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Dave Donhoff – What does your crystal ball say?

Posted by seattlemike (My Page) on
Thu, Mar 26, 09 at 15:34

Hi Dave,

We appreciate reading the comments by you and other smart folks on this forum.

We are looking at a home mortgage refi and are at the point of deciding whether to grab the best deal now or to wait for something better. The $64k question.

Here’s our situation, in approximate numbers:

Original mortgage - $400k, 30 yr fixed, 7.6%, now about half way (14 years)
Second with same lender - $25k,
HELOC with same lender- $25k
Other debts - $50k
Current estimated appraisal - $900K
FICO – above 750
Retired; do not expect to relocate

Our thoughts regarding refi:

Seek $500k, 15 year loan; pay off original home lender; use cashout to pay off $50k debts

It doesn’t appear that we qualify for any of the new initiatives. No ARM, no hardship, etc.

Depending on ….(who you ask, what day it is, time of day, etc.), it looks like we might be able to land somewhere between 4.2 and 4.5% and a point or so. We aren’t in any particular hurry, unless, of course, those terms are heading upwards.

What would be your advice/recommendation? Jump now or wait? While many experts might have different views, we know one thing for sure – your crystal ball is infinitely better than ours! TIA!


Follow-Up Postings:

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RE: Dave Donhoff – What does your crystal ball say?

Hi Mike,

What would be your advice/recommendation? Jump now or wait? While many experts might have different views, we know one thing for sure – your crystal ball is infinitely better than ours! TIA!

Here's a very simple answer.... then a more responsible answer.

1st, the simple; The longterm interest rates appear to be heavily weaighted down to what appears to be a fairly impenetrable floor, and it doesn't look like we're in serious risk (at the moment) of any major economic events that would cause these rates to increase dramatically.

NOTE: These are the FNMA Mortgage Backed (Bonds) Securities. They move in the inverse of interest rates... IOW, as the bonds rise, rates fall. As you may see here, the bonds seem to be butting their heads against an impenetrable ceiling.


March 26th 2009 FNMA 4.5% Mortgage Backed Securities Quarterly chart
March 26th 2009 FNMA 4.5% Mortgage Backed Securities Quarterly chart

EVENTUALLY longterm rates will begin crawling back upwards again. Over the last 4-5 years I've been telling anyone who would listen that rates were still in a downward trend (that ENDED in December, in my opinion,) and that longterm rates are not likely to again rise above 7% for the lowest 30 FRM programs in most of our lifetimes (and my position on that remains unchanged.)


NOW, the RESPONSIBLE answer; You have apparently over $450,000 of your family net worth frozen in market-vulnerable real estate equity. From your brief post I have no way of knowing how the rest of your balance sheet is distributed, how your cashflows (revenues, expenses, taxes and protections) are organized, nor what your timeline estimations are for needing to convert your accumulated frozen equity into safe positions and income streams.

NOW is the time to get this structured with a conscious, intelligent intention... rather than haphazardly letting it simply "fall into place." The difference between designing & managing your balance sheet from an intelligent holistic perspective... and doing it piecemeal a la "rules of thumb" and old wives' tales can be a HUGE shortfall in later retirement comfort & safety.

I would strongly encourage the idea of consulting with a holistic financial planner (someone who's not incented to merely "gather assets" but also very well versed in structuring leverage/liabilities, and balancing real estate residential equity.)

My parting two points... minor as they be, are;
A) conforming limits are still at $417,000 for a single family residence... keep that in mind when talking of higher numbers. There are ways to combine a conforming 1st with a piggyback 2nd, but they aren't as easily accessed as they were as recently as a few months ago.

B) loans written into the shorter term from the outset give an appearance of savings, but they really not only do nothing of the kind, they are more dangerous to boot. In a 15 year term you have a heavier forced amortization (the surrendering of your money to the mortgage bankers.) Every dollar you hand over is lost working dollars for you, and in the current environment you can DEFINITELY have your working dollars earning better than your mortgage dollar's interest costs. The faster & safer way to eliminate your mortgage once & for all is to accumulate a side-balance account, and when you've accumulated enough simply write a check for the full amount to the mortgage bank.

Hope that's helpful.
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff – What does your crystal ball say?

The faster & safer way to eliminate your mortgage once & for all is to accumulate a side-balance account, and when you've accumulated enough simply write a check for the full amount to the mortgage bank.

