The Home Decision II:Answers to Questions

(Updated 2014/02/11)

Personal Finance: Another Perspective

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Objectives

• 1. How are mortgage brokers paid?• 2. How do I know when to refinance my

home?• 3. What happens when good credit marries bad

credit?• 4. What about prepayment penalties? What

should I know?• 5. What’s the lowdown on buying down or

paying discount points?

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Objectives (continued)

• 6. How do I make sure that brokers give what they promise, i.e., no bait and switch?

• 7. How much of a percentage should I pay for a down payment?

• 8. Should I pay off the loan early or stick to the loan schedule?

• 9. Is a 15 or 30 year loan better?• 10. Do I have to pay Private Mortgage

Insurance (PMI)?

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Objectives (continued)

• 11. How do I know whether to rent or buy?• 12. How easy is it to refinance a home with an

interest only loan?• 13. If a person is upside down in their

mortgage (i.e., they owe more than the house is worth) and they would like to sell their house, what can they do? This is called a short-sell.

• 14. If a person is upside down in their mortgage, can they still refinance?

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Objectives (continued)

• 15. What do you think about purchasing distressed properties out of state?

• 16. If you move from your first house, do you recommend keeping it as a rental?

• 17. If the offer is not accepted, is the earnest money returned?

• 18. What is your recommendation on your first house?

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Objectives (continued)

• 19. What type of account should you use to save for a down payment (e.g., ETF, stocks, bonds, money market, etc.)?

• 20. With home values depressed, home values are bound to increase. How do we weigh this in the decision to purchase a home? Should we accelerate the purchase so we can buy when the market is low?

• 21. How do we balance our current home size need with the fact that our family will be growing?

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Objectives (continued)

• 22. With a tax shield on mortgage interest payments and low rates on student loans, doesn’t it make sense to invest for retirement instead of immediately paying off these loans?

• 23. Can you review the Home Buying process?

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1. How do Mortgage Brokers get Paid?

• Principle: Stewardship• Logic: If you understand how people are paid, you

can use that knowledge to your advantage in getting a lower interest rate

• Mortgage brokers are out to provide a service (and make money)

• They generally work with similar lenders with similar rates

• They are done with you after your loan—there is no follow up

• Your goal is to minimize your interest rate received with the fewest discount points (if any)

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Mortgage Brokers (continued)

• Mortgage brokers make money three ways:• Origination fees: These are the costs and profits on

making the loan• Discount Points: These are payments you make to

lower the loan interest rate• Backend bonus: These are bonuses paid to the

mortgage broker if they get a higher interest rate than what the lender requires

• There is a relationship between discount points you pay and the broker’s backend bonus• Your goal is to minimize the interest rate and the

discount points you pay. This will likely reduce the broker’s backend bonus as well.

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Mortgage Brokers (continued)

• How do I estimate the Lenders required rate or return for mortgage loans?• Logic: Broker’s earnings are origination fees,

discount points and backend bonus

• Find out the lowest rate (the interest rate and points) they will let you buy-down to, i.e., 3.75% with 3 points

• This may be close to the lender’s rate, as they will not let you buy-down below the lender’s required rate of return

• Use this information in your negotiations10

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The Underwriting Process

The Underwriting Process

From http://upload.wikimedia.org/wikipedia/commons/0/08/Borrowing_Under_a_Securitization_Structure.gif on 7Oct08

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2. How do I know when to refinance?

• Principle: Stewardship • Logic: Determine the costs you would pay before

refinancing and the costs you will pay during and after refinancing, including any prepayment penalties

• Calculate an internal rate of return on your savings, which takes into account the time value of money

• Calculate a breakeven analysis and a total cost analysis as well

• These are all inputs into your decision. See LT 19: Home Loan Comparison with Prepayment and Refinancing tab for help

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Refinancing (continued)

• Calculate:• A. Current monthly principal and interest costs• B. Refinance monthly principal and interest costs• C. Monthly savings from the refinance• D. Total new fees/costs, including origination fees,

discount points, and other fees from the refinance. In addition, be sure to include all new costs that will be incurred in taking out of the new loan including prepayment penalties

