Mortgage Tips for Different Phases in Life with Tim Kay
Mortgage Tips for Different Phases in Life Show Notes
With Thanksgiving right around the corner, I’ve started to think a lot about the things I’m thankful for. Of course, there’s my family, great friends, and everyone that trusts me to help them with various aspects of financial planning. But another thing I’m obviously thankful for is my home. So, I figured this would be a great opportunity to discuss some key mortgage tips to think about when financial planning for people of different ages.
I’m excited to have Tim Kay, who is a branch manager at Guild Mortgage to help me review those mortgage tips on The Guided Retirement Show. We’ll discuss mortgage tips for people looking to buy their first home, people who might be looking to buy a summer or winter home in retirement, and so much more.
In this podcast interview, you’ll learn:
- How today’s housing market compares to the Great Recession.
- When and when not to refinance your home.
- Mortgage tips to consider for people who are looking to buy their first home, second home, and so on.
- What is a HELOC (home equity line of credit)?
- “If the 30-year-old first-time home buyer has 20% down, great. Or if their family can gift them money for 20% down, that’s also great. I sort of think of it as having a goal to put as much money down as you can to get a cheaper payment. Or put as little money down as you can and do something different with your money. Don’t get stuck in the middle.” – Tim Kay
- “People that have bought a house in the last 10 years or so aren’t going to want to refinance right now. The rates are probably going to be higher than what they’ve got.” – Dean Barber
- Tim Kay – Guild Mortgage
- Barber Financial Group Educational Series
- America’s Wealth Management Show
- Our Financial Planning Tool
Interview Transcript – Mortgage Tips for Different Phases of Life
Welcome Tim Kay to The Guided Retirement Show
[00:00:28] Dean Barber: Hello, everybody. I’m Dean Barber, founder and CEO of Barber Financial Group and your host of The Guided Retirement Show. Today, we have a very special guest. Tim Kay has been a friend of mine for several years. He is a branch manager for a company called Guild Mortgage. Tim has been in the lending business for over 20 years and has several mortgage tips for people in different phases of life.
I always get questions from people about refinancing a home, making a first-time home purchase, and about buying a second home. That’s part of why I’m so excited to have Tim Kay on The Guided Retirement Show to share some of his mortgage tips. The conversation that Tim and I are going to have is going to open your eyes to a lot of things that you need to know when it comes to buying a home, selling a home, getting into your next home, and how much money should you put down. I’ll discuss all that and more mortgage tips in my conversation with Tim Kay.
[00:01:16] Dean Barber: Before we hop into today’s episode, I want to remind everyone that you can access the same financial planning tool that we use for our clients. You can use it on your own time and from the comfort of your own home. All you need to do is click the “Start Planning” button below. From there, you can start building your retirement plan at no cost or obligation.
Tim’s Background in the Mortgage Business
[00:01:35] Dean Barber: All right, we’ve got Tim Kay. He is the branch manager at Guild Mortgage in Overland Park. Tim, thanks for taking time to join me on The Guided Retirement Show to discuss some mortgage tips.
[00:01:43] Tim Kay: You’re welcome. I’m happy to be here. Thank you.
[00:01:45] Dean Barber: Tim and I have known each other a long time. And the mortgage business has been your business for as long as I’ve known you.
[00:01:50] Tim Kay: I think I’ve been a lender since either 1995 or 1996, so 20-plus years. There have been a lot of changes in those years.
The Many Changes in the Mortgage Business
[00:01:56] Dean Barber: Tim has seen a lot of changes in those years. He had all these crazy loans that were taking place back in the mid-2000s. Coming off the Dot-Com Bubble, when stock markets crashed, everybody was saying to put money in real estate. What was it like back then?
[00:02:23] Tim Kay: Oh, it was crazy. Back then, I probably could’ve made more money if I would’ve done those loans. But they didn’t feel good, so I didn’t ever do them. That was a blessing because they all but outlawed those kind of loans and they pretty much went away.
Those of us that did good-quality business are the only ones still around. They were stated income loans, stated asset loans. For example, a secretary that wanted to buy a big house could say that she made $20,000 a month and nobody would even ask. And it was just a minimum-wage person, but you were acting like they made more. Or you could do pay-option ARMs, where they were negative amortizing. In other words, you weren’t even paying the full interest.
Instead of your balance going down, it was going up a little bit every month. But they said that was OK because house prices were increasing more than their loan amount was going up. That was all well and good until about 2003 when all that stopped happening.
[00:03:19] Dean Barber: I call those liar loans. Nobody verified any of your income. They didn’t verify your assets.
[00:03:33] Tim Kay: Stated income, stated asset.
[00:03:34] Dean Barber: Yeah. There were several different issues, but one thing that I think what led to the Great Recession were a lot of the lending standards in the housing market. So, let’s go to one of the loans that Tim is talking about.
Just Sign Here, and Here’s Your House
[00:03:53] Tim Kay: We didn’t even realize how easy, not good, but how easy we had it back then. You could just say, “Sign here,” and get an appraisal. Sometimes, they didn’t even require an appraisal. They just pulled your credit, and that could be marginal, and then you had your house. The other thing was that you could close three days later. They tried to do that in a way that sort of made it so that people truly didn’t have time to look at what they just signed. It was just slam and jam.
[00:04:23] Tim Kay: And they didn’t really ever do 30-year fixed on those kinds of loans. They would do what’s called a 2/28 ARM, which meant the rate was fixed for two years, or a 3/27 ARM that was only fixed for three years. But then there was a prepayment penalty for a full five years. The prepayment penalty was generally 4% of the balance.
So, if you borrowed $200,000, your prepayment penalty was $8,000. After two or three years, your payment was pretty much going to double. The only way you could get out of that is if you had $8,000 sitting around in the bank. None of those people were the type of people that had an extra $8,000 in the bank to buy out of their prepay.
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A Flood of Foreclosures During the Great Recession
[00:05:01] Dean Barber: Right. Then came the foreclosures.