It sounds like you are saying keep your money to yourself until you have built up enough "safety" to pay off chunks of your mortgage. But in that scenario, each dollar you keep safe is a dollar that you are being charged interest on.

We have a HELOC open with our bank for about 20% the value of our house. Total costs to obtain and keep this open: $25 / year.

Can you please explain how keeping the 20% to myself (and paying interest on the mortgage for that amount) is any safer than paying down the mortgage and having this HELOC open for emergencies? (That question is not supposed to be asked in a "snarky" manner, btw)

If we never need to tap that HELOC, we are only out the yearly fee, right? So what's the downside?


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RE: Dave Donhoff – What does your crystal ball say?

What'd be the comparable rates of interest that you'd be charged?

Is either or both deductible? Do you have some easily-accessible money in case of emergency?

What kind of health-care coverage do you have (assuming that you're U.S. residents)?

In case you haven't become aware of it elsewhere, at age 80, I'm carrying about 80% of my assets in various equity-based mutual funds (mainly bought a number of years ago) and stocks, some of them international ones ... that are "worth" (whatever that means) a lot less now than a couple of years ago.

Having lived in 22 places, I've never owned a home.

Considering the huge U.S. gov't. debt ...

... and individual as well, meaning that U.S. residents couldn't pick up a lot of new gov't. debt even if they had a mind to ...

... and the huge (and increasing) deficits that they're running in current account ...

... and the fact that they're printing money hand over fist ...

... plus the fact that several countries are making noises that they want the world's basic system of settlement of payments to be in a variety of currencies rather than almost exclusively U.S. Dollars ...

... I'm not nearly as optimistic as Dave - and a number of others - that low inflation is in the offing ... and low interest rates along with it.

Sorry to rain on your parade.

ole joyful


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RE: Dave Donhoff – What does your crystal ball say?

Hi Shadow,

It sounds like you are saying keep your money to yourself until you have built up enough "safety" to pay off chunks of your mortgage.

Actually no, not "chunks" but accumulating side funds until you have ALL you need to surrender the full amount of the mortgage leverage.

TECHNICALLY the SAFEST is to wait even further, until you've accumulated enough to not only eliminate your leverage, but ALSO have sufficient safe working capital that generates enough passive income for your financial independence.

But in that scenario, each dollar you keep safe is a dollar that you are being charged interest on.

Sure... and earn money on.... and do not have to beg & requalify to re-borrow from your own assets if needed.

We have a HELOC open with our bank for about 20% the value of our house. Total costs to obtain and keep this open: $25 / year.
Can you please explain how keeping the 20% to myself (and paying interest on the mortgage for that amount) is any safer than paying down the mortgage and having this HELOC open for emergencies? (That question is not supposed to be asked in a "snarky" manner, btw)

No 'snark' assumed ;~)

Two things;
A) Currently HELOCs are rapidly being frozen... undrawn line amounts are being withdrawn (it's completely legal, check your line agreement.) Anyone can face (and are) having their assumed "safety" HELOC eliminated without warning, literally overnight.

B) Carrying costs on a mortgage dollar are in the low 4%s (or lower) after tax... and much lower after inflation effects over the long run. Alternatively, relatively safe longterm growth & accumulation accounts can be had at 5%+, tax-deferred or tax free. Sending pre-inflation 2009 dollars at 4%-ish to eliminate long term debt that is likely to be halved by inflation over the coming 10-20 years... ESPECIALLY when those dollars could be compounding tax-free at 5%+... is NOT the better idea ;~)

If we never need to tap that HELOC, we are only out the yearly fee, right? So what's the downside?

See the part about undrawn HELOC balances getting frozen, let alone the lost safety & earnings.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff � What does your crystal ball say?

OK ... I'm starting to see where you're coming from.

We have about $70k left on a $115k / 15 year / 5.375% mortgage. We are currently putting an extra $325 / mo to principal. This effectively turns a 15 year mortgage into a 10 year.

What instruments are there that are a better vehicle for our $325 / mo?

As far as the HELOC being withdrawn, I have not talked to the bank specifically about that. From what I understand, since they are a very conservative, small, local bank they are not hurting right now. They haven't sold a mortgage they've written in at least 10 years (they provided a look-back report of 5 years when we started dealing with them 5 years ago), so that makes them a little more discerning to whom they lend to.

Sure, they were not the absolute lowest rate, but they do everything with a personal touch (including sending a bank officer to our closing - which made it take 10% the time of the closing when we sold our house). Maybe that will mean nothing in the long run, but I surmise that leads to a certain stability amount customers. Next time I'm in, I'm going to ask about withdrawing HELOCs and see what their policy and history is.