• Note that costs that are the same for both loans, i.e., escrow or reserve accounts, do not need to be included in these calculations

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Refinancing (continued)

• To determine if refinancing makes sense, look at three calculations:

• 1. Internal Rate of Return,

• 2. Breakeven Analysis and

• 3. Total Cost Analysis

• If all are reasonable, then do it. If only one calculation makes sense, I would likely not do it

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Refinancing (continued)

• 1. Internal Rate of Return• Outflows:

• A. Calculate all costs and fees for the loan• Inflows:

• B. Calculate the monthly savings• C. Determine the number of months of savings

• Note: Set the number of months on the new load equal to the number of months remaining on the old loan so you are not extending the loan!

• Recommendation:• Set PV = - A, PMT = B, N = C, solve for I• If your IRR is greater than your risk-free rate, then

refinance

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Refinancing (continued)

• 2. Breakeven Analysis • Calculate:

• A. All new costs and fees for the new loan• B. Savings in principle and interest over the old loan

• Recommendation:• Divide all new costs (A) by monthly savings (B)

which will give you your breakeven point in months (C)

• If your breakeven point (C) is:• Less than 4 years, it may be a good idea • If 5-7 years, it might be considered• Greater than 7 years, be careful

• You may likely move before 7 years

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Refinancing (continued)

• 3. Total Costs Analysis (no Time Value of Money)• Calculate:

• A. Your total new costs and fees from the loan until it is paid off

• B. Your total current monthly principal and interest costs remaining without refinancing

• C. Your total refinance monthly principal and interest costs

• Recommendation:• If you will be paying less overall, think about it

• If A + C < B, it may make sense.• If A + C = B, it may not make sense• If A + C > B, it does not make sense

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Case Study #1Data

• Steve has a $150,000 30 year 6% fixed rate loan that he has paid on for 10 years, and he owes $125,529 on the loan. He is looking to refinance. He has found a 20 year 5.25% loan with origination fees of $1,500, and $2,500 in other fees. His risk-free rate is 8%.

Calculations:

Calculate the three types of refinance analysis for this new loan: IRR, Breakeven and Total Cost Analysis.

Application:

Should Steve refinance with this loan?

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Steve has a $150,000, 30 year, 6% fixed rate loan that he has paid on for 10 years ($125,539 remaining). He has found a 5.25% loan with a $1,500 origination fee and $2,500 in other fees. Calculate Steve’s Breakeven and Total Cost calculations. Should Steve refinance with this loan?

1. IRR Analysis• A. Calculate all costs for the new Loan? $4,000• B. Calculate the monthly savings: Old versus New

• Old: -$150,000=PV, N = 360, I = 6%, PMT = ?• PMT = $899.33

• New: -$125,539 PV, N = 240, I = 5.25%, PMT = ?• PMT = $845.87

• Monthly Savings = $899.33 - $845.87 = $53.46• C. Months on the new loan N = 240• Recommendation: Calculate the IRR

• PV = -4,000, PMT = $53.46, N = 240, solve for I? I = 1.27% * 12 =15.27%. Compare this to their risk-free rate

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Steve has a $150,000, 30 year, 6% fixed rate loan that he has paid on for 10 years ($125,539 remaining). He has found a 5.25% loan with a $1,500 origination fee and $2,500 in other fees. Calculate Steve’s Breakeven and Total Cost calculations. Should Steve refinance with this loan?

2. Breakeven Analysis

• A. Calculate new costs and fees

• $1,500 + $2,500 = $4,000

• B. Calculate monthly savings

• Current principal and interest: PMT = $899.33

• Refinance principal and interest: PMT = $845.87

• Monthly Savings: $53.46• Recommendation: Calculate the Breakeven in Months

• Divide the total costs (A) by the monthly savings (B). The Breakeven is $4,000 / $53.46 = 74.8 months / 12 = 6.2 years. Not a great payback period 20

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Steve has a $150,000, 30 year, 6% fixed rate loan that he has paid on for 10 years ($125,539 remaining). He has found a 5.5% loan with a $1,500 origination fee and $2,500 in other fees. Calculate Steve’s Breakeven and Total Cost calculations. Should Steve refinance with this loan?

