Should we put our rental property into an LLC?

Question of the week: Should we put our rental property into an LLC?

Answer:  As many of you know, LLC stands for Limited Liability Company, which is a legal entity has some components of a corporation, a partnership and sole proprietorship. Like each of those entities, LLCs have plusses and minuses depending on the purpose of creating an entity for ownership.

For real estate, properties are broadly divided into two main categories, residential and commercial. In general terms residential real estate is considered properties that are 1-4 units (inclusive studios, condos, own-your-owns, etc). Commercial property is considered as commercial business properties, and residential properties with five units or more, or residential properties that also have a commercial entity in place. An example of the latter may be a building with retail stores on the street level and apartments above the store.

For our discussion today, we will concentrate on whether or not to put residential rental properties into LLCs.

For the past few years, we have seen more and more clients with residential rental properties in LLCs, almost always having purchased the property as individuals, either as sole owner or with spouse or significant other, and then transferring the property into an LLC they created for the purpose of owning the property.

Why?

There are several benefits for owning property in an LLC, primarily is the liability shield they create to protect you from personal liability. Another is the LLC has pass-through taxation, meaning there is no separate tax return for the LLC, it is reported directly on your personal tax returns.

The primary benefit that most of my clients who have transferred their residential investment properties to LLCs has been the liability protection afford them to protect their current assets and future income from lawsuits.

One less tax return and personal protection should someone become injured on your property, sounds like an easy decision.

The biggest downside to have residential property in an LLC is when it comes to obtaining a mortgage for the property as loans to LLCs are not as available as loans to individuals and general have different terms and rates. The biggest factor being that Fannie Mae and Freddie Mac do not fund loans to LLCs, therefore taking out the biggest mortgage market for residential real estate with the longest terms and lowest rates.

This issue arises when refinancing a property in an LLC, or if selling the property and purchasing another property under the guidelines of an IRS 1031 exchange to avoid paying capital gains taxes on the appreciation of the property being sold.

In a 1031 exchange, a property owner sells a rental property and purchases another property by transferring the net proceeds from the sale. There are several rules to the 1031 exchange. A few are, that the new property has to be of equal or greater value to the sales price of the property being sold (the “downleg”), all of the proceeds from the sale (the “boot”) must be invested in the new property, and the owner(s) of the new property must be the same as the property being sold.

The last regulation is where LLCs come into play. Let’s look at a realistic scenario. You purchased a new home on 1st Street in 2012 for $450,000. After living there for five years you purchased a new home on 2nd Street in 2017 and converted the 1st Street property to an investment property, at the time the value had increased to $550,000.

In 2019 you transferred the property to 1st Street LLC, with you and your spouse as the managers/members of the LLC.

Today the home is worth $975,000 and you only owe $250,000 on the mortgage. There is an opportunity to purchase a 3-unit property for $1.3 million that by transferring your equity in 1st Street to purchasing the new property will greatly increase your monthly positive cash flow. To avoid taxes, you need to sell 1st Street, have all the funds go directly to the new purchase, and buy the new home with 1st Street LLC being the new owner.

Because the LLC is purchasing the property, any lender will be funding the loan for a business entity as owner and requiring members of the LLC to be personal guarantors of the loan. Instead of a relatively low 30-year fixed rate mortgage from Fannie Mae or Freddie Mac, you are likely looking at getting a hybrid-ARM mortgage that will have a fixed rate for a period (3, 5, 7, 10 years) and then become an adjustable mortgage.

The trade-off for the personal liability protection and pass-through taxation you receive from having your residential investment properties in an LLC is that you have fewer mortgage options, that will be less desirable in terms of rates and fees than if you own the property as individuals (or in your family trust).

For some investors the financing is more important than the personal liability protection and they prefer to keep their properties out of LLCs, for others the risk of a potential lawsuit outweighs the reduced financing options and put their properties in LLCs.

Which is best for you? There is no pat answer. The mechanics and regulations are more complex than the broad overview above when it comes to tax deferred exchanges and transfers. As well, the legal obligations and tax benefits of LLCs.

Before making the decision I strongly suggest you consult your tax preparer to determine how an LLC may impact you and your property ownership, an attorney to learn about the protections are and are not afforded to you, and finally, your insurance agent to see what products are available that can protect you from personal liability and what the cost is for the protection. Weigh all these factors with against the costs associated with an LLC, from filing fees to mortgage options, and then determine which method of ownership is best for you and your family.

Have a question? Ask me!

Flying. That describes our economy in the 2nd quarter as GDP grew at a 6.5% rate, resulting in our nation’s economy being larger as we entered July than it was pre-pandemic. Consumers are driving the growth, and in June increased their spending by 1%. Despite declining federal supplement checks for unemployment as many states have ceased the bonus funds, personal incomes rose 0.1% in June. Half of the increase in consumer spending was the result of higher prices in the economy as inflation rose 0.5% for the month and prices for goods and services are 4% higher than June 2020. With inflation outpacing wage increases, and the potential of the Delta variant impacting the economy and whether some shutdowns return there is concern for the sustainability of growth in spending and economic activity. The economic news today has little impact on rates, while historically the data would push rates up.

The big reason for the lack of impact is the Federal Reserve is still purchasing $120 billion every month in mortgages and U.S. Treasuries. The end of the purchasing program may appear on the horizon soon as Fed news this week indicates that “progress” is being made to the goal of lower unemployment and stable inflation. When the Fed feels this goal has been met it will begin to taper its purchase of financial instruments that impact interest rates.

Rates for Friday July 30, 2021: Despite the economic news that would normally push rates up, the market has been flat all week, as a result, rates are flat for the fourth Friday in a row.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625%  Flat

30 year high-balance conforming                   2.75%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Like hundreds of thousands of other families in our country, ours was impacted by Covid-19 as Leslie’s father passed away from the virus in January. Also, like hundreds of thousands of families, an appropriate service and remembrance were delayed until family and friends were allowed to remember a father, grandfather, uncle, brother and friend.

This evening, rosary service, and tomorrow, funeral and reception, we will remember Don-Pa, as our children called him, with some tears and laughs. He grew up as one of eleven children on a farm in Iowa, and his midwestern values, humor and wisdom were cause for all who knew him to admire him and call him “friend.”

When I married Leslie, I gained a wonderful father in-law with whom I was able to share some rounds of gold and rounds of whiskey through the years. He will be missed, but never forgotten. Cheers, DonPa!

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

What happened to your solar project?

Question of the week: What happened to your solar project?

Answer:  Some WR&MU readers may recall that last September are question of the week was, “Should we get solar?” In the response I stated that Leslie and I were meeting that afternoon with a representative from a company Southern California Edison contracted with to work with customers interested in installing solar panels. Essentially a solar-broker who would shop our solar plan to contractors for the best bid for installation.

We did meet with the representative and she was excellent in explaining the process. They did an analysis of our electricity usage, sent out someone with a drone to look at our roof, drew up a plan with the size of our roof and in which direction various parts sloped (we have an odd roof with about 45% being flat from an addition in the ‘70’s, the original roof line having three ridges with sloped facing East-West or North-South).

From this they drew up a schematic plan for the number of panels we would need to meet our goal* and how they would be placed on the roof. *Those with great memories, or who clicked the link above, will recall our home has no air conditioning. One reason we added solar panels was to offset the energy cost of adding air conditioning to our home. As a result, we insisted on more panels than our electrical usage at the time merited.