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RE: Dave Donhoff – What does your crystal ball say?

Hi Shadow,

What instruments are there that are a better vehicle for our $325 / mo?

It really depends on what you need the vehicle to provide, and how long you want it to do so. Its assumptive that you were throwing the $325 into the real estate equity on a longrun expectation... so you were not likely planning to re-tap into it for what, 10 years? 15? 20?

With those time-windows there are investment-grade accounts offered by insurance companies with principal gauranteed (secured against any losses by guaranteed reserves,) that also grow to match the upside of any annual or monthly-average growth in the large stock indexes (like the S&P500, the Dow, the Nasdaq, the Russell5000, and others.) These accounts grow tax-free, allow you to spend down the money whenever you ARE ready to retire & re-access it income tax free, and they offer the ability to fund them tax-free in much larger portions (if you so chose) than the ROTH IRA, or similar qualified accounts. Further, if you don't care about the potential of the markets' upsides (which are generally capped at 15%, and floored at a "no loss zero" in the case of down markets,) then you can choose a flat guaranteed 5%.

That's just one particular class of account... there are many available of many different structures that can be custom fit to your specific financial life needs.

As far as the HELOC being withdrawn, I have not talked to the bank specifically about that.

Wouldn't matter if you had... when they freeze lines they do so intentionally without warning (else what would be the point of freezing the line... they'd be letting the cattle out of the corral before slaughter time ;~)

From what I understand, since they are a very conservative, small, local bank they are not hurting right now.

The smaller they are, the less likely they have extensive deposits to cover the banking reserves requirements for lending... which is the reason the undrawn portions of HELOCs have been getting squelched.

They haven't sold a mortgage they've written in at least 10 years (they provided a look-back report of 5 years when we started dealing with them 5 years ago), so that makes them a little more discerning to whom they lend to.

Actually, its most likely that they haven't sold the SERVICING of their mortgages (thus, the name and phone number on the monthly bill is theirs.) If they didn't actually sell any mortgages, they'd probably only be able to have a few hundred clients, period. The funding providers are the ones who own the notes, and ultimately face the music for the undrawn HELOC close-downs.

Next time I'm in, I'm going to ask about withdrawing HELOCs and see what their policy and history is.

Asking history won't do much good, as HELOCs haven't existed long enough to stretch back to any historical credit collapse. Their stated policy may or may not be much help either (see above about "not scaring the cows out of the corral before slaughter time.")

See these links;
http://money.cnn.hu/2008/04/18/real_estate/heloc_freeze.moneymag/index.htm?postversion=2008042104

http://www.oneprojectcloser.com/finance/lender-freeze-close-home-equity-line-of-credit/

NOW.... in reality, with your Combined Loan to Value at or under 50%, you're not AS likely to have your undrawn line frozen... so the safety is less of an issue than the effective financial planning.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff – What does your crystal ball say?

Dave,

Thanks for your feedback. I must admit that some (much?) of what you said sorta flew over my head. Not your fault; just an indication of my level of knowledge in this area. Just a few questions (I don't know how to bold your comments, so I've put them in quotes):

(1) "The longterm interest rates appear to be heavily weaighted down to what appears to be a fairly impenetrable floor, and it doesn't look like we're in serious risk (at the moment) of any major economic events that would cause these rates to increase dramatically."

Are you saying that the refi rates are pretty much at their lowest point at this time, but also that you don’t envision them to suddenly rise? So how long would you estimate that this scenario would essentially hold steady? Guess this gets back to my initial question of "jump now or later". Should I decide within the next week, or do I have a month to mull things over without missing out on good deals.

(2) "Loans written into the shorter term from the outset give an appearance of savings they really not only do nothing of the kind, they are more dangerous to boot. In a 15 year term you have a heavier forced amortization (the surrendering of your money to the mortgage bankers.)"

I’m puzzled. Are you recommending a 30 yr over a 15 yr? Either way, we still repay the loan amount, but aren’t we paying less total interest with the 15?

(3) "The smaller they are, the less likely they have extensive deposits to cover the banking reserves requirements for lending... which is the reason the undrawn portions of HELOCs have been getting squelched."