3. Total Cost Analysis

• A. Calculate new costs and fees for new loan until paid off: 240 * $845.87 = $203,008

• B. Total costs without refinancing: 240 * 899.33 = $215,838

• C. Costs to refinance: $4,000

• Recommendation: Total Cost Savings

• Since $203,008 + 4,000 = 207,008 < $215,838, the savings are positive (they would save $8,830), I would think about refinancing

• Summary: Since the IRR is greater than their risk free rate of 8%, and since they will save $8,830, they likely should refinance.

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3. What Happens when Good Credit Marries Bad Credit

• Principle: Stewardship Logic: Determine the cheapest way of getting the highest

credit score so you can pay the lowest interest on your loan

• There are five main options:

• 1. Buy the house as co-owners and co-borrowers

• 2. Have “good-credit” buy the house alone

• 3. Have “good-credit” buy the home using a “no-income verification” mortgage (if available)

• 4. Have a third party with good credit replace the “bad-credit” as the co-borrower

• 5. Improve “bad-credit’s” credit score22

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Good Marries Bad Credit (continued)

• 1. Buy the house as co-owners and co-borrowers• Bad credit will result in bad credit for the loan and a

higher interest rate• This is what you want to avoid

• 2. Have “good-credit” buy the house alone• This is the preferred option

• However, this may limit the size of the loan to the income that good-credit can support

• Do not buy a house on two incomes when you know you will drop to one income in the future—it is a recipe for disaster

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Good Marries Bad Credit (continued)

• 3. Have “good-credit” buy the home using a “no-income verification” mortgage• This would be OK, but these mortgages are much

harder to get• These mortgages also require higher down

payments of 25-30% of the property value

• 4. Have a third party with good credit replace the “bad-credit” as the co-borrower• Co-signers are hard to find

• Usually, only a parent would be willing to do this

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Good Marries Bad Credit (continued)

• 5. Improve “bad-credit’s” credit score• Suggestions include:

• Put “bad-credit” on joint accounts with “good-credit” spouse. This can improve history and score

• Call bank to increase the available credit limits on “bad credit” to reduce usage percentage

• Have “bad credit” and you pay bills twice a month to reduce amount used to reduce percentage of credit

• Have “bad credit” and you pay off debt as quickly as you can

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4. What about Prepayment Penalties? What should I know?

• Principle: Stewardship Logic: Understand what you are getting into before

you sign the Loan papers Mortgage lenders usually do not require a

prepayment penalty on a first mortgage, but they do require it on a 2nd, 3rd, or subprime loan

If mortgage brokers get a prepayment penalty on a loan, they may make more money

Make sure there is no prepayment penalty on your first mortgage

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Prepayment Penalties (continued)

• There are two main types of prepayment penalties: soft and hard• Both have:

• 1. A stated period of time, i.e., 1, 2, or 3 years the prepayment penalty is in effect

• 2. A maximum pay down percentage (MPP), i.e., 6% of the principal per year, and

• 3. The prepayment penalty if you sell it before, i.e., 6 months interest

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Prepayment Penalties (continued)

• Soft Prepayment: You cannot within the stated period of time without penalty:

• Refinance at all

• Sell the loan to family members

• Pay down more than your MPP each year

• The only way to get out of a soft prepayment penalty is to sell the property to an unrelated party

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Prepayment Penalties (continued)

• Hard Prepayment: You cannot within the stated period of time without penalty:

• Refinance at all

• Sell the loan to anyone

• Pay down more than your MPP each year

• There is no way to get out of a hard prepayment penalty before the defined period without paying the penalty

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5. What is the Low Down on Buying Down (Points)?