Once the plan was presented and approved by us, the solar broker sent the it to several contractors and came back to us with three bids. The timing from initial information meeting to receiving the bids to review was about ten days.

After the initial bids we made some changes so that we would not have to install a new electrical panel, and new bids were presented. About fifteen days after our initial contact, we signed a contract and the process of installation began.

As part of the starting process, we were provided with some options for financing the project with an eight-year loan with a local credit union with terms that matched the average of our prior monthly electric bills. The contractor was on hold until they received word that our loan was approved so they could get paid directly from the credit union.*

Later, we opted instead to obtain a Home Equity Line of Credit for more flexibility and ability to reuse for future home remodeling/maintenance projects.

Once the loan was approved, we were presented with our first invoice and the contractor sent an engineer to inspect our property and electrical panel and capacity.

The contractor returned with a new bid that included replacing the electrical panel. I asked why we would need a new panel and the explanation was if we want to add more service later, such as adding air conditioning, we would need a larger panel. The change in cost added about 5% to the project; a new contract was sent out the we signed.

At this point they requested an inspection from SCE to sign off on the plan. Low and behold, SCE wanted our panel to remain where it was it would require moving our wire from the main and it would take four months for them to do so, if we moved the panel to another location on the same wall it would have no delays. By now we are six weeks from our starting the process. The contractor has spoken to SCE and were “working with our engineer to come up with plan and cost.”

Three weeks later the contractor returned with a new bid, and added trimming trees to their costs. The new bid added more to the cost, now about 7% higher than originally provided, adding about one-year to the cost to repay the project based on using average monthly bill for payments.

At the beginning of these three weeks, I was playing golf, I mean networking. I was telling the group about my woes with the changes and delays and one of them said, “call my friend, I’ve known him since high school and he has a solar company that does commercial and residential installations.”

I am not one to change service providers very easily, I try to stay with who I am comfortable with and have built some trust. In this instance my trust was with our representative, and not with the contractor. When the bid was issued, I called my friend’s friend and explained the situation. He said in our call, he would take a look but he has done plenty of installations and knows what SCE was suggesting, but said that it does not have to be done.

I was getting pressured to sign the new bid and contract and told the solar broker I was getting a second bid from another contractor. At this time we were coming up on Thanksgiving and I said if they wanted to cancel the contract that was fine but I would not be making any decisions for at least a week.

The bid came in from the new contractor, it provided slightly more energy, no moving of panels, and the cost was about 10-12% lower. He was a local business, in Long Beach, and had very good communication. I informed the SCE solar broker I would not be moving forward with them and the contractor they put us in touch with for the project.

The day after I informed the broker I was not signing the contract the contractor called and was pretty aggressive and nasty. Long story short he was trying to get me to sign saying I would have to pay cancellation charges, which would have applied had I signed and cancelled; however they changed the contract so the old contract was void—he tried to argue the point. For those who are wondering, this contractor was Ameco Solar. I relayed the conversation to my broker representative, who had been very nice and helpful, who relayed it upstairs and after a few conversations it was confirmed we were under no obligation for anything.

Our project with the new contractor, Jarrod the owner of Solar Source, began at the end of November when after an inspection and bid we signed a contract to begin the project. At the time Jarrod told me that it will take a while for permits…

Did I mention we live in Long Beach? Since many years before the pandemic the building department for the City of Long Beach has been a black hole for permits and inspections. Our permit application was submitted in early December.

In mid-March we received our permit and installation was completed in three days. At which time SCE was notified and we were put in line for the installation of a “GMA” for the panel—which bypassed getting a new panel or moving it. In mid-June SCE sent out an inspector, the same one who came for the prior contactor, and said we needed to move the panel….

Our contactor immediately contacted the inspector, told him the installation with the GMA did not require movement, he agreed and out paperwork went back into line for installation.

Finally, our installation with SCE was scheduled for late June and we needed to wait for another inspection from the City of Long Beach. The inspection was a week later, which put us in line for SCE to finalize the project and put us online.

I am not saying SCE was dragging it out to ensure more sales of electricity to the Smith household, but there were not fewer than five changes to the application they requested from the contractor, not at once but one at a time, before the project was fully approved.

On July 13th, ten months almost to the day that we started our process, our project was live, producing energy for our home and selling excess production back to SCE. We will not see the full impact until our August billing, which will have one full month of solar production impacting our usage of electricity from SCE.

Project approved, completed and active on budget with excellent communication through the stages, and the waiting.

The actual process of getting plans, installing the panels and hooking them up was about ten days. From the start of our initial call to Jarrod, to completion about six and a half months. Our project was delayed several months by the City of Long Beach and SCE not providing permits and inspections, making a ten-day project about twenty times longer than that.

Now, time to start calling air and heating contractors for bids. Since we will have to go through the City of Long Beach building department for permits, I will assume we should have air conditioning by the end of next summer…

Have a question? Ask me!

Rates for Friday July 23, 2021: Very little economic news this week, next week are several announcements that may move markets. Rates are flat for the third Friday in a row.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625%  Flat

30 year high-balance conforming                   2.75%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Are you a fan of the Olympics? I have been since the first Olympics I can recall, 1972 in Munich. Those games were very emotional, especially for a ten-year-old kid. I remember how exciting it was to see Mark Spitz win gold after gold after gold…seven in all! And little Olga Korbut flying around the gymnastics events. And of course, the tragedy of the Black September terrorist group taking nine Israeli athletes and coaches hostage in the Olympic Village and the subsequent tragedy at the airport when commandos tried to free them.

Every four years, five this time, we learn about amazing athletes from around the world. Home-grown competitors who are famous in their one events and unknown to the population at large become superstars, Katie Ledecky comes to mind as she stacked up four gold medals in Rio in 2016.

One of my favorite stories from the Rio Olympics is Michael Phelps, winner of twenty-three gold medals (plus three silver and two bronze) showing Ledecky how to drape her medals for a photo shoot.

Who will be the big story in the Tokyo games? What athletes will have incredible performances that will grab the headlines?

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

What are points and do I have to pay them?

Question of the week: What are points and do I have to pay them?

Answer:  Before we answer what points are let’s answer if you have to pay them. No, you do not, but read on to see if it is better to pay points or not pay points.

This question has come up more frequently over the past year as we have more first-time buyers entering the market, or buyers who have not purchased a home in some time and either do not remember having points in their transaction, or they did not pay them.

Points are the upfront cost of a loan. One point is equal to one-percent of the loan amount. For a $500,000 mortgage, one point is $5,000, one and one-half points is $7,500. Points are paid at closing as part of the funds needed in escrow for your purchase to be complete.

Calling the cost points instead of percentage of loan is helpful to avoid confusing as the cost of repaying the loan is based on the interest rate.

To clarify, points are the upfront cost of a loan and the rate is the factor determining payment.

Points and rates have an inverse relationship, like a teeter-totter. The higher the points the lower the rate, the lower the points the higher the rate.

You are purchasing a new home and getting a $500,000 mortgage. You call to lock in your interest rate for 45 days your closing date in on August 25th*. Based on the points teeter-totter you may have the following options:

1.875 points for a rate of 2.5%

1.25 points for a rate of 2.625%

0.5 points for a rate of 2.75%

No points for a rate of 2.875%

As you can see the higher the rate the lower the points, and if you do not want to pay points you can avoid them by taking the highest rate shown.