You reply to Shadow related to comments about a small, local bank that was providing excellent service. We are basically comparing loans from two institutions. One is a huge national bank with assets over $5B and a 5-star rating by Bankrate.com (I have no idea if their ratings are good or not). The other is a local savings and loan that is not listed by Bankrate but claims a 5-star rating by Bauer Financial and is well-regarded by the community (for whatever that’s worth). We have presented our data to both and both have come back with essentially the same terms. Do I understand your reply to Shadow to mean that, all other things being equal (I know they never are), that you would go with the larger bank?

Thanks again, Dave.


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RE: Dave Donhoff – What does your crystal ball say?2

FWIW, the larger bank with the 5-star rating from Bankrate also has a 3.5 star rating from Bauer Financial.


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RE: Dave Donhoff – What does your crystal ball say?

I was thinking of asking the same question.

We've refinanced our residence twice in the 10 years we've owned it. We also have a HELOC with a small balance and refinanced that once (when the big lender froze it! switched over to a credit union). When we did the first refinance, to a 15-year loan, we also took out cash to pay off the mortgage on a rental property that was at 7.25%. The second refinance was back to a 30-year so we could build up our savings (having in the meantime decided to put the max into retirement accounts). I say this to explain why we basically owe the same amount that we did on this mortgage 10 years ago (though our total debt load is lower because we no longer have the rental property mortgage). We sold the rental a few years ago and bought a different property (for cash) that is earning a modest income for us. So I think overall we're ahead of where we were 10 years ago in terms of net worth.

I am sold on Dave's advice RE accumulating cash rather than paying extra into a mortgage, and that is what we are doing, even though interest rates are so low right now that we're not earning much on that money.

So, is it worth it to refinance once again? We could save a few hundred dollars a month, but (a) it would cost us a couple thousand dollars up front, and (b) we would start the loan over again at 30 years. It sort of seems like a wash to me, but is there something I'm missing?


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RE: Dave Donhoff – What does your crystal ball say?

Hi Mike,

Here's how to Bold, Italic, and Underline;
http://faq.gardenweb.com/faq/lists/neweng/2007014019017474.html#*WHAT COMMANDS ARE THERE BESIDES COLOR AND SIZE?
Simple HTML for GardenWebbers

Are you saying that the refi rates are pretty much at their lowest point at this time, but also that you don’t envision them to suddenly rise?

Precisely.

So how long would you estimate that this scenario would essentially hold steady? Guess this gets back to my initial question of "jump now or later". Should I decide within the next week, or do I have a month to mull things over without missing out on good deals.

I'm very confident that longterm fixed rates aren't going to rise until the market starts recognizing the inflation occuring under the hood. If our president is lucky, that won't happen for up to another 1-2 years.

I’m puzzled. Are you recommending a 30 yr over a 15 yr? Either way, we still repay the loan amount, but aren’t we paying less total interest with the 15?

Yes, I am recommending the 30 yr over the 15 yr, and no, you are NOT paying less interest with the 15 yr... that's a fallacy that is conveniently allowed to be promoted by the banks.

Let's imagine a 30 FRM at 5%, and a 15 FRM at 4.5%... LOOKS like the 15 is "cheaper" right? Its not.

The 15 sucks your dollars away, at demand, TWICE as fast as the 30 FRM. Every dollar you surrender is ALSO no longer earning you an interest yield/return... and *BEGINS* earning the BANK the yield you would have gotten. This lost yield (to you) is an interest % COST taht you must add back into your true cost of leverage... bringing your REAL costs back up to even, and more frequently HIGHER than the costs of the 30 FRM.

Think of it this way; The banks don't care whether you take a 30, 25, 20, 25, or 10 year amortization. If one of those plans were more profitable for them, they would steer you in that direction, but they do not. The reason why; They PRICE them to be EQUAL to them in terms of actual profit. In other words, they make NO LESS INTEREST from you on a 15 FRM than a 30 FRM.

SO... if, all things considered, they are really all factored equal... and there is really no savings advantage either way... HOW SHOULD YOU CHOOSE?

Answer; Safety! Which one gives YOU more control over your own cash, and surrenders LESS of that control to the banks? (The answer; The longer amortization period... the 30 FRM.)

Do I understand your reply to Shadow to mean that, all other things being equal (I know they never are), that you would go with the larger bank?

Not necessarily. On closed-end loans (mortgages,) the financial contract is legally set in stone (unless the government later unwinds it, or "crams it down" ;~) from the point of closing... unlike a HELOC, where there is an ongoing draw-and-repay revolving relationship. For mortgages, if you are paying less than 8-12% interest, your loan *WILL* be sold off on the secondary markets (the SERVICING may be retained... but the funding of the loan note itself will be replenished by selling it to investors.) Both the note, and the servicing rights, are "assets" to the bank and subsequent investors, and should any bank become insolvent their assets (their portfolio of notes & servicing rights) will be re-sold to the highest bidders.