• Principle: Stewardship• Logic: You can reduce your loan interest rate by

paying discount points (these points go to the mortgage broker—not the mortgage lender)

• The longer you actually stay in the home the more valuable the discount points as those costs are allocated over more years

• Since the average homeowner is in their homes only 5-7 years, the savings from the discount points should break even before that time is up

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Buying Down (continued)

• There are two different analyses for determining whether you should buy down your interest rate:

• 1. Internal Rate of Return Analysis

• Outflows:

• A. Calculate all costs for the new loan

• Inflows:

• B. Calculate the monthly savings

• C. Determine the number of months savings

• Recommendation:

• Set PV = - A, PMT = B, N = C, solve for I

• If your IRR is greater than your risk-free rate, then refinance

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Buying Down (continued)

2. Breakeven Analysis• A. Calculate your monthly payments:

• 1. Without the discount points, and • 2. With the discount points

• B. Calculate the savings between options 1 and 2• C. Calculate the cost of the discount points• Recommendation:

• Calculate your breakeven point in months by dividing the cost of your discount points (C) by your monthly savings (B). If your breakeven is less than 4 years, it may be a good idea, 4-7 years, be careful, and greater than 7 years, it is likely very questionable

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Buying Down (continued)

• Before you pay the points, ask yourself:• Will you be refinancing soon? If so:

• There may be better uses for your money than to buy down a tax-deductible interest rate

• Better uses may include:

• Paying down higher-rate debt

• Saving for retirement in tax-eliminated or deferred accounts

• Building your emergency fund

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Case Study #2Data:

Mark is looking into a $250,000 6.0% fixed 30 year mortgage for his new house. The broker offers him 6.0% with 1 origination point (Loan A to receive $247,500). He also says that he can buy down the loan to 5.75% with 1 additional buy down points (Loan B with 2 points total but for $252,551). Mark’s risk-free rate is 8%.

Calculation:

Calculate the IRR and Breakeven Analysis for Loan B.

Application:

Assuming Mark will take one of these two loans, which loan should he take?

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Mark is looking into a $250,000 6.0% fixed 30 year mortgage for his house. The broker offers him 6.0% with 1 origination point (A). He also says that he can buy down the loan to 5.75% ($252,551) with 1 additional buy down point (B).

IRR Analysis:• A. Calculate the monthly payments for both loans

• Loan A: PV=-$250,000 , I = 6%, N=360, Pmt = ?• PMT = $1,498.88

• Loan B: PV=-$252,551 , I = 5.75%, N=360, Pmt= ?• PMT = $1,473.82

• B. Monthly savings: $1,498.88 - $1,473.82 = $25.06• C. Cost of discount points: 2%* $252,551 = $5,051 - $2,500 for

Loan A = 2,551.02• IRR

• PV=-$2,551, PMT =$25.06, N=360, solve for I?• IRR = 0.95% * 12 months = 11.4%

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Mark is looking into a $250,000 6.0% fixed 30 year mortgage for his new house. The broker offers him 6.0% with 1 origination point (loan A). He also says that he can buy down the loan to 5.75% with 1 buy down points (loan B).

Breakeven Analysis:• A. Calculate the monthly payments for both loans

• Loan A: $1,498.88, Loan B: $ 1,473.82 • B. Monthly savings: $1,498.88 - $ 1,473.82 = $25.06• C. Calculate the cost of the discount points

• 2 points * $252,551 – 1 point * $250,000 = $2,551

Breakeven• Divide the cost by the monthly savings

• $2,551 / $25.06 = 102 months or 8.5 years• Since the breakeven point is greater than 7 years, I

would recommend they not buy down the loan

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Mark is looking into a $250,000 6.0% fixed 30 year mortgage for his new house. The broker offers him 6.0% with 1 origination point (loan A). He also says that he can buy down the loan to 5.75% with 2 buy down points (loan B).

Recommendation Their IRR is 11.4%, higher than the 8% risk-free rate, but

their breakeven analysis is 8.5 years. Since break even it is greater than 7 years, it may not be a good idea. I would recommend Mark to think about it carefully and likely go back and negotiate

I would use Learning Tool 19 as a negotiating tool Using Goal Seek, set IRR to your required rate, i.e. 15% and

solve for points (about 1.8 points) Using goal Seek, set Break Even in years to your required

breakeven point, i.e. 5 (about 1.6 points). Negotiate and tell the mortgage broker if they can do 5.75%

with 1.6-1.8 points you will do it

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6. How Do I Get the Best Deal with Mortgage Brokers?

• Principle: Accountability• Logic: You can reduce your overall costs by

shopping around and holding mortgage brokers accountable for what they say.