“Thank you for the explanation, which of the options should we choose?”

There are several variables that may come into choosing the points-rate combination that is best for you. In some instances, we the decision may be based on if we need the lowest rate for qualifying, in others we may need the no point option as you are a bit tight on funds for closing. In most instances we do the math.

This chart shows the cost in points for each of the rates above and the monthly payment. The final column, “Months to recapture,” is dividing the difference between the no-point option payment and the payment for that point and interest rate option and dividing it into the cost in points. Example below chart.

Points/Rate Cost in Points Monthly PaymentMonths to recapture
1.875 / 2.50% $        9,375.00 $        1,976.0096
1.25 / 2.625% $        6,250.00 $        2,008.0095
0.5 / 2.75% $        2,500.00 $        2,041.0076
0 / 2.875% $                     –   $        2,074.00 

At a cost of 1.875 points for a rate of 2.5% the months to recapture is 96, or eight years. What does this mean. Here is the example I always give clients when explaining the recapture figure.

Leslie and I purchase the home next door to you. We close on the same day, at the same price, with the same loan amount. Leslie and I decided to purchase our home with a the zero-point option and the higher payment, you decided to purchase our home with the lowest rate and highest point option.

On the first Friday evening of every month we get together for a cocktail. We do what neighbors do, complain about the dog down the street that always barks, the new restaurant that has opened, what we are doing for the PTA fundraiser at the kids’ school.

Also every month when we get together, you put $98 into a coffee can, this is the amount you saved on your mortgage payment that month compared to the mortgage payment you would have had if you had also chosen the zero-point option with the higher rate.

After we have had 96 First-Friday-Of-The-Month cocktail gatherings you will have $9408. You will have saved a little bit more money over that time frame as we saved up front by not paying points. From that month on our home will “cost” more as our total of payments plus points as closing will be greater than yours by $98 each month.

As you can see by the chart, the recapture difference between the 2.5% rate and the 2.625% rate is only one-month, so for $32 per month in savings per month you only gain one-month in savings. To delve further into this cost-payment comparison, the actual difference between the 2.5% rate and cost and the 2.625% rate and cost is actually 98 months ($3125 upfront savings for $32 more per month).

At this pricing the lowest rate makes very little sense mathematically since it will take about 8-years to recoup your cost of the loan no matter which rate option you select.

Please note that the cost difference between different rates is changing every day, some days the difference between rates is compressed making the lower rates “cheaper,” other days the difference is higher making the higher rates more of a long-term value.

One other way to avoid paying points is to put in your offer to purchase that you would like a credit from the seller for closing costs, which can include the points and more. In the current market this option is not very viable due to the number of offers on most listings for the seller to choose from. However, when the market becomes more level between supply and demand, or tilts in the buyer’s favor, this option is a good one for buyers to save cash at closing on their purchase.

As you can see, there is no clear cut answer to whether to pay points, or how many points, or not. The decision is situational depending on your needs, the timing in the market, and most importantly what you feel most comfortable doing.

As I always tell my clients, I am not paying for your home, I am not making your mortgage payment and I am not sleeping there—you are, so you need to make the decision based on what you feel is best for you. I just provide the options and the math.

*Rate lock terms are typically price in 15-day increments, 15, 30, 45 and 60 days. Longer terms are also available but after 60 days the increments are in 30-day periods. The longer the rate lock the longer the rate lock period the higher to cost in terms of points.)

Have a question? Ask me!

Thirteen years, and twenty-nine years, that was the last time, respectively that month-to-month and year-to-year inflation has been as high as it was in June. Consumer prices were 0.9% higher in June than May, and 5.4% higher than in June 2020. The “core” rate (food and energy prices stripped from data) is 4.5% higher than last year, the biggest jump since 1992. Inflation almost always leads to higher interest rates and the numbers released this week certainly add to upward pressure on rates.

Pushing prices higher were used car prices, up 10.5% in June, accounting for about one-third of the total increase in prices. New car production is slowly increasing as more computer chips needed for auto makers are finding their way into factories; as more new cars are available in showrooms and lots used car prices will soften. Also pushing inflation is the price at the pump, gasoline is 45% higher in June 2021 than June 2020.

A bit of a change in tone from the Fed, as a result of the surprising data on inflation. Still calling the spike in prices over the past several months “transitory,” it appears that many members of the Federal Reserve feel there is a “risk” that inflation will be higher and longer than initially estimated. As the kids used to say, “ya think?”

In part due to inflation, but more the result of opening wallets, retail sales saw another large increase last month, up 0.6% from May and 18% from last June. Retail sales exceeded in June exceed pre-pandemic levels. Retail sales are based on dollar spent, so part of the increase is due to inflation, with many states still providing additional funds in unemployment compensation there is additional support for consumer spending. Adding to the pool of funds for consumers to spend is the federal child-tax credit checks that start hitting bank accounts this week.

Rates for Friday July 16, 2021: Rates started heading up later in the day last Friday and continued rising Monday and Tuesday of this week. A bit of a rally on Wednesday and early yesterday has resulted in another flat week. At some point the Fed will need to act on inflation instead of analyzing it, when that occurs, and it will likely not be announced beforehand, rates will start to move higher.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625%  Flat

30 year high-balance conforming                   2.75%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

We did something unusual yesterday evening; we went to the movie theater. Unusual in that the last time we saw a movie in a theater was Christmas break 2019, where our tradition is to go to Scottsdale for a week and see several movies while we are there.

We saw “Black Widow,” and it was wonderful to see the action on a huge screen and have big sound…especially when something blow up or crashed unexpectedly causing me to jump a bit in my seat. The movie was pretty good, I am not a huge follower of the Marvel genre of movies, but it was easy to follow along without the backstory and the stunt driving in some of the scenes were terrific. Better than the story was enjoying a movie the way it was made to be enjoyed!

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

If we purchase our new home with cash, how soon can we get a mortgage and get some of it back?

Question of the week: If we purchase our new home with cash, how soon can we get a mortgage and get some of it back?

Answer:  You can start the process as soon as you close.

Since early in the pandemic homebuyers have been challenged to get offers accepted due to the surge in home seekers due to historically low interest rates. I have no actual data on this, however there has probably been a higher percentage of all cash sales in the previous 14-months than any 14-month period since FHA loans were created enabling long term mortgages with low down payments.

As a result, many buyers have leveraged themselves to produce cash for their purchases. Borrowing funds from 401(k) accounts, taking out equity lines on their current homes or properties, parents taking out funds using equity lines or from their savings and providing for the purchase. Whatever the means, a not insignificant number of new homeowners own their homes free and clear and would like much of the cash they put into their homes returned to them.

When obtaining cash from your home after purchasing, the transaction is a “cashout refinance.” If you are refinancing an existing mortgage and not obtaining any cash from the transaction, nor paying off a mortgage or lien taken out after the purchase, it is a “rate and term refinance.”

This distinction is important as there are different guidelines for cashout refinances than rate and term refinances. Most importantly are the loan-to-value limits; as well for most cashout transactions the rates and costs can be higher.

Because you are pulling cash out of your home, even if it was just put in a day, a week, a month, before your purchase, the loan is considered a cashout refinance.