[00:05:04] Tim Kay: Exactly. A large percentage of the U.S. lost their house in 2007-2008.
[00:05:09] Dean Barber: And there was another issue there. Tim talked about the negative amortization loans.
[00:05:14] Tim Kay: ARMs.
A $1 Million Mistake—A Mortgage Tip of What Not to Do
[00:05:15] Dean Barber: There were a lot of the loans out there that were 30-year amortization, five-year balloon, interest-only loans. I have what I’ll call an acquaintance who made a very foolish decision. He decided that he wanted a bigger home than what he could really afford. I told him at the time that he was absolutely nuts. Because it was a 30-year amortization, we got five years of interest-only, he went and bought a $1 million home. Let’s say that the interest rate was 5% with a really cheap payment.
[00:05:56] Tim Kay: That’s an arbitrarily and temporarily cheap payment.
[00:05:58] Dean Barber: Right. He did this in 2006. It wasn’t until late 2007 and into 2008 when the defaults started happening on a lot of the subprime loans. That’s what Tim was alluding to there a few minutes ago. Those were the subprime loans. Suddenly, we have all these defaults on the subprime loans, which leaked into the prime loan market and ultimately started collapsing the value of real estate. So, this guy’s house that he bought in 2006 for $1 million, the five-year balloon came due in 2011. Now, all the lending standards had changed. The laws had changed and what the banks would do and the lenders could do had changed to the conservative direction of change.
When the Five-Year Balloon Blows Up in Your Face
[00:06:39] Dean Barber: So, his five-year balloon was up. That meant he either had to pay the $1 million off or had to refinance.
[00:06:49] Tim Kay: And it wasn’t an ARM, it was a balloon.
[00:06:51] Dean Barber: It was a balloon, yeah.
[00:06:51] Tim Kay: So, the balance is due after 60 months.
[00:06:53] Dean Barber: Right. If he doesn’t pay it off, he must refinance.
[00:06:56] Tim Kay: Because he’s been making interest-only payments, he didn’t pay any principal balance down. And then, because of all the defaults that happened in the last five years, values went down because every default in his neighborhood sold for half price or pennies on the dollar.
Suddenly, He Owes $1 Million on a $600,000 House…
The way appraisals work is, “What have your neighbors’ houses sold for?” Probably $600,000 or something in this case.
[00:07:15] Dean Barber: Exactly right. That’s the number, $600,000.
[00:07:17] Tim Kay: So, by comparison, his house is worth $600,000, which is probably less than he owed on it because he probably borrowed.
…And Owes 20% Down for Refinancing!
[00:07:26] Dean Barber: He borrowed $1 million. He didn’t put any money down. It was a five-year interest-only balloon. So, he owed $1 million and the house is now worth $600,000. Oh, and guess what. To refinance, you need to put 20% down of the $600,000. Now he needs to come up with $520,000 to stay in his house. He didn’t have anywhere near that kind of money. Those kinds of things snowballed on each other.
[00:07:51] Tim Kay: Exactly right. Eighty percent of $600,000 is $480,000. He has $1 million, and they’re saying, “We’ll do the refinance for you if you pay it down to $480,000.” Well, if he had $520,000, he might have put that down in the first place.
Then and Now in the Mortgage Lending Business
That’s my fear right now. The difference is that in 2007 and 2008, the good news and the bad news is that Congress got significantly involved in regulating our business. They started doing licensing. They started doing sort of a barrier to entry in terms of needing to pass a test and do continued education.
Thirty years ago, someone would say, “Do you want to be a lender? OK. You start tomorrow morning. Here’s your desk and phone.” It’s not incredibly hard to become a lender now, but you need to do 20 hours per year of continuing education. You must do a background check and pass tests for every state and the national test.
Liar Loans Are Close to Being Illegal Now
At least they’ve pretty much outlawed the liars’ loans. I don’t know if it’s true to say that they’re illegal, but it’s pretty close. And they should be. They fall under the category of bad mortgage tips.
[00:08:56] Dean Barber: Well, they should be. Because they’re baiting people get in over their head. Do you remember the commercials that said, “We’ll loan you up to 120% of the value of your home.” And people were like, “I can get a $500,000 home. and go get $100,000…”
[00:09:21] Tim Kay: Yeah, 125s. Yes. Second mortgages too.
The Writing on the Wall (or in This Case, in the Newspaper) of When the Housing Market Was Going to Crash
[00:09:23] Dean Barber: That was a disaster. Do you know when I knew it was all over? This is going back to when I got the newspaper. I walked out into my front yard on a cold December morning to get my newspaper and went back inside to read it. I went to the finance section and there’s a full-page ad that you could get a free BMW with the purchase of a Pulte home.
[00:09:55] Tim Kay: That’s pretty funny. You buy a Pulte home and they give you a Beamer.
[00:09:57] Dean Barber: I told my wife that and said, “This housing market is going to crash. This is insanity.” That was December 2007.
[00:10:10] Tim Kay: I believe that. That’s crazy. That doesn’t surprise me. There was so much money in it because it was really Wall Street-type investors looking for junk bonds, higher yields, and much riskier stuff that was sort of hard to define what it really was at the expense of quality underwriting and quality approvals.
The Client’s Best Interest Wasn’t in Mind with These
[00:10:33] Dean Barber: They packaged all these securities together and then sold them out into the market to individual investors as AAA credit.
[00:10:47] Tim Kay: Some of them probably were fine, but for the most part, they were sold by people that did not have their clients’ best interest in mind. The other thing was the big commissions that they were looking for. The biggest of commissions were paid on these things. Where a normal bank probably makes 2% or 3% when they sell a loan, these were 5% to 10% commission deals.
[00:11:08] Dean Barber: Oh my God. I had no idea that that was the case.
[00:11:10] Tim Kay: Oh yeah. Instead of making $5,000 or $6,000 on a $200,000 loan when they sold it to Fannie Mae, the bank made $20,000.
[00:11:20] Dean Barber: Wow. Well, thank God those times are behind us.
[00:11:24] Tim Kay: Me too. I agree.