• Following are a few ideas to help you in this process

• 1. Work with a number of brokers to find the lowest interest rate and fees

• 2. Research the reputation and background of potential lenders. Check with the BBB

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Dealing with Mortgage Brokers (continued)

• 3. Beware of the “bait and switch” routine. They should follow through with what they promise.

• 1. Hold them accountable for their closing and other costs by seeing the complete (not summary) Good Faith Estimate and comparing it to final closing costs

• 2. Hold them accountable for the interest rate that they promise by having them show you their “Rate Lock Commitment sheet” to make sure it is consistent with what they promise.

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Dealing with Mortgage Brokers (continued)

• 4. Beware of lenders who advertise “no closing costs” or “no origination fee.” Generally, they will either raise the interest rates, call it a processing fee, or add the costs to the principal of your loan. There are costs to processing the loan

• 5. If your lender promises a short turn around or processing period for your loan (7-14 days), ask to confirm that their underwriter is in the same state (or in the same building). Sending data to underwriters out of state can result in loans that take much longer to process.

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7. How much of a down payment should you make?

• Principle: Stewardship• Logic: First, fulfill the covenants of the loan, and

second, make sure you have an adequate Emergency Fund after all closing costs are paid

• Having a buffer the first few years are important in case of job loss or other concerns

• Once you have this buffer in place, you can pay as a down payment amount any additional funds you have saved

• However, I recommend you both pay down your loan and save for your other goals at the same time (not just pay down the loan)

• Have a balanced plan for your goals41

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8. Should you pay off the loan early?

• Principle: Stewardship• Logic: While there are some tax benefits, you are

paying interest instead of earning it with a mortgage even after tax benefits

• We have been counseled to buy a modest home, fix it up, and pay it off as soon as we can

• We should use wisdom in all that we do

• I recommend to both pay off principal and save for your other goals at the same time (diversification)

• Maintain a balanced plan for your goals

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9. Is a 15 year or 30 year loan better?• Principle: Stewardship

• Logic: While there are some tax benefits to a mortgage, you are paying interest instead of earning it. My inclination is to pay it off sooner.

• The inputs into the decision for a 15 versus 30 year mortgage are:

• Monthly cash flow and budget under both rates• Stability of your job and job outlook• Interest rate differences between 15 and 30 year

• Realize you can also take out a 30 year mortgage and pay it off in 15 years as well (see TT19: Prepayments) if you have other concerns

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10. Do I Have to Pay PMI?

• Principle: Stewardship• Logic: Pay PMI only if required, and then get rid of it

as soon as your equity in your home is greater than 20%• PMI is generally required if your down payment is less

than 20% of the appraised value of the home. This can be due to:

• Principal being paid down• Home value appreciation, or• Both

• PMI may be avoided through “piggy-back” loans if available, but these are as well

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Eliminating PMI (continued)

• Once your principal is reduced to 80% of the value of the loan:• Contact the loan servicer

• Request information on cancellation of PMI

• Often, they will require a new appraisal to determine the Loan to Value ration (LTV)

• Once the appraisal is completed and documentation is provided (at your cost), PMI will no longer be required.

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11. How do I know whether to rent or buy?

• Principle: Stewardship• Understand what you are trying to do before you do

it.

• There are a number of rent versus buy calculators on the internet.

• One student sent this one to me. It looks only at monthly rent, home price, down payment, mortgage interest rate, and annual property taxes.

• It does not take into account what you spend on landscaping, appliances, repair, etc.

• http://www.nytimes.com/interactive/business/buy-rent-calculator.html 46

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12. How Easy is it to Refinance a Home with an Interest Only Loan?

• Principle: Stewardship• Refinancing with an interest only loan is the same

as with a traditional fixed or ARM

• It is a fixed or ARM loan with an interest only option

• You will follow the same steps as if you were refinancing a traditional mortgage

• It is easy

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13. What is a Short-sell?