IN SHORT; Which bank actually fills the commodity service of the mortgage is irrelevant. Their future strength or weakness will have no bearing on you as a borrower, either way.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff – What does your crystal ball say?

Thank you, Dave!


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RE: Dave Donhoff – What does your crystal ball say?

Let's imagine a 30 FRM at 5%, and a 15 FRM at 4.5%... LOOKS like the 15 is "cheaper" right? Its not.

Assume the two mortgages:

100k, 30 yr @ 5%
Monthly payment: $563.82 ($120.15 principal, $416.67 interest)
After 15 years: Spend $91k to own $34k at a cost of $57k.

100k, 15 yr @ 4.5%
Monthly payment: $764.99 ($389.99 principal, $375.00 interest)
After 15 years: Spend $138k to own $100k at a cost of $38k.

So, if I understand what you are saying, your point is that with the 15 yr, I would spend an additional $47k (138 - 91) to make $19k (100 - 34 - 47) and that other vehicles exist that would generate a better return over that time frame.

Correct?


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RE: Donhoff – What does your crystal ball say?

Note that I know that the numbers above ignore a few factors (eg - interest deduction) ... I'm just trying to start off simple.


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Wanted to include calcuated interest.

I wish there was an edit feature to posting!

I wanted to include that with just the calculations above, the $47k to make $19k represents a 4.8% interest rate on that "investment" (I think).


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RE: Dave Donhoff – What does your crystal ball say?

Hi Shadow,

So, if I understand what you are saying, your point is that with the 15 yr, I would spend an additional $47k (138 - 91) to make $19k (100 - 34 - 47) and that other vehicles exist that would generate a better return over that time frame.
Correct?

No... you are confusing "spending" (as in paying interest) with surrendering principal (which loses interest.) Your gross mortgage payment includes both, but they have opposing results.

In your example (originally my example,)

A) You 'saved' $26,813 in pre-tax interest costs over 15 years by choosing the 15 FRM,
($64,511 in 30 FRM interest paid over 15 years, minus $37,699 paid for the 15 FRM.)

B) You surrendered $67,884* of your interest-earning capital over 15 years by choosing the 15 FRM,
$100,000 principal surrendered over 15 yrs in the 15 FRM, versus $32,16 surrendered in the 30 FRM.)

C) You forfeited the annual compounding interest on that $67,884 each month you surrendered it.
(I ran it out on an amortization table, and at 3% annual interest (you could do better, but let's stay conservative) you'd have lost $13,778 in earnings over that 1st 15 years. You'd have further lost another $17,119 over the remaining 15 years of the 30 FRM.)

D) $13,778 yield on the $67,884 is over 20% gross return over 15 years... well over 1.33% per year growth that would be forfeited if you took a 15 FRM in order to 'save' 1/2% in interest.

(* You "OWN* 100% of your HOME value from day #1... don't let the fallacy of "the bank owns it if I have a mortgage" fool you. The bank gets none of the growth, none of the benefits, and only the interest on the amount of YOUR OWN money you choose to use. The value is yours... you can use its cash value for your benefit, or not.)

To make it much simpler, you are agreeing to surrender an extra dollar each month in return for a 0.05 (half of one percent) 'savings.' In essence you are declaring that you can't find anywhere to employ your additional dollar that will return to you greater than that 0.05 (half of a percent) in interest, growth, or benefits.

Make more sense now?

Cheers,
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff – What does your crystal ball say?

Not sure I completely follow this example, Dave. If one assumes that you save that capital in increments over the 15 years rather than starting with the lump sum (as would be true for most people who take out a mortgage), wouldn't the yield be much smaller?

I do agree with the idea that cash in hand is better than cash tied up in a house, but in our case I'm assuming we're just going to break even by saving the difference rather than paying down the mortgage early. (But will also save ourselves from possibly having to borrow money for big expenses along the way.)


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RE: Dave Donhoff – What does your crystal ball say?

Dave,

I appreciate the response, but things are still moving to fast for a rodeo clown like myself. Of course, it didn't help that I screwed up my calculations, too. What I am attempting to do is a step-by-step "derivation" or "proof" that will allow me (and hopefully other readers) to understand this process. As I move through the steps, I can remove/alter assumptions to get closer to reality.