The Layers of Lending and Useful Mortgage Tips
[00:11:26] Dean Barber: Tim, what I would really love to do is peel back the layers of what goes on in lending and review some mortgage tips. I’d like to start with the basics. Let’s give some mortgage tips on some of the things that people really need to know when they’re going to get a loan for a property. That can be a house, an investment property, whatever. I know the loan rules are different for investment property than they are for a house, but let’s stick to the house individually. What are some things that people need to be aware of when they’re going to go get a loan?
Most Mortgages Are Uniform in Nature
[00:12:04] Tim Kay: For the most part, mortgages are made to be sort of uniform. That’s a good thing because it makes them not dependent upon the mood of the loan officer or the lender. They’re just based on the credit and the capacity to pay back, the collateral value—like the house value or the house condition—and certain things that you can put on paper that you can sort of measure. In other words, at least in in my part of the business, there’s not too much of doing somebody a favor and getting them a loan. Maybe in some sorts of banking there is, but in mortgages that go through Fannie Mae, they’re pretty much standardized.
[00:12:41] Dean Barber: So, you have the interest rate on the loan. That’s something that you need to know about. And then you have potential points on the loan and closing costs. Are these things standard as well?
[00:12:53] Tim Kay: Among good lenders, they’re similar. Everybody sort of gets their money from the same place, which is called Fannie Mae. Everybody, in accounting terms, kind of has their same cost of goods sold of all the input costs. More or less, all lenders have the same rates, at least within a 10th of a percent.
Using the Market for Baselines
I sort of liken it to if you want to go buy Apple stock. I don’t say, “Dean, what’s your price for Apple stock?” and then go to another financial adviser and say, “What’s your price for Apple stock?” because the market is giving you your price. In mortgages, the market is giving the lender their price and interest rate.
[00:13:27] Dean Barber: But the lender can also choose to mark up those rates for extra profit.
[00:13:30] Tim Kay: Lenders almost always do. And that’s that 2% to 3%. That’s not 2% to 3% of interest rate. That’s called servicing value. In other words, getting the interest over the life of the loan.
30-Year Mortgage Hovers Around 7%
[00:13:45] Dean Barber: As Tim and I have this conversation, the 30-year mortgage is around 7%. If that were the standardized rate across the board, might you find a lender that’s loaning it at 7.125% or 7.25% or something like that?
[00:14:02] Tim Kay: Or 6.875%. It’s interesting to think about that. In these times right now, 7% is about 4% higher than they were a year ago. But if you go back to pre-COVID times, 5% to 6% was the normal interest rate range for the last 30 years before COVID. That was before the Fed started doing quantitative easing.
[00:14:24] Dean Barber: This time last year, it was around 3%. I saw a lot of our clients getting under 3%. I was like, “That’s free money.”
[00:14:36] Tim Kay: You need to compare it to inflation. Even if inflation slows down closer to 2%, if you’re borrowing money at 2.5% and inflation is 2.5%, then you’re not losing. Not very much, anyway. And it’s tax-deductible a lot of times.
How Do Points Work on a Loan?
[00:14:50] Dean Barber: Absolutely. Talk to us about how the points work on a loan. That’s an important mortgage tip. You can buy the interest or you can pay that lender to lower the rate.
[00:15:00] Tim Kay: Yes. It’s called discount origination points. That’s pretty much a slang way of saying, “Paying money upfront to the lender in exchange for getting a lower interest rate during the life of the loan.” Generally, one point is 1%. So, again, say you’re borrowing $200,000. One percent of that would be $2,000 in extra closing costs. That’s just fee income to the lender. In exchange for that, they might offer you a 0.25% lower interest rate.
When to Pay the Points
So, if the rate is 6%, you pay one point, which is $2,000 extra upfront. They would charge you 0.25% less, so your rate goes from 6% down to 5.75%. Then, you just sort of need to think of it in cost benefit terms. You’re paying $2,000. You’re saving $100 a month because of your lower interest rate. So, after 20 months, you’re better off with the lower interest rate. Before 21 months, you’re better off with the higher interest rate, but with $2,000 extra in cash reserves.
[00:15:58] Tim Kay: You just need to evaluate it based on how long you feel comfortable that rates are going to be like that. If rates are going to go low before your break-even points, then don’t pay the points. But if this is like a couple of years ago when people were borrowing money at 2.5% or 3% and were never going to move, that’s probably their forever 15, 20, 30-year loan. And so, it did make sense to pay points a couple of years ago, whereas now we’re likely to go back over the cliff and get cheaper rates at some point.
How High Will Rates Go?
[00:16:28] Dean Barber: If the economy goes into a recession from where we’re at here, then yeah, we could start to see rates come back down again. But honestly, I think rates are going to go higher before they start going lower.
[00:16:41] Tim Kay: I have heard from a couple of different economists that the Fed’s main goal is to push rates up to 8.3%, maybe even 8.5%. It’s sort of a race to push them up, in my opinion. The Fed keeps bumping the Fed Funds rate, which is not the same as mortgage rates, but it sort of trickles down. They keep bumping up the Fed Funds rate like 0.75% per month. They just did it again to begin November.
Remembering the Fed’s Monetary Policies
At some point, we’re probably going to have 8.5%. The Fed’s main job is to control prices to not let inflation get too high or not too low. They want it to be around 2% or 2.5%. The ways that they can do that are by controlling the rate that banks borrow money from the Fed in the short term and by controlling the money supply.
[00:17:35] Tim Kay: Right now, they’re raising rates. They’re also selling off some of the treasuries that they bought in the last couple of years to increase the money supply. Now, they’re selling them, which means they’re giving the treasuries back. They’re getting the banks and the big investors money, which basically means that they’re taking money off the street and then they’re going to hold that, which lowers the money supply. Those two things make less money out in the world and make inflation slow down.
[00:18:01] Dean Barber: Which could also lead to a recession.