There are several factors that go into structuring a post-purchase refinance, among them are:

Loan Limits There are three loan limits that we consider

  • Conforming (Fannie/Freddie) $548,250
    • High-balance conforming $822,375
    • Jumbo generally above $822,375

These are important as they determine many of the following guidelines and pricing. As loan amounts go higher, rates go higher, loan-to-value limits may go lower, and underwriting guidelines may get stricter.

Loan-To-Value (LTV) Loan-to-value is the percentage of the property value being covered by the mortgage. If the value is $700,000 then 80% is $560,000, if the LTV is 75% the loan amount would be $525,000.

For conforming, and high-balance, cashout refinances the maximum LTV is 80% of the value (see below). For jumbo loans, the maximum LTV depends on the lender. Some lenders will fund cashout refinances to 75% LTV, others cap their LTVs at 60%.

From the LTV example above, for a property valued at $700,000, an 80% LTV loan is a high-balance conforming mortgage, at 75% LTV the loan becomes a conforming mortgage.

Determining Value The general rule of thumb for the value used for underwriting for a property that sold within the past 12-months is the lesser of the appraised value or purchase price; keep reading for exceptions.

If you purchased your home for $700,000 in April, are applying for a refinance in July and the appraisal comes in at $690,000, the LTV of the mortgage will be based on the $690,000 value in the appraisal report. If the appraisal has a value of $725,000, the LTV will be based on your purchase price of $700,000 (keep reading).

The primary exception to this guideline is if you can show you have made significant improvements or upgrades to the property. For instance, we are in process on a post-purchase cashout refinance where the purchase closed in April. The value on the appraisal report is $15,000 over the purchase price because the buyer/borrower added air conditioning and showed the costs of the units. The appraiser then used comparable sales that had air condition to reach the value.

Because of the upgrade and availability of other sales with similar size, bed/bath count, and air conditioning, the appraiser can show the home is worth more than it was purchased for three months ago and our lender should accept this higher value.

Another factor that can result in a higher appraised value being used for loan-to-value calculations is if the purchase has due to distress, for example in a divorce where lower price to ensure a quick sale, or to bail out a seller from foreclosure or default. These circumstances are a bit more difficult to get an exception to the lesser of purchase price or appraised value, but if well documented the exception may be granted.

Rate/cost For the same LTV, at the same cost in points (upfront cost of the loan), rates for cashout refinances are higher for a jumbo loan than a high-balance conforming loan which is higher than a conforming loan.

Because of this, when looking at a cashout refinance we take into consideration the loan-to-value and loan type and the lower rate that may be available if we are able to use a conforming loan instead of a high-balance loan, or high-balance instead of jumbo. Depending on the spread in the dollar amount to the next level down of loan limits, and the LTV, different strategies may apply.

Take our example above where for a property valued at $700,000.

At 80% LTV the loan amount is $560,000, is a high-balance mortgage and the rate may be 3.5%, and the payment is $2515 per month.

However, by taking $11,750 less from the property the loan amount becomes a conforming loan of $548,250 with a rate, at the same cost in points, of 3.00% and a monthly payment of $2310 per month. Do you need the additional $11,750 for $205 per month?

The spread between the high-balance and jumbo loans can be even greater, in which case we often council clients to fund the maximum high-balance loan of $822,375 and after closing the refinance obtain a HELOC for the ability to access additional funds if needed.

Documenting Funds Long time readers of the WR&MU know that documenting deposits into bank accounts is a primary sticking point in loan approvals. Large deposits into bank accounts that are not sourced from an employer or another bank account you have that we have verified as your own and without large deposits in the past few months, require documentation as to source and that the funds are not the result of any new credit and therefore payments.

Consider your free and clear home you purchased a few months ago with all cash and no loan to be similar to a new bank account opened with a very large cash deposit. Where did the money come from for the purchase?

As part of the post-close refinance, we will need to source and document the funds used for purchasing your home. If some, or all, of the funds were borrowed from another source, that is fine, however we will need to document the terms of the loan, how much will be paid back as part of our refinance transaction, will there still be a balance and payment we need to consider for our transaction?

Note that the guidelines above are for owner-occupied single-family residences, other restrictions and guidelines are in place for investment and multi-family properties, and other loan types such as FHA and VA.

If you have purchased a home in the recent past with cash, or a significant amount of cash down payment, and would like to look at options for pull some of that cash back out please contact me to assist you.

If you are considering purchasing a home and accumulating funds from different sources for the purchase with the intention of a post-close refinance after closing, please contact me so I can help you structure the cash transactions so that the post-close refinance goes smoother.

Have a question? Ask me!

What the heck? Over the past week U.S. Treasury yields have fallen somewhat significantly, putting downward pressure on mortgage rates. Why? Reading ten different analysts provides ten different responses. All signs point, as usual when it comes to rates, to the Federal Reserve. Minutes released from the June meeting indicated some officials, no numbers given just vague references to “various,” or “several,” slowing the purchase of U.S. Treasuries and mortgages, slowing the purchase of mortgages sooner than later due to higher home prices, keeping the course on rates and purchases until “significant progress” is made in employment and inflation. It appears there is no consensus one way or the other, but those experienced at reading Fed minutes, akin to reading tea leaves, feel that some of the more powerful members are for the status quo and therefore not much change. The minutes did appear to open up more conversation, and perhaps action, at their July meeting.

What the heck? Long time readers of the WR&MU know that I have felt rates should have risen some time ago and today should be at least one-half of one percent higher than they are. Talking to others and reading from several different sources, I am not the only who feels this way. Seeing another dip in rates this week has me scratching my head and wondering what I am missing and why investors are buying into such low rates for long-term investments.

Rates for Friday July 16, 2021: After climbing all week (lower rates), the Mortgage Backed Securities market reversed today with a decent drop in prices (higher rates). This either indicates that the MBS price climb was technical in nature, or that after completely digesting the Fed minutes overnight and looking ahead to possible (likely?) changes by the Fed in the near future, investors are anticipating higher rates. Rates this week dip from last Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625% Down 0.125%

30 year high-balance conforming                   2.75%   Down 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Many of you know that I have been a member of the Rotary Club of Long Beach for many years. Rotary is an international organization with clubs around the world who are helping build better communities in their hometowns and across the globe. Rotary is not just for “older people,” but also for students and young adults.

Our Long Beach club has recently re-started two “Rotaract” clubs, so labelled as they are for younger generations and are meant to be an entry into Rotary and stepping stones for their members to become Rotarians when the timing is right for them.

Our community Rotaract club is for young adults, generally between 21-35 years of age, who are looking to create new relationships and work with others on projects that benefit our community, network professionally and receive support and opportunities from Rotarians. If you are, or know someone, who may be interested in learning more about our community Rotaract club please contact me.

After being off campus for many years, several students at Cal State Long Beach, with assistance from members of Long Beach Rotary, have certified a new Rotaract club on the campus. This is an opportunity for CSULB students to become part of Rotary International and come together with a common purpose of expanding their network of friends and connections all with a common goal of community centered projects on their campus and region. If you have a son, daughter, niece, nephew, grandchildren, neighbors who are enrolled at CSULB and are looking for a meaningful extra-curricular activity, have them contact me and I can put them in touch with the leadership of the CSULB Rotaract.