I realize this is kindergarten stuff to you, but it goes against years of beliefs for me and need the baby steps to see it all laid out so I can understand it. As for nomenclature, I know how hard it can be to deal with a neophyte talking about your area of expertise, but I ask you to please bear with me. I have to do it all the time when I am working with others and I've found it best to just do the conversion from "unfamiliar" terminology to "official" in my head as I talk with people.

Definitions:

Spend - Amount withdrawn from personal checking/savings account
Own - A "spend" amount that ends up in an asset that I own; How much an asset is valued
Cost - A "spend" amount that ends up in an asset that I do NOT own

For this example: Spend = Own + Cost

If I take $20 from my right pocket (checking account), give it to third-party (bank), and they give me $15 (principal) to be put in my left pocket. I have spent $20, to own $15, at a cost of $5. For this step, the only difference between money in my right and left pockets is that the money in my left pocket is much harder to get out.

or

I spend $1000 on a new gadget. When I get it home and open it, it has a value of $750 (since it is no longer "new"), hence at that moment it has a cost of $250. So, I spent $1000 to own $750 which cost me $250.

Assumptions:

I am ignoring appreciation/depreciation of the home over this time.
I am ignoring the tax deduction for the mortgage interest.
I am ignoring any work that could be done by the spending difference.

Consider:

100k, 30 yr @ 5%
Monthly payment: $563.82 ($120.15 principal, $416.67 interest)
After 15 years: Spend $96.6k to own $32.1k at a cost of $64.5k. (Month 180 payment: $252.92 principal, $283.90 interest)

100k, 15 yr @ 4.5%
Monthly payment: $764.99 ($389.99 principal, $375.00 interest)
After 15 years: Spend $137.7k to own $100k at a cost of $37.7k. (Month 180 payment: $762.99 principal, $2.86 interest)

Results:

The difference in spending is $41.1k. (137.7 - 96.6)
The difference in ownership is $67.9k. (100 - 32.1)
The difference in cost is $26.8k. (64.5 - 37.7)

The extra spending of $41.1k yielded $26.8k. (100 - 32.1 - 41.1)
I _think_ this is equivalent to a 7.35% yield.

Given the assumptions above, do the results make sense? If they do, then I can move on to removing assumptions.


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RE: Dave Donhoff – What does your crystal ball say?

Hi Harriet,

Not sure I completely follow this example, Dave. If one assumes that you save that capital in increments over the 15 years rather than starting with the lump sum (as would be true for most people who take out a mortgage), wouldn't the yield be much smaller?

I started from $0... the very first month the 30 FRM borrower was left with more of his principal in hand, and at a 3% annual yield it was under a buck or so... and we grew from there.

I do agree with the idea that cash in hand is better than cash tied up in a house, but in our case I'm assuming we're just going to break even by saving the difference rather than paying down the mortgage early. (But will also save ourselves from possibly having to borrow money for big expenses along the way.)

Right! There's a serious "hidden premium benefit" to having the cash in hand & not having to pay costs to re-access it (let alone worry about even qualifying for some banker's "permission.")

============================================

Hi Shadow,

FIRST OFF, no need for all those humbling apologies... EVERYTHING I know financially has been learned in the real world. I was not born to a financially savvy family, nor was my formal education in finance (my degree was in business, but I was not all that into the financial sides at the time.) All I teach here & elsewhere now is what I have learned in the last decade of "life."

I *DO* try to simplify things & explain in examples & metaphors... but inevitably I end up accidentally falling into jargon (deeply sorry when that happens,) or else I introduce ideas that are SO "killing the sacred cow" of old wives tales that some folks just can't hear it.

OK... NOW....

Your Assumptions; FINE.
Your Consideration; FINE.

Your "basic English" is OK to start... but let me see if I get it in translation...

"Spend" = Amount withdrawn from personal checking/savings account (what interest rate WOULD you receive if you kept these funds working?)

"Own" = convert working capital into real estate capital

"Cost" = interest paid to maintain working capital, working.

Here's where I'm getting a bit boggled;
Results:
The difference in spending is $41.1k. (137.7 - 96.6)
The difference in ownership
(working capital surrendered?) is $67.9k. (100 - 32.1)
The difference in cost is $26.8k. (64.5 - 37.7)

The extra spending of $41.1k yielded $26.8k. (100 - 32.1 - 41.1)
I _think_ this is equivalent to a 7.35% yield.