• A short-sell is where a lender allows a property to be sold for less than the amount owed on a mortgage and takes a loss• A short sell requires:

• A borrow who wishes to sell the property

• A lender who decides that selling at a moderate loss is a preferable alternative to pressing the borrower into foreclosure and incurring the risks and costs from that process

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Short-sell (continued)

• A short sell allows:• Borrower to avoid foreclosure, which involves

hefty fees for the bank and poorer credit outcome for the borrower

• Lender to make “less” of a loss on the property and to not enter foreclosure

• A short sell does not:• Necessarily release the borrower from the

obligation to pay the remaining balance of the loan (called the “deficiency”)

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14. If a person is upside down in their mortgage, can they still refinance?

• That depends:• If the entire mortgage is a first mortgage, then the

answer is likely no

• However, if there is both a first and second mortgage, and the first mortgage is significantly less than the market value of the home, you may be able to refinance the first mortgage because the first mortgage has first claim on the home and it must be paid before the second is paid

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15. What Do You Think About Purchasing Distressed Properties Out of State?

• Principles: Stewardship and Accountability• 1. Can you adequately assess the quality of rental

properties from out of state?

• Generally no. You would need to trust someone else’s opinion as to the quality of the investment

• Be very careful about advertisements that state you can buy rental properties at 85% off retail

• If it was that good, they would buy it themselves

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Distressed and Out of State (continued)

• 2. Can you adequately maintain these rental properties from out of state?

• Generally no. It is very difficult to maintain these properties unless you use a property management company (PMC)

• Do you know the quality of the work done by the PMC?

• PMC fees are very high, often > 50% of your rental costs

• It is hard enough managing properties in your same city. It is not a good idea

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16. If you move from your first house, do I recommend keeping it as a rental?

• Principles: Stewardship and Accountability• A few questions

• 1. Can you sell the house?

• 2. Will cash flow cover principle, interest, taxes and maintenance costs after PMC fees?

• 3. Do you have the time (and patience) to be a landlord? It is a ton of work and time (and PMCs are expensive)

• Generally, I do not recommend it

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17. If the offer is not accepted, is the earnest money returned

• Yes. The earnest money is contingent on the acceptance of the offer• If the offer is not accepted, the money is returned

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18. What is your recommendation for your first house?

• What is your recommendation for your first house: condo, townhome, or single family?

• This depends on three things:• 1. On the area you are moving to (i.e., San Francisco)

• What is available in your acceptable area?• How many miles are you willing to drive each

way to work and back?• Is there mass transit that you would be willing

to take?• What is your maximum commute time each

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The First House (continued)

• 2. On your budget ($150-250K)

• What is available in your price range?

• Often your budget will determine the decision

• 3. On your preferences (yard versus no yard) and available time

• Can you do the upkeep on a yard?

• Can you pay others to keep up the outside?

• Can you live with close neighbors in condos?

• Can you take the externalities with condos/town homes?

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The First House (continued)

• I would first answer those three questions

• You might find your choices are limited by the answer to those questions

• Where has appreciation been the best?

• From my understanding, generally appreciation has been greater in single family homes than condos and town homes

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19. What type of account should I use to save for a down payment?

• Principle: Stewardship• Understand your competing principles:

• Investing to preserve principle will earn lower returns

• Investing to increase returns will increase risk and may not, over the short term, lead to higher returns

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Down Payment Account (continued)

• Recommendations• If you have one-three years before you will be buying the

house• Invest to preserve principle

• MMMFs, CDs, internet savings, and bond funds (with shorter maturity)

• If you will be saving for more than three years• Use a combination

• Invest the majority to preserve principle• You may also want to invest some (10-40%) in

low-risk equity index funds/ETFs or longer-term bond funds for a higher return

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20. Should I purchase a home now when the market is very low?

• Principle: Stewardship• Understand yourself:

• Your behavior

• Your ability to forecast housing prices, and

• The financing process

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Should I Purchase Now (continued)

• Understand yourself• Behavior:

• Do you really consider this an opportune time to buy, or is this really an excuse to buy now because you are impatient?

• Forecasting:

• Is the home market really as low as it is going to get, or could it possibly go lower?

• Financing:

• Do you have the down payment money?

• If you save more, can you get PMI removed from the outset (put 20% down)?

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21. How do we balance home size need with the fact that our family will be growing?