How to Assess a Recession
[00:18:04] Tim Kay: Most likely, yes. In the mortgage world, I look at recessions differently. In the last 30 years, almost every recession has been a boom in the housing industry. If you think about it, when we’re having a recession, we’re questioning whether the recession is affecting your job, employment, and ability to put food on the table and take care of your family.
If there is a recession and you feel good about your job, it’s an excellent time to buy a house because probably rates are cheaper and there’s probably a little less competition for the houses because some people got laid off. It’s an excellent time to buy a house because of those two reasons.
Mortgage Tips for First-Time Home Buyers
[00:18:44] Dean Barber: Let’s talk about mortgage tips for somebody that’s a first-time home buyer. They’re out of college and have saved up a little bit of money. They’re in their mid to late 20s, maybe 30 years old by now. They might be married and are starting to think about having kids. They want to get out of the metro area or the suburbs and buy a house.
[00:19:02] Tim Kay: Move out of mom and dad’s basement.
[00:19:03] Dean Barber: Yeah, that too. I’ve got one of those right now. I always like to tell people to put 20% down, but that’s not necessarily something that has to happen on that first-time home purchase.
Don’t Get Stuck in the Middle
[00:19:16] Tim Kay: If the 30-year-old first-time home buyer has 20% down, great. Or if their family can gift them money for 20% down, that’s also great. I sort of think of it as having a goal to put as much money down as you can to get a cheaper payment. Or put as little money down as you can and do something different with your money. Don’t get stuck in the middle.
A lot of times, I don’t think it makes sense to put 7% or 8% down because that’s just using more of your money. Every $1,000 that you put down on a house only lowers your payment by about $6. When I was 30, $10,000 was a lot of money. Well, $10,000 only lowers your payment $60 a month. If you have a $1,500 payment, you’re still going to have a $1,440 payment and you’re going to be $10,000 broker.
Private Mortgage Insurance
[00:20:03] Dean Barber: But your payment is going to be higher if you don’t have 20% equity in your home or the 20% down because you have something called private mortgage insurance. That’s something I think confuses a lot of people. Can you explain PMI, Tim?
[00:20:17] Tim Kay: Private mortgage insurance is sometimes just called MI or mortgage insurance. Back in the day, you had to put 20% down to buy a house. The government came out with PMI, which is basically default insurance. It ensures banks that if they do a loan for less than 20% down and it defaults, then the government, the PMI, the insurance company will step in and insure them up to the first 20% of their loss. And that 20% of loss insurance is basically intended to be foreclosure costs, lawyer costs if the house is torn up so they can fix it up so they can sell it. It just basically makes it so that banks can still feel safe making low-interest rate loans with less than 20% down.
[00:21:03] Dean Barber: What’s the cost on that?
The Cost of Private Mortgage Insurance
[00:21:08] Tim Kay: It’s usually a percentage. It’s usually around 0.3% or 0.32%. Generally speaking, it’s $100 or $200 a month. It’s a deal, and it’s not a small deal. But it’s not a killer either.
[00:21:22] Dean Barber: If somebody has the 20% down and they can avoid paying that—let’s just call it $150 a month/$1,800 a year over the course of 10 years—that’s $18,000 that isn’t going to anything other than that mortgage insurance.
[00:21:34] Tim Kay: Overall, houses have appreciated 3% to 6% for the last 30 years. But as houses have been appreciating, you might buy a house with 5% down. Loan-to-value is what we’re talking about. It’s the loan amount divided by the value. If you put 5% down, you’re at 95% loan-to-value. As you pay it down a little bit over two or three years and as house prices continue to appreciate, it’s common in two to five years to automatically have 20% down, even though you haven’t paid it down the full $40,000.
[00:22:15] Dean Barber: To get the PMI removed, nobody is going to come in and say, “You have 80% loan-to-value.”
[00:22:22] Tim Kay: The PMI is kind of a crazy thing. It’s what the consumer needs to pay, but it doesn’t insure the consumer. And it insures the bank. The bank won’t likely call you and say, “We’re going to lower your payment by $200 a month. We’ll take the risk.”
You just need to pay attention to it. At Guild, we send an anniversary email and sometimes make an anniversary phone call when we think people are getting close. For example, we’ll say, “I think you’re getting pretty close to being at 80% loan-to-value with 20% equity. If you want, I’d be happy to help you do a three-way call to your current servicer.” Or, at Guild, we service all our loans, so we would still have it. I would just get on my computer and take care of it for them. I’d make their PMI go away. At that point, it’s a pretty easy process. We send them something and say, “Print this, sign it, and email it back to me.”
[00:23:10] Dean Barber: But they need to get an appraisal done?
Fannie Mae and Freddie Mac
[00:23:13] Tim Kay: Sometimes, sometimes not. Fannie Mae has almost every house in their system. Fannie Mae and Freddie Mac are government-sponsored entities. They’re private companies that are funded or sponsored by the government. They sort of set the rules on that. Most lenders on 30-year fixed are lending that money with Fannie Mae-backed money. Every time somebody buys a house, your loan goes into Fannie Mae’s system. So does your neighbors’ and everyone else’s. They have sort of an online AI-driven appraised value.
Removing the PMI
Let’s say that you need $400,000 to $450,000 to have 20% equity. As long as the amount you need is within the range that Fannie Mae thinks it is, then most of the time they can just drop the PMI off.
[00:24:07] Dean Barber: Interesting. I don’t think people really understand that. That’s another valuable mortgage tip. And I think there are a lot of people that may be in a position where they’re still paying that PMI and they don’t even know that they can call and get it removed.
When Refinancing Does and Doesn’t Make Sense
[00:24:16] Tim Kay: And you can do all this without having to refinance. A refinance is just getting a new loan that pays off the old loan. And certainly, if rates go low again in a year, refinancing makes sense. But if rates go high and you have 3% or 4% or 5%, a relatively low interest rate, you may not want to refinance. You may want to leave that there, make the PMI go away, and keep on with your 28-year loan.
[00:24:37] Dean Barber: Interesting. I know that there are a lot of younger buyers that don’t put the 20% down.
[00:24:44] Tim Kay: All the time.