OK... "spending" in your words includes both interest paid, and principal surrendered.

Surrendering principal carries a negative yield (since you lose its ability to earn by the going payable rate.)

"Cost" interest savings is the "yield" you get for surrendering extra principal (paying down the loan faster than the 30 FRM.)

I'll see if I can work up a spreadsheet illustration this weekend...
Dave Donhoff
Leverage Planner


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RE: Dave Donhoff – What does your crystal ball say?

Dave,

Sounds good, but do you mind waiting a day or so? I'd like to post the next step of my "derivation" and that will provide more accurate financial targets.


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RE: Dave Donhoff – What does your crystal ball say?

Assumptions:


  • I am ignoring appreciation/depreciation of the home over this time.

  • I am ignoring any work that could be done by the spending difference.

  • I can take the full deduction available to me for mortgage interest.

Consider:

At the 28% bracket, the breakdown is as follows -

100k, 30 yr @ 5%, 28% bracket
Actual monthly payment: $563.82
Effective first monthly payment: $420.15 ($120.15 principal, $416.67 interest - 28% deduction)
Effective 180th monthly payment: $457.32 ($252.92 principal, $283.90 interest - 28% deduction)
After 15 years: Spend $78.5k to own $32.1k at a cost of $46.4k.

100k, 15 yr @ 4.5%, 28% bracket
Actual monthly payment: $764.99
Effective first monthly payment: $659.99 ($389.99 principal, $375.00 interest - 28% deduction)
Effective 180th monthly payment: $765.05 ($762.99 principal, $2.86 interest - 28% deduction)
After 15 years: Spend $127.1k to own $100k at a cost of $27.1k.

The difference in spending is $48.6k. (127.1 - 78.5)
The difference in ownership is $67.9k. (100 - 32.1)
The difference in cost is $19.0k. (46.4 - 27.1)

The extra spending of $48.6k yielded $19.3k. (100 - 32.1 - 48.6)
I _think_ this is equivalent to a 4.75% yield.

At the 35% bracket, the breakdown is as follows -

100k, 30 yr @ 5%, 35% bracket
Actual monthly payment: $563.82
Effective first monthly payment: $390.99 ($120.15 principal, $416.67 interest - 35% deduction)
Effective 180th monthly payment: $437.45 ($252.92 principal, $283.90 interest - 35% deduction)
After 15 years: Spend $74.0k to own $32.1k at a cost of $41.9k.

100k, 15 yr @ 4.5%, 35% bracket
Actual monthly payment: $764.99
Effective first monthly payment: $633.74 ($389.99 principal, $375.00 interest - 35% deduction)
Effective 180th monthly payment: $764.85 ($762.99 principal, $2.86 interest - 35% deduction)
After 15 years: Spend $124.5k to own $100k at a cost of $24.5k.

The difference in spending is $50.5k. (124.5 - 74.0)
The difference in ownership is $67.9k. (100 - 32.1)
The difference in cost is $17.4k. (46.4 - 27.1)

The extra spending of $50.5k yielded $17.5k. (100 - 32.1 - 50.5)
I _think_ this is equivalent to a 4.2% yield.

Results:

At 28%:

The difference between 15 and 30 year mortgages in 1st month's effective payment: $239.84 ($659.99 - $420.15)
The difference between 15 and 30 year mortgages in 180th month's effective payment: $307.73 ($765.05 - $457.32)
The extra spending of $48.6k yielded $19.3k, 4.75%. (100 - 32.1 - 48.6)

At 35%:

The difference between 15 and 30 year mortgages in 1st month's effective payment: $242.75 ($633.74 - $390.99)
The difference between 15 and 30 year mortgages in 180th month's effective payment: $327.40 ($764.85 - $437.45)
The extra spending of $50.5k yielded $17.5k, 4.2%. (100 - 32.1 - 50.5)

Next Step:

(And this is where you come in Dave - this is what I wanted to post before you went and did any spreadsheet work)

Drop the "ignoring the work" assumption and compare these results to the yield of other investments, based on the following:

(28% bracket) 180 monthly investments, starting from $239.84 and increasing in equal increments to $307.73
(35% bracket) 180 monthly investments, starting from $242.75 and increasing in equal increments to $327.40

_After_ this is done, the final step will be a discussion on how to best integrate the appreciation of the underlying asset into the original yield. In other words, let's not starting talking about how an increasing / decreasing home value affects the calculations just yet.


 o
RE: Dave Donhoff – What does your crystal ball say?