• Principle: Stewardship• Understand your competing principles. Your goal

is to balance among the three key areas:

• Home size: Larger homes will be more expensive than smaller

• Location: Homes closer to the City will be more expensive than those farther away

• Travel time: Homes with less travel time to the City are typically more expensive than those with longer travel times

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Balancing Home Size (continued)

• Understand your options:• Your primary options are:

• 1. Buying a large home to support your future family may be more than you can afford and outside your budget

• 2. Buying a smaller home may be within your budget but may require a new home within five to seven years or require significant travel time

• Are there other alternatives?

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Balancing Home Size (continued)

• Secondary options could be:

• 3. Moving in 4-7 years may be a viable alternative if you can build up sufficient equity to overcome the 6-7% cost of selling the house

• 4. Buying a smaller home with an unfinished basement or attic may also be an alternative as you could refinish the basement or attic as income and time permits

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Balancing Home Size (continued)

• 5. Buying a smaller home with a big lot to allow a possible home addition in the future may also be an alternative

• This could be a good opportunity to learn additional home skills (carpentry, plumbing, electrical, etc.), but there are expensive risks as well

• Be careful that with the addition you do not make the house significantly more expensive than those in the neighborhood

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22. Shouldn’t I be investing instead paying off my cheap home equity and students loans?

• Principle: Stewardship• Understand competing principles

• Build your emergency fund then pay off your high-interest credit card and consumer loans

• Use wisdom in working toward all your goals• Let time be your ally in investing, begin now• Mortgage interest and students loans have a tax

shield, so they are relatively cheap • A diversified portfolio for retirement and other goals

(including company match), should be able to earn more than what you are paying on your mortgage/student loans over time

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Investing versus paying off debt (continued)

• Generally I recommend (in this order):• Build your emergency fund

• Pay off consumer and credit card debt

• Continue to pay off student and mortgage loans from your normal budget expenses (the 80%)

• Save your 20% for retirement, missions, and education expenses (get the company match) and invest wisely

• Any extra above the 20% can be used to pay down your mortgage and students loans

• Note: I might also use the savings for the 20% down payment to avoid PMI

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23. Review the Buying a Home Process

• Purchasing a house is a four-step process• 1. Understand your limits

• Understand your budget and how much you can spend

• Pull your credit report and score. Aim for a FICO score of 760 and above

• Calculate your front-end (28%) and back-end ratios (36%) and how much you can afford

• Calculate your ratios for LDS (TT11) which includes tithing and savings

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Buying a Home (continued)

Know how much for a down payment Have copies of current income (2 years if possible)

and tax records Choose the preferred type of loan (fixed, variable,

interest only option—I recommend fixed) Determine the term of the loan (30 years?) Get pre-approved

• Note that for students, due to work history and down payment, an FHA loan may be the best alternative

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Buying a Home (continued)

• 2. Find your home• Develop a plan for finding a home• Determine what is important to you• Use a realtor or other resources to find a home in your

price range• Use Zillow.com to find current home values• Once you are serious about the home, get a home

inspection (offers can be contingent on the home inspection)

• Determine any CCRs and homeowners fees for your prospective purchase, and add them into your prospective costs

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Buying a Home (continued)

• 3. Negotiate the loan• Choose multiple lenders to compete for your

business

• Get Good Faith Estimates from each of your lenders

• Determine the amount time you estimate you will be in the home.

• Take the various loan offers from the lenders to calculate your lowest Effective Interest Rate

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Buying a Home (continued)

• Determine (as best you can) the investors rate by finding the minimum brokers will allow you to buy down to

• Find the best rate from the prospective lenders chosen

• Take the best rate to your favorite (nicest) broker, and ask them to beat it by ¼ to ½%.

• See the Interest Rate Commitment sheet

• Fulfill the covenants of the loan and have the loan funded.

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Buying a Home (continued)

• 4. Enjoy home ownership• Maintain it well

• Take care of your purchase and it will take care of you

• Generally it will take roughly 1-2% of the home’s value annually for upkeep

• Put this amount into your annual budget

• A professional cleaning a few times a year can help retain a home’s value

• Now keep the value of your home up!

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Questions?

• These were the questions that were sent to me. Do you have any other questions?