From paying for water wells in Mozambique, to providing polio vaccinations in Mexico, to reading to elementary students in Long Beach schools, to purchasing hundreds of thousands of books for Long Beach schools and pre-K programs, to running a camp for high school students teaching business principles and practices, to installing a program in local middle schools that teach ethics to students, our Rotary club is engaged and active. All while members have a good time working together. Young adults can become of this worldwide network of men and women who like to say, “we have fun with a purpose.” 

Please contact me for more information on our Rotaract clubs for young adults, or if you are interested in a Rotary club in Long Beach, or where every you may live or work, I am happy to make and introduction for you.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Has underwriting loosened up for self-employed borrowers?

Question of the week: Has underwriting loosened up for self-employed borrowers?

Answer:  No.

Prior to the pandemic the underwriting guidelines for self-employed borrowers were either one or two years of personal and business tax returns (if applicable) depending on how long you have been self-employed, or owned a business. As well, some cases called for a year-to-date profit and loss as well.

During the pandemic guidelines on self-employed borrowers tightened up due to the number of businesses that were negatively impacted by the pandemic, either having to close due to government regulations, or lost business and declining revenue.

Despite the surge in business activity, with many businesses seeing revenues approaching pre-pandemic levels, the self-employed guidelines for determining income remain the same.

Guidelines put in place last year require not only the tax returns but also a year-to-date profit and loss, plus bank statements for the prior three to six months for the business to show the income was in line with the profit and loss revenues.

It is evident from the conditions and requirements for needed documentation that some of the lenders we work with are not interested in funding loans from self-employed borrowers; we have identified these lenders and have them off our potential list for our self-employed clients. We have also had self-employed clients come to us who were applying with on-line lenders or direct lenders who do not want to take the time and effort required to follow the current underwriting guidelines.

These guidelines not only apply if you own a business, file a Schedule C with your tax returns for self-employed income, but also for applicants who own investment property and the net income from those properties are needed for qualifying.

For those using rental income for qualifying, underwriters are asking for proof rents have been paid and current. This is to ensure that applicants tenants have not been withholding rent payments as allowed under city, county or state regulations in various regions.

Will the guidelines for self-employed and rental income loosen in the future to pre-pandemic guidelines? That is a big question to which we do not yet know the answer. My inclination is if they are loosened it will likely be sometime in 2022 and not before the end of 2021.

I have been wrong before in my opinions in the WR&MU, hoping I am wrong here as well and the guidelines loosen sooner than later.

Have a question? Ask me!

A surge in employment in June beat expectations as new hires for the month were almost 50% more than in May as 850,000 new workers were added to payrolls. By the far the largest amount of hiring was in the service industry, in particular hospitality, as 343,000 job openings were filled.

More people are also seeking work, as shown by the increase in the unemployment rate from 5.6% in may to 5.9% in June. With approximately 9.3 million job openings in June, it appears many of those seeking work are not jumping at the first offer they receive and are being more selective in where they will collect a paycheck.

With twenty-six states ending federal stimulus funds of $300 per week to unemployed workers, expect more potential workers to be seeking employment in those states. Not helped by any unemployment payments are those who are voluntarily quitting their jobs, an estimated one-million workers did just thin in June.

Rates for Friday July 2, 2021: Despite the good news from the Labor Department on June employment and the three-day weekend which usually sees upward pressure on rates, this Friday we see rates flat from last week.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   3.00%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

As is tradition in the WR&MU on the Friday before Independence Day, I encourage everyone to read the Declaration of Independence, and forward to others to read as well. Here is the transcription from our founding document as displayed in the National Archives.

Have a Happy Fourth, pursue your happiness with joy and others.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

What is a “piggyback” and should we get one?

Question of the week: What is a “piggyback” and should we get one?

Answer:  Between prices climbing and sellers reluctant to accept offers with contingencies for a buyer’s home to sell, many home buyers are utilizing a financing strategy that was very popular in the early to mid-2000’s, the piggyback.

When we were kids, we would often play piggyback games, a smaller kid would climb on the bigger kids back and we would race, have “chicken” fights trying to pull the kid off another’s back, or just run around. (Note, I was rather small in stature growing up so I was almost always on someone else’s back).

Piggyback financing is somewhat similar. Substitute a primary long-term mortgage for the big kid and a smaller mortgage or equity line for the smaller kid; the smaller mortgage rides on top of the bigger mortgage.

For example, you own your current home and have about $150,000 in equity. You have available for a purchasing a new home about $90,000 and want to offer $750,000 on a new home without having a contingency that your current home sells to obtain down payment and closing costs. Your income is such that you can qualify for the new home without selling your current home.

Using a piggy-back, your offer shows your intended financing is to obtain a new 30-year mortgage for $545,000 and a Home Equity Line of Credit for $130,000. If you have already done the math, you see that your down payment will be 10% of the purchase price, $75,000.

You purchase your home with a conventional mortgage, instead of a higher rate high-balance conforming mortgage, have a minimum payment of interest only for the HELOC, and when you sell your home, you use the proceeds to payoff the HELOC. As a bonus, when all the financial dust is settled you have an equity line in place that you can use in the future to obtain funding for projects or emergencies.

Note that we also use piggyback financing for homebuyers who are expecting to receive a very large sum of cash in the future from a settlement from a lawsuit or divorce, an inheritance, sale of a company or large bonus. When the settlement comes payoff or down the HELOC and you have the lower primary mortgage for the remainder of your homeownership.

Other opportunities where we have used piggybacks in the recent market are to avoid “jumbo” financing, generally mortgages above the high-balance conforming rate of $822,375, to avoid stricter underwriting standards.

Client Smith wants to purchase a new home in the $1.1 to $1.2 million dollar range and has about $250,000 for down payment. Because of some financial challenges several years ago, Smith filed Chapter 13 bankruptcy. Almost all jumbo lenders require that a bankruptcy be discharged for 7-years before an applicant is eligible for financing. Fannie Mae and Freddie Mac however have a 2-years since full discharge on Chapter-13 bankruptcies for eligibility. This same guideline is also used by some lenders that fund HELOCs.

Smith writes an offer for $1,150,000 with $250,000 down payment, a mortgage at the high-balance limit of $822,375, and a HELOC for $77,625.

Home Equity Lines of Credit piggyback transactions became very popular starting in the late 1990’s and early 2000’s as a way to leverage purchases and avoid paying mortgage insurance, which is required on mortgages over 80% of the sales price (aka loan-to-value, or LTV). For instance, purchase price was $500,000 (high price in 1998) and buyer had $50,000 for down payment. Traditionally, until then, the buyer would get a mortgage for $450,000 and have mortgage insurance payments. When the HELOC piggyback products became available, the buyer would put down $50,000, obtain a loan of $400,000 at 80% of the home value and therefor have no mortgage insurance, and get a HELOC of $50,000.

Because the standard regulation for mortgage insurance is that it can be removed after twenty-four consecutive on time payments and showing the property has equity of 22% or more, in retrospect many home buyers who funded HELOCs just to avoid mortgage insurance would have been better off paying mortgage insurance for two years as property values were climbing.

The same is true in our current market, we have had clients who purchased homes in 2018 and 2019 with mortgage insurance instead of using piggyback transactions, have been able to show their homes have increased in value and dropped their mortgage insurance payments.