What happened to this discussion. It was getting real interesting. We are in the same place with 15 years left on a mortgage and 13 on HE Loan. We are 15 years from retirement and the 30 year mortgage worries us about making the payments after retirement. As Dave alluded to old perceptions die hard. We want to see this discussion through to see if we can "get" it
Our mortgage balance is 180K at 5.375% and it started as a 20 year and is down to 15 years. Our original 15 year HE Loan balance is at 96.4K at 6% with 13 years left. We were thinking of a 15 mortgage at 4.675 with no points and 2.5K in closing. We have virtually no other debt other then a auto loan with 3 years left and payments of 350/M. We max out my 401K and catch up. We would like to fund my self employed spouses SEP more. We have about 7 months of reserve "cash" on hand. I still need more convincing on why a 30 year is better.

Thanks


 o
Bank Mortgage rates BELOW 4%

Great to see that the mortgage rates are coming down. Also nice to see that these banks are asking for a 20% downpayment. This is the way it should have been all along.

2 Wash. banks offer mortgages below 4 percent
April 4, 2009

SPOKANE, Wash. (AP) - Spokane-based Sterling Savings Bank and Walla Walla-based Banner Bank are offering mortgages at interest rates below 4 percent to stimulate sales and help builders move homes.

Bank officials said the low rates benefit buyers and builders, and demonstrate the banks are putting federal government bailout money to work in the Northwest.

Banner received $124 million from the federal Troubled Asset Relief Program, or TARP, while Sterling collected $303 million.

Banner Bank is offering fixed mortgages rates as low as 3.875 percent under its "Great Northwest Home Rush" program.

"We have been very pleased with what we've done so far," Banner Vice President Doug Bayne told The Spokesman-Review. "There's a time to buy, and that time is now."

Banner's program has helped move about 60 of 250 homes in the Portland, Ore. area that Banner builders had not been able to sell, he said.

The bank expanded the program to Spokane, Idaho and the Puget Sound area after its success in Portland.

Most borrowers must have a 20 percent down payment, Bayne said.

Sterling is working with Golf Savings Bank, its mortgage lending subsidiary, to offer qualified borrowers either a 3.875 percent fixed mortgage rate or a 3 percent lender contribution, up to $20,000.

A link that might be useful

www.komonews.com/news/local/42474947.html


 o
RE: Dave Donhoff – What does your crystal ball say?

Dave,

Back to my original question to you, esp. regarding yesterday's news of the two WA banks offering 3.875% on purchases.

Do you see refi rates dipping below 4% here in western WA?? Associated points??


 o
RE: Dave Donhoff – What does your crystal ball say?

Hi All,
My apologies if I'm slow on the more detailed questions & threads... I promise I *WILL* get back to them... but at the moment I'm pretty time constrained with the recent surge in the mortgage business and the number of our clients requesting support in principal-guaranteed (insured against any market loss) growth accounts.

NOTE: The sub-4% rates are currently (to my knowledge) 100% Builder-provided, and require a deep discount-point buydown... which the builder's are happily paying on behalf of the buyers.

This naturally makes great defensive sense for the builders... because if they pay 3-4 discount points (3-4%) in order to sustain a sale of a property that otehrwise might have required a 3-5% (or more) price discount in a numerous subdivision, they ALSO prevent a recorded "closed sale" at the discounted price on the county records, which would otherwise immediately reflect on the appraisals of *ALL* the other unsold properties in their portfolio.

In essence, its a way for the builders to "lose a lot on ONE property" with an indirect 'phantom' discount that appraisers aren't able to know about... and thereby keep the rest of the public from becoming aware of it.

This thereby helps the builders prop up their sale prices and avoid a naturally dropping market by the public reporting of the actual total price terms.

To SeattleMike's question;
I'm seeing 30 FRMs available as low as 4.25%, with breakeven periods on the associated costs from 2.5 to 3.5 years. (The actual discount points required for a 4.25% depends on other factors in a borrower's file... thus the "spread" of 2.5 to 3.5 years to break even.)

Will we get back under 4%? I don't see the natural markets taking us there... so it really depends on if the government gets taken seriously on another "purchase campaign" by the treasury of mortgage securities.

What will Obama's team do? If you determine how to know, please let me know ;~)

Cheers,
Dave Donhoff
Leverage Planner


 o
RE: Dave Donhoff – What does your crystal ball say?

Thank you, Dave, for all your assistance and advice!


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