[00:24:45] Dean Barber: I bet there are people out there that are out there right now that have less than 80% loan-to-value and they still have the PMI.
Don’t Pay the PMI When You Don’t Need to
[00:24:54] Tim Kay: In the last couple of years, because of COVID, the government was trying to push mortgage rates low to keep the economy sustained. So, we did quite a few refinances. More than we’ve ever really done. It was astonishing to me how many people had 20% equity and were still paying PMI. It just sort of lulls you to sleep and you kind of forget about it.
[00:25:14] Dean Barber: It’s a great gig if you can get it. You just keep collecting from millions of people.
[00:25:18] Tim Kay: It’s free money. Just go to the mailbox, get your money, go back in. It’s a nice thing.
[00:25:23] Dean Barber: Tim has already taught me something. If you know somebody that you think that maybe didn’t put 20% down, people, let them know about this. Because that’s a big deal.
[00:25:42] Tim Kay: Or just have them call me. That’s the easiest way.
Refinances Are at a 20-Year Low
[00:25:45] Dean Barber: We will make sure that people can get in touch with you, Tim. I think we mentioned that refinances are at a 20-year low. That’s not surprising, obviously. We’ve been in a very low interest rate environment ever since all the stimulus happened with the Great Recession. And then dust off the stimulus package, inject it full of some steroids, and throw that out as a COVID rescue package.
[00:26:14] Tim Kay: Exactly. Free money.
[00:26:18] Dean Barber: People that have bought a house in the last 10 years or so aren’t going to want to refinance right now. The rates are probably going to be higher than what they’ve got.
[00:26:26] Tim Kay: Probably not. They wouldn’t want to refinance to just lower their rate of their payment, at least. If they’re going to refinance, it’s going to be some extraordinary circumstance, like they just actively need money.
Home Equity Loans
[00:26:38] Dean Barber: But for that, a home equity loan would work.
[00:26:40] Tim Kay: Almost always, yes.
[00:26:42] Dean Barber: Talk to us a little bit about home equity loans, Tim. How do those work? Can you open a line of home equity that you don’t borrow from unless you need it?
[00:26:52] Tim Kay: Yep, I have one on my house. It’s a nice thing. There’s a home equity loan, and there’s a home equity line of credit. It’s often abbreviated as HELOC, home equity line of credit. Think of a home equity loan like a car loan. You get it, pay it off, and you’re done.
A home equity line of credit sort of operates on a revolving basis more like a credit card operates. You get it, use half or all of it—whatever you need—and pay it down. You can use it again, pay it off, and can use it again. They generally stay open for five to 15 years.
Downsides of Home Equity Lines of Credit
There are two downsides to home equity lines of credit. One is that they generally only bill you for the interest only as your minimum payment. You need to pay at least a little bit extra. That’s usually an easy calculation for a lender to say, “Here’s your 15-year amortization. Pay $50 or $100 extra a month.” The other thing is that they’re generally not fixed interest rate loans like 30-year fixed. So, like the first mortgages. As the Fed keeps raising prime, home equity lines of credit rates keep going up also.
Rainy Day Funds
[00:28:02] Dean Barber: You got a variable rate but let’s say somebody wanted an opportunity fund or an emergency type of a scenario.
[00:28:13] Tim Kay: Rainy day funds.
[00:28:14] Dean Barber: They open a home equity line of credit. It doesn’t mean they have to take any of that money out.
[00:28:20] Tim Kay: It’s an excellent thing.
[00:28:21] Dean Barber: It’s almost like a checkbook.
[00:28:23] Tim Kay: Exactly. In fact, mine did come with a checkbook. They’re handy if you need $30,000, $40,000, or $75,000 because your roof needs replaced, or you need to buy a car and you don’t have time to go through the car loan process. Whatever you may need money for, most of them come with a checking account. You just log online, transfer $30,000 from your line of credit to your checking account, and write a check. That’s your loan. And a month later, you start making payments.
[00:28:51] Dean Barber: If somebody was going to do that, how would they know the current rate was going on that loan?
[00:28:57] Tim Kay: I believe prime is 6.25% right now. Generally, those are prime-plus-a-half. Their prime-even to prime-plus-a-half. So, 6.25% to 6.75%.
Not an Ideal Time to Buy a Car with a Home Equity Loan
[00:29:07] Dean Barber: If somebody buys a car today with their home equity loan and it’s 6.25%, 6.5%, you probably wouldn’t want to do that. You can get better lending standards directly from a bank for a car loan, credit union, or something like that.
[00:29:21] Tim Kay: GMAC would give you 3% or something. But sometimes it makes sense in the short run or if it’s for a used car, trailer, or something like that. If nothing else, it’s nice to set one up. Then, if you ever need one, it’s there.
Being Contingent with Home Sales
Another more relevant reason in my world to set one up is because it preps you for when buy your next house. It’s a funny thing. We do a lot of purchase money mortgages. People always say, “I love this house, and I’m never moving.” And then five years later, they’re buying a new house because they had a baby or two, outgrew it, or found their dream house somewhere else. When you have equity in your house, the problem with that is you need to sell your house to get your money. You might have the same net worth, but you need to sell your house where you live. It’s often hard to coordinate buying and selling.
[00:30:18] Dean Barber: They may need to put a contingency in the purchase of the new house. It might say, “Hey, we’ll buy yours, but we need to sell ours first.”
More Risk to the Sellers
[00:30:25] Tim Kay: Exactly. Being contingent on the sale of your house means more risk to the sellers. That means they may not accept your contingent offer if somebody else shows up with the same sales price and a non-contingent offer. So, if you have a home equity loan already set up from three years ago, then you just write yourself a check. That way you have your $50,000 ready to put down.
[00:30:45] Dean Barber: So, you put that money down and now you have two mortgages.
[00:30:48] Tim Kay: Yep. Then, you sell your house. Instead of getting $100,000 in equity out of the sale, you maybe only get $50,000 because you already have the other $50,000 off your down payment.