Piggyback financing is an important tool for home purchases that many lenders do not use due to lack of experience and knowledge. Not every buyer needs to use piggyback financing, but it is available for those who can benefit from a lower long-term rate, to bridge the sale of their current home to new home, or to obtain easier funding guidelines.

Have a question? Ask me!

The Federal Reserve has seven governors, this week two of them had comments that are of interest to those who follow interest rates. The New York Fed governor said that inflation will drop back down to 2% in 2022 and that the feeds tapering of its purchase of U.S. Treasury debt and mortgages (known as Quantitative Easing) is way off. The Feds QE activity is a major factor in interest rates remaining as low as they are, when they start purchasing less that will put upper pressure on rates, when the Fed, if the Fed, starts selling its inventory of Treasuries and mortgages, that will definitely put upward pressure on rates. These comments are in line with those released last week by the Fed from its committee that determines its interest rates.

“Way off” to many would mean six months or a year. The Fed governor for San Francisco this week said that she feels in the Fall the Fed will start to talk about tapering. Is this statement from San Francisco at odds with the statement from New York? It would seem so, depending on a) which if either is correct and b) how long the Fed talks about tapering its purchases before actually doing. Neither comment seemed to impact investors or rates, however it is a sign that at least tapering by the Fed is on the horizon.

May economic data shows the economy is very strong. With reduced stimulus payments consumers have been a little less eager to make purchases, as seen by consumer spending being flat from April’s spending. Personal incomes for the month declined by 2%, not due to lower wages so much as fewer Americans collecting unemployment benefits that were elevated with federal stimulus funds. Spending may have flattened out, but it has done so with total spending in May above pre-pandemic consumer spending levels—in some part due to the higher prices, 3.9% higher, than the costs of goods and services a year ago. The news is negative for low rates, but with the Fed’s QE gobbling up mortgages there was little impact on rates.

Rates for Friday June 25, 2021: Conforming rates for the sixth week in a row, high-balance conforming rates have floated down after last week’s spike.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   3.00%  Up 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

As I have been transitioning back to the office, increasing the number of days each week I am there, I notice I am not alone when I head home in the evening. After over a year of our local freeways having the same amount of traffic during rush hour as they usually do at 6:00 a.m. Saturday and Sunday mornings (the other golfers know this wide open traffic pattern) that we had gotten used to, we now need to factor in increased commute times to get to and from our destinations.

Bittersweet is the reaction to this increase in traffic, bitter because we once again spend more time in our cars, sweet because pre-pandemic normalcy is returning.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

What tips do you have for smoother loan process?

Question of the week: What tips do you have for smoother loan process?

Answer:  This question came from a networking meeting last week, and the tips are very simple.

Be prepared.

Be compliant with requests.

Be timely.

Despite the mortgage industry going to complete “full qualifying” since the market meltdowns in 2007-2008, many mortgage applicants still ask why they need to provide certain documents and forms because “we are obviously qualified.” Certainly, you are, we just need to prove that to an underwriter following the regulations and guidelines established by government and quasi-government agencies and individual lenders.

Since the Dodd-Frank Act in 2010 almost all mortgage packages have to show borrower’s ability to repay on a consistent basis; i.e. they have to show income that is available for payment every month. This means that just having enough money in the bank to pay-off your applied for mortgage does not mean you show m

When applying for a mortgage, have readily available, preferably in electronic format, if possible, paystubs, federal tax returns, letters or communications that detail your monthly income from pensions or government payments such as social security. Any income you receive, we will need to show proof and validation of the amount received.

All funds used in a transaction and, if necessary, reserves that will remain in accounts after closing, need to be verified for at least two months prior to the loan application. Checking, savings, investment, and retirement accounts will need to be documents with two months’ statements.

NOTE! All pages of your statements will need to be provided. If your statement says page 1 of 15, you will need to provide all fifteen pages, regardless of what is on each page. If page 15 of 15 is blank and states, “This page left blank intentionally,” we need page 15.

Again, we need the statements, not screen shots from your on-line banking website, the monthly statements.

If you own property, we will need copies of your mortgage statements,

property insurance declaration page and payment statement to verify the coverage, payment and also contact information for your insurance agent.

As we process your mortgage package, depending on the dates on the documents and forms you are issued, we may need to update some documents that are more recent. This is almost always the case with paystubs and quite often bank statements. As you receive any items for income or assets, save them for your loan package as they may be needed.

Often after reviewing a package an underwriter may request clarification of certain aspects of the file, such as a large deposit into your checking or savings that is not from your employer. We will let you know what we need and why.

Going through a mortgage application process can feel invasive to some, I have likened it to a financial enema. Every item we request is requested for a reason, the more information you are able to provide, and the faster you provide it, the easier your transaction will be.

Since the end of January 2020 when interest rates began to drop, our industry has been inundated with applications. This has slowed down the approval process dramatically. Providing items requested in a timely manner will ensure your file continues to move through the pipeline to closing and not get put aside waiting for those items and then getting back into line.

Our objective is to make the mortgage process as easy as possible, having financial records for income, assets and credit obligations readily available throughout your transaction makes the process a lot smoother.

Have a question? Ask me!

Other than a couple booking a wedding at The Plaza Hotel in New York, not many announcements are made two years in advance. Unless you are the Federal Reserve discussing interest rates. Earlier this week the Fed released an announcement that it was looking at increasing interest rates in 2023, with two rate hikes. Having a two-year runway before rates go up would not have investors making early bets with their funds. However, other statements in the announcement, combined with comments made by Fed Chair Jerome Powell in his news conference, triggered a sell of in bonds and mortgages that spiked rates mid-week.

“Inflation, inflation, inflation,” being bellowed by many economists, pundits, and yours truly (the voice the Fed could care less about), is reminiscent for many of us in a certain age bracket of Jan’s, “Marcia, Marcia, Marcia,” with about as much whining. Despite strong increases in consumer prices the last two months, trillions of dollars dropped into the economy from Washington with trillions more being debated in Congress, spiking wages costs for employers to lure workers, the Fed has been as consistent as Carol and Mike Brady with their messaging that the recent surge in inflation is transitory and will slow down in a month or two.

This week the Fed sort of, kind of, maybe acknowledged that inflation might rise faster and longer than expected—expected by members of the Federal Reserve. The official Fed position is its forecast for 3% annual inflation this year that will drop in 2022, a position it has held for the past three month. Recent releases show several members of the Fed’s Open Market Committee (the group that sets rates) are starting to question the forecast and are ready and will to act on rates before 2023 as seven of the voting members now see the Fed raising rates for the first time in 2022. Seven of eighteen voting members will not cause rates to increase, however in March only four members saw a 2022 rate hike.

Rates for Friday June 18, 2021: After the rate spike on Wednesday, conforming rates have tenuously settled back to last Friday’s level, whereas high-balance conforming rates are up slightly from a week ago.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                     2.75%  Flat

30 year high-balance conforming               3.00%  Up 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

A lot of events this week. June 15th saw the transition of our state to being fully open and relaxing of mask mandates and requirements. Yesterday President Biden signed the bill to make June 19th a federal holiday, starting tomorrow, and Sunday is Father’s Day and the first day of summer. With celebrations planned in many communities tomorrow for Juneteenth, and Father’s Day Sunday, many families and friends will be openly gathering and enjoying being together in person rather than through a screen, our summer is starting on the right track to get closer to how we were in June 2019 than June 2020.

I hope all of you have a wonderful weekend and are able to enjoy your time with family and friends.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Update on inflation and rates

Question of the week: No question this week as we are travelling today, currently writing from Phoenix airport, as a result the WR&MU is abbreviated.

Have a question? Ask me!

Soars, spikes, jumps, climbs, pull out your Roget’s Thesaurus (more likely use an internet search engine) to find synonyms for “increases rapidly to describe consumer prices in May. The Consumer Price Index increased 0.6% in May from April, lower than April’s 0.8% leap, but still a very big jump in prices. The annual rate of inflation is 5%, the highest since 2008 when the economy was coming out of the Great Recession and surging oil prices pushed up costs globally.

Data bias is part of the increase, as measuring prices in May 2021 to May 2020 is skewed due to lower prices from many retailers of goods and services to retain business in the early months of the pandemic. “Part” may be attributed to the pandemic price slump. Most of the price increases are attributed to increasing demand as our economy opens up with most areas of the country fully open with no restrictions. A very large component of the jump in prices is supply-chain issues across a broad range of industries.

A factor not commented on in as many articles regarding May’s price jump is the higher cost of labor that is being built into prices by retailers of goods and services. The large amount of job openings across the economy has resulted in employers offering higher salaries and bonuses to attract workers. To ensure profitability these higher employment costs must flow through to prices paid by consumers.

“Don’t worry…” is the Federal Reserve, and many economists’ message regarding the surge in prices the last few months. Their reasoning is that the price increases are temporary due to the supply chain issues and sudden surge in demand, and that once the economy settles into “normalcy” inflation will cool back down to 2% by next year.

But 2% on top of 5% means prices will not drop, they will just increase at a slower rate. Some economists are skeptical of the 2% inflation rate expectation due to a wage-inflation push on prices that create a cycle of rising prices that is hard to break.

The news is not positive for rates, for two main reasons. First, the primary tool for slowing prices in an economy is higher interest rates. Rates will increase due to the expected need for higher rates. Second, the expectation that Congress will pass more legislation that will result in several trillion dollars above the pre-Covid budgets being pushed into the economy. This will greatly increase the amount of borrowing by the Treasury Department to fund the programs being funded. Increased borrowing leads to higher rates as the borrower, i.e., the Treasury, must increase rates to entice buyers to purchase the debt.

Rates for Friday June 11, 2021: As markets opened this morning prices on bonds and mortgages were dropping, which leads to higher rates, however at the moment rates are flat again from Friday to Friday. I am surprised that rates are where they are and my expectation was, is, they would be at least one-quarter of one percent (0.25%) higher than they are.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Flying today for the first time since September 2019, and other than everyone in face masks everything is the same—full airports and planes. A good sign that America is getting closer and closer to our old normal.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Should we pull equity out of our home to pay for college?

Question of the week: Should we pull equity out of our home to pay for college?

Answer:  Many families will be looking at options to finance tuition for their college bound children this summer, and every summer. Many homeowners, especially those in California, fall into the gap between qualifying for scholarships and financial assistance based on need due to earning too much to be eligible, and not earning enough to comfortably paying the ever-rising costs of college.

As a result, either college options change to reduce costs, or some borrowing is required. Assuming they have enough equity in their homes, many parents feel the need to use some of that equity to help pay costs for their children’s education to fill the gap.

Being the father of two college age children, and also having a bit of knowledge how debt and finances work, our family did a lot of exploring for options to pay for college. The least favorable options were, to us, using any home equity. For a few reasons, a few of which are given below, and primarily, it is our firm belief that students must have a strong financial stake in the cost of their pursuit of a degree to ensure accountability and add value to the work and result of their college experience.

Here are the primary options most families consider:

Cashout refinance: The advantage of this options is a fixed rate payment that is relatively low due to being amortized for 30 years. There are two primary disadvantages to using a long-term fixed rate mortgage. First, you are paying for college costs for 30 years, or until you sell the home; if you refinance later, you are extending the time you make the payments. Second, let’s suppose the amount of money you will need to borrow for four years is $60,000. With a standard refinance you will borrow all $60,000 and then use $15,000 in year one, $15,000 in year two, $15,000 in year three and the final $15,000 in year four. While it will be four years before you use all the money, you have to pay for it at month one.

Equity line of credit: The primary advantage of obtaining a HELOC is you only pay for the amount of money you borrow. Using the example above, in year one you access $15,000 and only pay interest for the $15,000 outstanding balance. As the years go by, depending on how you manage payments, the highest balance you will have is $60,000 but you will not pay for that amount until it is needed and borrowed. Another advantage of most HELOCs is flexible payment options, as many have a minimum payment of interest only. A disadvantage of the HELOC is the rate is adjustable and over time will likely be higher than it is today. One additional advantage I have seen for some families is that while their student is in college, the parents may make the interest payments, when their son or daughter get a job they repay their parents monthly to pay down the loan.

Federal student loans: These loans have a few options that you don’t get to choose, but are offered to you depending on your financial profile. These loans are either offered to students or to parents depending on financial need based on parent’s income; as well the college or university determines how much you are eligible to borrow. If your student qualifies for a “Direct Subsidized Loan” the U.S. Department of Education pays the interest while the student is enrolled at least half-time and for the first six month after leaving school. The other standard type of loan is a “Direct Unsubsidized Loan” and interest is paid by the responsible party; this loan has the option of deferring interest while in school, however the interest accrues. Some students receive loans from both categories and must understand that one loan has interest that is accruing which will increase the amount of money they will owe when they leave school. The advantages of the federal loans are the payment subsidy for those who qualify, and deferred payments while the student is in school. The primary disadvantage is the low loan amounts available to most California homeowners due to the average income of most applicants from our region, resulting in many families needing other financing options to cover the cost – loan gap.

Private Student Loans: There are many of these loans available and offer a lot of flexibility. Typically, these loans have parents and student co-signing on the loan and have several advantages. They are offered for varying repayment periods, enabling the ability to choose longer terms for lower payments to make it easier for graduates to pay with their lower starting pay in the job force. Most lenders offer fixed or variable rate loans, depending on your risk aversion. Finally, it helps students build a credit history with assistance from parents. For parents a disadvantage is they are on the hook for the payments. If your student is out of job five years after graduating and stops making payments, either you make the payments or see the hit to your credit score.

Federal and private student loans are made per quarter or semester, therefore if a student graduates from a four year college attending three quarters per year, they will end up with twelve loans, or if using federal and private loans up to twenty-four loans. This is easily managed as the loan servicers usually consolidate all the payments on one statement (to be clear, all the loans of the same type with same lender will be consolidated for one payment statement).

After graduating, students have the opportunity to consolidate their loans through one of many private lenders. This allows for easier management of the student loan debt, and may result in lower payments and/or interest rates.

Discussions about how to pay for college are quite often the first financial education many young adults have. They are important conversations that can help students decide the value of the degree they seek, weighed against potential income after graduation to pay for the degree they earned.

In our home, our conversations began with how student loans work. We discussed how interest deferment works, and of course how much their payments would be after graduating. In our conversations, the girls learned how much would be contributed to their education and any costs above that would be student loans that would be their obligation to repay.