[00:30:57] Dean Barber: And then do you take that other $50,000 and put that on the new loan that you just got? Can you do that? Or do you need to then go through and do a refinance?
Making the Best Use of Your Money
[00:31:04] Tim Kay: All the time, yes. What I normally advise on that is if your initial down payment equals 20%, oftentimes it doesn’t make sense to take the rest of it and put even more down. Sometimes it does because people just want a cheaper payment. But oftentimes it makes more sense to maybe call your financial advisor and ask what a better use of the money is.
But sometimes people do a home equity line of credit like a bridge loan for down payment on the new house. They’re only going to have enough equity in their old house to put 5% down upfront. So when they sell their house, they put the other sale proceeds down and either make the PMI go away or reduce it. That’s three or four months later, not waiting three or four years.
Setting Up a Line of Credit
[00:31:44] Dean Barber: That’s an interesting idea and another great mortgage tip, Tim. I hadn’t really thought about having that home equity line of credit in place in case you decide you want to move. So now I’ve got the money to put down, so I don’t have to worry.” It doesn’t have to be a simultaneous transaction.
[00:31:59] Tim Kay: I was just saying to someone in my office before I drove over here today that we should just get everybody to set one of those up. Generally, there’s no closing costs for getting one, and they’re generally open for 15 years. And we could make our life sort of a lot easier if we would just get everybody to do it two years ago. Because what normally happens is, somebody finds a house, and then we wish we had done it two years ago, but now we’re scrambling to do it right now. Which, when you’re buying a house, there’s a lot of moving parts to that, and the less stuff you can have to worry about, the better.
[00:32:31] Dean Barber: That’s fascinating. Anybody that doesn’t have a line of credit should probably just set one up. It doesn’t cost anything to do it, right? And you don’t have to take any money out.
How the Banks Benefit from HELOCs
[00:32:41] Tim Kay: Banks that do home equity lines of credit will usually allow you to open a free checking account with them. What they really want is for you to be a bank customer. They use a HELOC like a loss leader to get you to open a checking account. They hope that you’ll do your banking stuff with them and do a car loan with them someday. Generally, if you’ll do a checking account, there’s no closing costs. And there are closing costs, it’s just the bank will pay them for you. It’s usually about $1,000 savings.
Home Equity Loan Limits
[00:33:08] Dean Barber: Cool. Let’s stay on that subject for just a minute because I have a couple more questions before moving on to other mortgage tips. What’s the limit on the amount of the home equity loan?
[00:33:19] Tim Kay: Most of the time, they’ll go up to a total of 85% of what your house is worth. I’ll do this math in my head. Let’s say you owe $500,000 times 0.85%. Whatever that number is, subtract what you owe on it. That margin between 0.85% and what you owe is what they’ll do the home equity line of credit for.
A lot of banks will cap you out at $250,000 or $350,000 on the large houses with a lot of equity. But still, 85% combined loan-to-value with your first mortgage and the new second.
How Much Do You Need to Qualify for a HELOC?
[00:33:49] Dean Barber: If somebody is putting 5% down, they’re not going to get a home equity line of credit because they’re not going to qualify. You need to have more than 15% equity in the house before you can even think about getting a home equity loan.
[00:34:02] Tim Kay: Right. Once you get to 20%, it’s a great idea to set one up. Generally, for the first year, a lender on one of these must go off the lesser of two things. It’s either the appraised value or the sales price. After a year, you don’t need to go off the lesser of the two. You can just go off the appraised value. If you buy a house for $300,000 and then house prices go up 20%, that means it’s worth $360,000 next year. So, you can act like it’s worth $360,000. Before a year, you need to go off just the $300,000.
[00:34:31] Dean Barber: Does that come from the same Fannie/Freddie deals?
[00:34:35] Tim Kay: Sometimes. Normally on those, you just get an appraisal. And the bank pays for that most of the time.
[00:34:39] Dean Barber: How much does an appraisal cost?
[00:34:30] Tim Kay: $465 almost always. Sometimes, if it’s a little further away, they’ll charge a trip charge of $20 for driving to the far parts of town. But usually, it’s $400 or so.
[00:34:51] Dean Barber: But the bank pays for that?
[00:34:53] Tim Kay: On HELOCs, yes. On a normal Fannie Mae purchase, that’s part of your closing cost. On a normal Fannie Mae purchase, like a 30-year fixed, then there’s probably between $2,000 and $2,500 of actual closing costs. And by closing costs, I mean the one-time costs that are associated with buying a house. That includes title work, appraisal, cost of the credit report. You need to get a flood cert from FEMA that says your house is not in a FEMA flood zone so you don’t have to buy FEMA flood insurance. All those sort of things equals $2,000 to $2,500.
Appraisal or No Appraisal?
The reason I say that much of a variance between $2,000 and $2,500 is because of the appraisal. If you don’t need to get an appraisal, it’s closer to $2,000. But we’re probably seeing appraisal waivers on eight out of 10 purchases right now.
[00:35:38] Dean Barber: Interesting. Why is that?
What All Does Fannie Mae Know?
[00:35:41] Tim Kay: Fannie Mae has a big database. They know what everybody’s house is worth. They know that at least when you bought it if you got an appraisal on your house. That probably got uploaded to Fannie Mae at some point. They’re tracking that and they’re tracking all your neighbors. They know how many bedrooms you have. They have a lot of data.
[00:35:56] Dean Barber: What happens on this if somebody does some home improvements. Maybe they’ve put on a sunroom or something like that or improved the landscaping? Or maybe they redid a bathroom or a kitchen, something like that? That can’t be known. If you think that increases the value of the home, you’d need to go get an appraisal.
How Long Does It Take to Get an Appraisal?
[00:36:22] Tim Kay: Exactly. When you get an appraisal waiver, that doesn’t mean you’re not allowed to get an appraisal. It just means that the lender calls the customer and the client and says, “We don’t have to get an appraisal if you don’t want one.” It’s probably easier to not get one, because there’s no risk of a low value or of a condition or a repair to be noted. But if the lender and the client see a reason to get an appraisal, then you just order an appraisal. It takes about a week and then you know what it’s worth.
[00:36:51] Dean Barber: I can think of an example where that might make some sense for somebody. There are a lot of DIY people that are going to buy a house. They’ll say, “This thing needs this different work. I can do that work myself.” So, over the course of 12-18 months, they’ve revamped the house. It’s worth a lot more than what they purchased it for.
Finished Basements Are a Big X-Factor
[00:37:12] Tim Kay: Oh yeah. Especially with finished basements and things like that. Maybe you finished your basement and put a rec room, bedroom, and bathroom down there. Suddenly, instead of having a three-bedroom house, you have a four-bedroom house. And when you’re comparing to other four-bedroom houses, you probably have higher sales prices. And thus, by comparison, higher appraised value. That’s a fun mortgage tip.
[00:37:30] Dean Barber: That’s another way that a person could put a little bit down, put some money into the house, then remove the PMI by getting a new appraisal.
[00:37:37] Tim Kay: If you bought a good house without a finished basement, hypothetically you could put 5% down, pay cash for the rehab cost of putting a fancy basement in, and then get a new appraisal six months later. Now with your finished basement, it’s worth $50,000 or $100,000 more than what it used to be before it had a finished basement because it compares to larger houses and make your PMI go away.
[00:38:02] Dean Barber: Interesting.
So Many Tax Deductions Have Gone Away
[00:38:04] Tim Kay: It used to be that PMI was tax-deductible. That was more than 15 years ago. A lot of deductions went away.
[00:38:14] Dean Barber: We get this new tax form, write down how much you make, and send it in.
[00:38:18] Tim Kay: Exactly. All of it.
[00:38:22] Dean Barber: It feels like that’s where it’s going, doesn’t it? Tim talked about tax deductibility there. On the interest on the HELOC, is that tax-deductible?
[00:38:38] Tim Kay: If you were talking about yourself, I would say sometimes it is, sometimes it isn’t. You need to talk to a tax professional like your Director of Tax, Corey Hulstein. Call him and ask him.
Mortgage Tips for Someone Who Has Live in Their Home for 10-15 Years
[00:38:47] Dean Barber: All right. Let’s move on to mortgage tips for somebody that has maybe lived in their home for 10-15 years. They found that next house and they’re getting ready to move. The standard thing is to take all the equity that you have on your existing house and put into the new house. Is that the case most of the time? How do you see it?
A Typical Home Purchasing Timeline
[00:39:15] Tim Kay: This is happening so much. And it’s funny. I’m 51. Fifteen or 20 years ago, a lot of people my age were buying their first or second house. When people start getting to about 50 or 60, that’s usually when people buy their big house. They may not live there forever, but for 10 or 15 years, people live in their largest house then. They probably bought their old house, it appreciated, and paid it down some.
When they go to move, they have a large chunk of equity that they could use for a down payment. That’s exactly what most people automatically default to thinking. Sometimes, that’s the best choice for them. But frankly, what I advise them to do is to talk to their financial advisor before they make any final decisions on that.
The Impact of Rising Interest Rates
[00:40:06] Dean Barber: Right. Up until 2022, my mortgage tips would include telling people to not put all of that down. Like I said earlier, you have free money. When interest rates were down at 2.5%, 3%, put the 20% down. Let’s take the other 20% of equity that you have and let’s invest this.
A Mortgage Offset Account
[00:40:28] Tim Kay: I just always call it a mortgage offset account. If you have an extra $100,000 that you could invest in the stock market or do something else with it or pay off your house and pay off a 3% loan, if you pay off your 3% loan, then minus the tax deduction, that’s probably like paying off a 2.5% loan. Or you could invest it. You just need to say, “Can I make more than 2.5% or 3% in the market?”
[00:40:54] Dean Barber: You need to judge that over time.
[00:40:58] Tim Kay: Mortgages last for five or 10 years, so why not look at this for five or 10 years, too? In addition, you’re liquid with that money the whole time. You don’t have to sell your house to get your $100,000 if you ever need it in case of emergency. And if you get four or five years down the road and are tired of having this mortgage, you could just pull it out of investments, and pay off your house. You can still get the same thing.
Mortgage Tips of What Not to Do
[00:41:20] Dean Barber: I think that’s interesting, Tim. Here’s what you don’t want to do. Let’s say that you have this extra $100,000 and want to go buy a new Tesla. You want to make sure that you keep that money so that at any point in the future, if you want to put that back toward the principal of your home, you can. Don’t just think that’s free money to go spend.
[00:41:39] Tim Kay: Especially on something that depreciates like a Tesla.
[00:41:43] Dean Barber: All cars, with the exceptions the last couple of years. Even used car values are going up. That’s crazy.
Closing Thoughts on Mortgage Tips
Tim and I have been talking for a long time about mortgage tips. Hopefully we’ve shared some really good information on those mortgage tips. There are a lot of different types of mortgages. You’ve got an adjustable-rate mortgage, fixed-rate mortgage for 15 years, fixed-rate mortgage for 30 years, or even 20 years.
[00:42:07] Tim Kay: They generally go in the fives, so 10, 15, 20, 25, 30.
Using These Mortgage Tips While Financial Planning
[00:42:11] Dean Barber: And the rates will vary for all those. Whether you pay points or don’t pay points, that’s going to vary your rates. How much should you put down? People have a lot of different choices. Tim and I get it, but I don’t think people understand that this is a financial planning choice. It shouldn’t be a choice about just the house itself because the choice that you make there can drastically impact your ability to get to or through retirement.
[00:42:42] Tim Kay: Yes. A lot of people that I see, even affluent people that make good money, just don’t have enough cash in the bank for retirement, cash in savings or retirement accounts in their 401(k) for money. Sometimes, if you have an extra big chunk of money from the sale of your house, you can invest that money and significantly help your long-term retirement picture. The house rates are still low. Even if rates are at 5% or 6% or 7%, then you’re still going to borrow that money incredibly cheap.
[00:43:18] Dean Barber: Here’s an idea for you, Tim. This is something that’s come up a lot over the last about 20 years. I’ve been helping people get to and through retirement for 35 years now. It seems like a long time.
[00:43:30] Tim Kay: Crazy.
Buying a Second Home
[00:43:31] Dean Barber: But I’ve had several clients over the last 15 years or so that have said, “Hey, Dean, we’re thinking about a second home.” They’ll want a second home, whether it’s in winter home in Arizona, Florida, Texas, or a summer home in Wisconsin or Michigan. They’ll ask the question, “Can I afford to do it?”
Well, the first thing I need to remind them is that if you’re 65, having two homes is going to be nice for the first 10-15 years. You’re going to be going back and forth. But by the time you get to about 80, one of those places probably needs to go. One, you probably don’t want to make the trip back and forth twice a year. And two, you probably don’t want to take care of two places anymore.
[00:44:20] Tim Kay: Double maintenance, double lawn mowing.
Mortgage Tips for Buying That Second Home
[00:44:21] Dean Barber: Right. So, I usually tell people to buy that second home. They can take out a 30-year mortgage on it and get the lowest rate that they can because chances are that they’re not going to have it for 30 years.
And when you sell it, you’ll regain your equity and anything that you paid down. That’s an area where people need to talk to people like Tim and I together. I’ll ask what this number going to look like? And then we can build that into the financial plan and make the right decision.
The Big Fallacy
[00:44:51] Tim Kay: Oftentimes, people come to me wanting to buy a second home in Florida or someplace like that. They think they can barely afford it if they do a 15-year loan. I’ll point out that they can, but if they do a 30-year loan, then their payment will be $500 higher a month. They can save that $500 per month, which will make them have less equity but more actual physical savings. In theory, they’ll have the same net worth. They’re liquid the whole time and their house is going to appreciate. The fallacy is that houses appreciate whether they’re paid off, paid down, or not paid down.
Retirement Is All About Cash Flow
[00:45:27] Dean Barber: Exactly. The real estate is going to do what the real estate does. And when you’re in retirement, it’s 100% about cash flow. How much money can I spend each month after my obligations? It’s all about cash flow.
Structuring a loan on a second home going into retirement is critical to think about purely in terms of how to get the most cash flow. How do you get the most free spendable money after you’ve paid that mortgage?
[00:45:54] Tim Kay: It’s a funny thing. People always ask about the interest rate when they’re thinking about buying a house. But I can tell you from personal experience, I don’t ever think about if I have a 30, 20, or 15, or do I have a low interest rate? I just think, “Well, here’s my payment amount,” and I write the check. Initially, so much gets made of what the interest rate is. But in the big picture, nobody really cares. Everybody just cares about what the payment is.
[00:46:22] Dean Barber: It’s about cash flow.
[00:46:22] Tim Kay: Yep, affordability and cash flow. Are you comfortable with your payment?
How Long Does It Usually Take to Get Pre-Approved?
[00:46:27] Dean Barber: Let’s say somebody comes to Guild Mortgage and wants to talk to Tim Kay. They say, “I need to get pre-approved. I’m going to buy a house.” What is the amount of lead time that you typically like to see to make sure that that person makes the right decision and gets the best deal?
The Loan Application Process
[00:46:45] Tim Kay: Let me tell you the process and then I’ll talk about the lead time on that. If you called me and said, “I want to buy a house. I’m a first-time home buyer and my lease is up in a month or two.” Well, pre-approvals last for 90 days. Let’s get the process started now.
Even though you’re maybe not buying a house for a few more weeks, something might need to be worked on. Sometimes, people will have something on their credit that they had no idea about. Maybe it’s a medical collection or something like that. Almost always, that isn’t the case. But if it is the case, you want to have time. You can almost always fix things like that if you have time to do it.
[00:47:28] Tim Kay: I would then email or text the link to do an online application. You’ll type in your birthday, where you live, work, and bank at, and all that loan-application boring stuff. Then, you hit submit or finish and it comes to me.
I’ll work through it and send you a text or email back saying that I’ve looked at it. If everything looks great, I’ll let you know that I’m ready to talk when you are. After we talk, I generally send out the pre-approval letter. The actual work time is probably 20 or 30 minutes. The process is usually like a day.
[00:48:27] Dean Barber: So, if somebody is thinking about buying a house in a year, they don’t need to rush with trying to talk to Tim right now. They need to get closer to making that decision.
Don’t Be Surprised When Home Prices Are 5% to 10% Higher Next Year
[00:48:15] Tim Kay: Not unless they’re worried about something. If they were thinking about buying a house in a year, I would say that you may want to think about buying a house now because prices are going to be 5% or 10% higher next year. But aside from inflation, which we’ve already talked about a lot, I’d say call me in six or eight months when it’s closer.
Thanks for the Mortgage Tips, Tim!
[00:48:36] Dean Barber: Tim, this is great information on mortgage tips. I really appreciate you joining me here on The Guided Retirement Show.
[00:48:52] Tim Kay: I love talking about this stuff. Feel free to call me anytime.
[00:48:55] Dean Barber: All right. Thank you, Tim.
[00:48:56] Tim Kay: You’re welcome.
Do You Have Any Questions for Tim or One of Our CFP® Professionals about These Mortgage Tips?
[00:48:56] Dean Barber: I hope you enjoyed my conversation about mortgage tips with Tim Kay. We talked for 50 minutes on mortgage tips, but we felt like it was 10. He knows exactly what he’s talking about when it comes to mortgages and mortgage tips.
[00:49:26] Dean Barber: Don’t forget that we’re offering you access to the same financial planning tool that we use for our own clients. Just click the “Start Planning” button below to begin your retirement plan from the comfort of your own home.
Before you make that decision on what you do with buying a home, I also encourage you to schedule a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals. We want to make sure that it fits best into your overall financial plan. We can even screen share with you while using our financial planning tool.
[00:49:45] Dean Barber: As always, thanks for joining us on The Guided Retirement Show.
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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.