After looking at schools, costs and subsequent loans needed to cover their financial needs, I broke down what their monthly loan payments would be, added estimates for rent, added estimates for costs of living such as food, clothing and transportation, and then showed them the income they would need to make sure all their costs, including student loans, could be met. Note, not included in the conversations were living at home rent free.

In the end, we, like most families, have a mishmash of federal and private loans. For the private loan we went with a lender that has a one-time approval process that results in essentially a line of credit. Each semester the needed amount is funded against the total amount for which we were approved, with the girls co-signing on each loan. This reduces the amount of paperwork and effort we must go through each semester. One other factor I liked about the loans is that after graduation, when we can show that the girls have made all the loan payments for twenty-four consecutive months, Leslie and I are released from the loan obligation; thus, removing liability and from our credit record.

To answer our question of the week, yes you can use equity from your home to finance your children’s education; however, in my opinion a better option is to pursue other student loan options in which your children are at minimum equally responsible for the cost of their education.

Have a question? Ask me!

Today’s jobs report was much better than last month’s, though if it were not our economy would be in serious trouble; but still not as positive as many on Wall Street expected. May saw 559,000 new jobs added to the economy, more than double the number of new jobs from April, but almost 20% less than expectations. The unemployment rate dropped to 5.8%, that is likely reflective of many potential workers not seeking jobs, as evidenced by over eight million jobs still missing from employment levels pre-Covid. 

The jobs that were added are not enough to cause more growth. Leisure and hospitality created more than half the jobs in May, and employers paid more to get those workers back on payrolls as evidenced by the increase in average salaries. The majority of jobs created were at or near minimum wages rates, which should have seen average pay decline nationally, however reflecting what many business owners have been saying, they have raised wages to entice workers to forego on-going unemployment benefits that are super-charged by government stimulus funds.

As reported in MarketWatch, economists are indicating several factors that explain why many workers are not returning to work. Among these factors are many workers took early retirement during the pandemic, challenges finding child-care and generous unemployment benefits. Expectations are that these conditions will last at least until fall, coinciding with expiration of the unemployment benefits increase.

Rates for Friday June 4, 2021: Markets continue to see choppy trading on a daily basis, but trending upward over the past week. Rates remain flat again this Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Next week’s update may be a bit late and truncated as Leslie and I, along with my siblings, will be headed to Tulsa, where several generations were born, for a memorial service. It seems that the next several months will be filled with such remembrances for all of us as we have an opportunity to honor, bless and remember those who have passed away during the pandemic and services were unable to be held.

While sad events, they are also joyous in that they provide us the opportunity to see family and friends we have not been with in some time. An opportunity to shed tears and share laughs as we remember good times with those who have passed, and those who remain.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Is it better to purchase a home with a high price but a low interest rate or a low price with a high interest rate?

Question of the week: Is it better to purchase a home with a high price but a low interest rate or a low price with a high interest rate?

Answer:  This question was posed earlier in the week from Adam, who purchased his first home a few years ago with his wife using his VA benefits.

It is an interesting question and the answer depends on several factors, including timing, math and personal wants and needs.

By asking this question in the way he has, Adam is commoditizing the home into a financial question. Long time readers of the WR&MU know that my opinion is that a home purchase should not be made from a return-on-investment perspective but rather from establishing a home for your family that is affordable, in a neighborhood that suits your means and needs, and for the long term. Yes, in most of Southern California home prices will likely increase during your time of ownership, giving you a return on your initial investment, however that gain should be secondary to quality of life gains you should expect to receive from homeownership.

“Better” therefore becomes a relative term to each family when considering the answer to the higher price/lower rate vs. lower price/higher rate proposition.

For my response, I am assuming the question is in regards to purchasing the same house, or very similar one in regards to what the value would be. My reply to Adam was as follows.

If you are asking, were you better off to buy your home at a lower price and higher rate in the past than you could today, the answer is yes, because you own the home, have seen it appreciate in value and later were able to refinance to a lower rate and payment. So not waiting for lower rates has benefited you.

If you are asking if today, in the current market, is it better to purchase a home with a higher price and a lower rate, the answer is yes because, again, you own the home, which will appreciate over time and you own it with a very low rate saving you money and the need to refinance in the future.

If you are asking for the future, the question begs the next question of, “will prices go down as rates go back up?”

My opinion is that when this real estate market cools, we will not see much of a decline in prices, if any, depending on the area or region where the home is located. Cooling off will mean less of a feeding frenzy created by fewer properties on the market than buyers chasing the limited supply of housing. We will see more of an equilibrium and “normal” market. This will slow price growth, may stall it to almost zero, but in most of our region I see little evidence of prices dropping much or at all, absent a big down turn in economy and job losses for those with incomes able to afford homeownership. The lack of job and income losses for most of those with incomes able to afford homeownership is what has created the current real estate market pushing prices higher and make it very difficult for buyers to have their offers accepted due to the competition.

My medium to long-term outlook is home prices stabilize as higher values as rates go up, which means the same home today will cost more in the long run due to higher mortgage payments.

Some quick math for those, like me, who benefit from numbers.

High price/low rate, assuming 20% down payments:

Price $650,000

Loan Amount $520,000

Rate 2.875%

Monthly payment = $2157

Low price/high rate (May 2019—assuming about 18% price increase)

Price $550,000

Loan Amount $440,000

Rate 4.00%

Monthly payment = $2100

As you can see the lower price/higher rate is a better financial proposition, for about the same monthly payment your cash to close is a lot lower, $20,000 in down payment plus savings in closing costs of around $2-3,000.

Looking forward to the implication of Adam’s question that prices will drop in the future and is it better to wait to purchase until they drop. I cannot see a drop in values of up to 18% in the future, again absent a catastrophic event resulting in large scale job losses.

However, let’s say prices drop 5% and rates go back to May 2019 levels:

Price: $617,500

Loan Amount: $494,000

Rate 4%

Monthly payment = $2358

As you can see, the down payment for the lower price is only $6500 less than the higher value of $650,000. Because of the rate increase, the monthly payment is about $200 more per month.

My position on when the best time to purchase a home has always been, when you can afford to do so; especially in Southern California where over time residential real estate has consistently shown growth in value over time, making it more expensive for you to purchase the same home the longer you wait.

If you, or someone you know is considering purchasing their new home, please contact me to explore the options and opportunities for homeownership.

Have a question? Ask me!

Economic data released today showed an expected slow down in consumer spending in April and a decline in personal income. The contractions were expected as March saw large increases in both spending and income due to the $1400 checks Washington sent most families. April did see inflation continue to increase, prices rose 3.6% on an annualized basis, the highest rate since 2008.

Rates for Friday May 28, 2021: Investors are sitting tight on fixed rate investments, such as bonds and mortgages, and as a result we see rates flat from last Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Growing up in the Midwest and East Coast, where there are four seasons, Memorial Day weekend meant the opening of swimming pools and was the official start of summer. Family cookouts and gatherings were the tradition.

This weekend we will recreate some of that at the Smith house as my older sister is visiting for the weekend to see her nieces, and my brother and family will be here Sunday for family barbecue.

I hope you and your families are able to get together, enjoy time together without mumbling through masks, and as, if not more, importantly hugging each other.

Besides protecting us from the Covid-19 coronavirus, the biggest benefit of the vaccines is their enabling us to enjoy each other’s smiles and physical contact with hand shakes and hugs. I look forward to more of each as we all feel more and more comfortable engaging with others.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog