Third Refinance

Yesterday, I closed on my third refinance. This is my fourth loan for the house in just over 6 years of owning it (http://eis271828.blogspot.com/2007/05/house-closing.html). I opted for a 15-year loan at 3.000% interest, which was the no-cost refinance rate. My out-of-pocket costs were #3115.86, which included $1549.21 in principal reduction, because I wanted the new loan to be a nice round $200K, and the customary prepaid interest and escrow pre-funding. I should get $1,433.34 refunded from my old escrow in awhile. Not too bad.

The 3% interest rate is lower than my estimated long-term rate of inflation (http://eis271828.blogspot.com/2010/08/annualized-inflation.html), which means I am borrowing money for free! The principal portion of my payment is also hugely higher than the interest portion, which makes me all kinds of happy inside. Because I was paying slightly extra on my old loan, my new payment is only about $20 more per month. I will not be paying anything extra toward this mortgage. Except, I am guessing that as I approach the end of the term, I will want to get rid of the monthly payment and still pay it off early.

I also have a nice happy feeling because I just helped the economy! For the most part, mortgages are owned by wealthy companies/individuals, and I lowered the interest rate they're earning from 4% to 3%. My local broker got some extra income, the state of Kansas got some extra fees, and everyone came out ahead!

Refinance, Round 2

I refinanced my mortgage back in May of 2009, and it's apparently time to do so again. I'm going about things a bit differently, this time. I'm using the same mortgage broker as last time, though he's with a different company now: First Trust Mortgage. I guess I'm just listening to his advice more now.

Currently, I pay $1400/month, which includes a decent pre-payment amount, and I would currently pay off my mortgage in 230 more months. I decided to formalize that this time around and get a 20-year mortgage, which lowered my rate 0.25% compared to a new 30-year. This puts my required payment at just under $1300/month, which means I'll round up to $1300, of course. So, I'll increase my projected term by 8 months, but save $100/month and pay less in interest.

Another change is that I've opted for a no-cost refinance. Here, the lender pays my closing costs in exchange for an increased rate of 0.25%. I crunched the numbers again, and paying the costs myself for the 0.25% would save me 2 months off the end of my loan. If I refinance again, or pay it off early (likely once I get down to the last few 10,000s in principal), paying the extra money out of pocket now does me little to no good. I don't plan on refinancing again, but I didn't think rates would drop when I refinanced two years ago, yet here I am.

I'm quickly realizing that no-cost refinances don't mean there are no out-of-pocket expenses. I still have to pay the prepaid interest that accumulates between my closing date and the date of my first payment on the new loan. And I have to pay the accumulated interest on my current loan between my last payment and the closing date. I've also opted NOT to waive escrow this time. So, I'm shifting some expenses from December up to now, to the tune of roughly $3300. Add the interest payments, and it'll be more than $4000 out of pocket. It's all money I would be paying this year anyway, though.

One of the main reasons I decided to not waive escrow (I still think this is one of the stupidest terms - you aren't waiving escrow, you're paying in order to not do it) is that I was told you can often call your lender after awhile and request to waive escrow then - with no costs. They don't have to let you do it, but it sounds like they often do. I also have the spare cash now, whereas I didn't have nearly the reserves in 2009. So, I can shift my payments from December to now in order to save $500 or so. And again, if I do refinance again, that money would either be paid to waive escrow again, or I'd be back where I am now.

Another interesting tidbit came from my credit scores. Back in 2009, I averaged around 796, I'm pretty sure. Now, I'm averaging just above the top tier cutoff of 740. I'm pretty sure most of the loss is from getting a credit card back in December that I've been regularly putting large balances on and then paying off again. The combination of the recent credit application, high utilization on that card, and some randomly high activity on a credit card of my parents' that they included me on long ago in order to build my credit history, has resulted in a slight ding on my credit. It still seems to be OK, since I'm over 740 on all three. However, it would be quite annoying to have problems because of these otherwise irrelevant credit score fluctuations. I'll find out within the month!

Insights from Mint.com

Going over my Mint.com trends for the past couple years, I noticed a few things I thought were somewhat cool. In no particular order:

• 75% of my out-of-pocket expenses are for housing and communications - mortgage, property taxes, insurance, and all utilities including TV, Internet, and phone.
• I spend more for Verizon Wireless than I spend at Walmart. To be fair, my Verizon bill covers five people. To be unfair, Walmart covers the majority of my grocery expenses and cat food and litter. To be fair again, I eat out quite a bit, so groceries are cheap.
• I will also spend more for Verizon Wireless than I spend on eating out, once figures include a full 24 months of Verizon bills.
• I spend a lot at Chili's ($800), and it is probably worth getting any discounted gift cards I see.
• My expenses have actually gone up since I've started paying attention to them. Every month, I've spent more in 2010 than 2009. I've also had more cash on hand.
• It's very important to set up renaming rules right when the name of a merchant changes for whatever reason. From that point on, it becomes automatic.
• Rollover budgets are great in theory, but end up making the overall totals meaningless as they drift way negative or way over budget. Really, the budget feature itself is not as informative as the Trends tab.
• "In the past 30 days, you spent $309.62 on Clothing. Usually you spend $9." That $9/month is inflated because it includes a tuxedo rental and a bunch of clothes that weren't actually mine. In other words, I spend very little on clothes.
• It is also important to realize tax refunds are income that the government held for you, and not taxes. Assigning tax refunds to the 'Taxes' category can result in negative spending for the month, which looks awkward.

Q&A: What's a good down payment size?

This is actually quite a complicated question. For one, things can change rapidly. For example, the interest rate penalties for high loan to value (LTV) ratios used to be higher. I believe they have been reduced in many cases as part of the effort to improve the housing market. On the other hand, a lot of loan regulations have gotten stricter to avoid bad loans entering the market again. Basically, rate changes related to your LTV need to be discussed with your lender.

Private Mortgage Insurance (PMI) still needs to be purchased when your LTV is greater than 80%. PMI is typically equivalent to a 0.50% to 0.75% interest rate hike for the period it needs to be paid. Some lenders advertise PMI-free loans even when your LTV is greater than 80%. The PMI still has to be purchased, but for these loans the lender buys it. They will pass this cost on to you via a higher interest rate - there is no such thing as a free lunch. Because your interest rate won't change for the life of a standard 30-year fixed rate mortgage, this interest rate, even if it results in lower monthly costs than buying PMI, could very well cost you more in the long run. Again, go over the details with your lender.

When it comes to deciding between making a larger down payment and buying PMI (or accepting a higher interest rate to cover PMI expenses), you have to look at the best use of your money. My previous post on whether or not to prepay your mortgage could be helpful in evaluating your options. Personally, I would rather avoid PMI than invest a few thousand dollars, say. Whatever you invest that money in would have to earn you more than the PMI payments and extra principal and interest payment amount (minus taxes on the interest and PMI, since PMI is tax deductible like mortgage interest). In fact, this should be considered an addendum to my previous post: The return needed to overcome PMI probably warrants paying extra principal at least until you reach 80% LTV. Psychologically, I just hate the idea of paying private mortgage insurance because it only benefits the lender.

Paying extra principal at the beginning such that you have less than 80% LTV ratio mostly follows my previous post's recommendations. The only difference is that the extra principal in this case does reduce your minimum monthly payment. When determining the terms of your loan, though, you have another option to reduce your payment: you can pay points to reduce your interest rate. As you can see using my refinancing calculator, reducing your interest rate can reduce the interest portion of your payment more than the total monthly payment amount in some cases. You have a choice in which number you use in determining your break even point, but obviously the total monthly payment might be all you care about.

I would make a point-paying calculator, but the cost of each interest rate reduction isn't always the same. For example, it may cost you half a point to move from 5.000% to 4.750%, but another half a point to move from 4.750% to just 4.625%. The user interface of such a calculator would be clunky at best. You can use the refinancing calculator fairly easily to get individual values and compile your own table of break-even times, though. Just find a payment amount for a 0-point loan and plug that into the current loan information fields. Then zero out the closing costs and adjust the points value and find the resulting interest rate entry.

Overall, I would tend toward a 20% down payment if you can afford it so you can avoid PMI. After that 20%, paying points will usually reduce your monthly payments more than extra principal. I paid half a point on my first loan, I think, and zero points on my refinance, other than the quarter-point fee I paid to waive escrow. For the most part, it comes down to what you feel comfortable paying up front versus owing later. I'm not sure there's ever a clearly wrong decision!

Q&A: Should I Pay Down Extra Principal Each Month?

Whether or not to pay down extra principal each month is a complicated question, and one that doesn't have a universal answer by any means. For the purposes of this discussion, we'll assume that an extra payment fits in your budget. Otherwise, the question is a bit moot.

Paying down principal has two primary effects. First, it takes money out of your pocket. Second, it increases your equity. Increasing your equity has the effects of reducing the interest you pay over the life of your loan and increasing your borrowing power. We'll go backwards through these effects this time around.

The borrowing power I'm referring to here will usually take the form of a home equity line of credit (HELOC). If you make a larger down payment, your monthly expenses can be lower, which can increase your borrowing power for a new loan, but if you're just getting a mortgage, chances are you're not looking for many other new loans. (Indeed, you shouldn't be, as new loan credit inquiries can negatively affect your credit score! Wait for your mortgage to be finalized before looking at car loans, for example.) The only thing I would use a HELOC for is an emergency fund. It's a great way to be able to pay down principal and still have access to that money in a pinch. If the pinch comes and you don't already have a HELOC, you're unlikely to be able to get a HELOC, so it's important to plan ahead. HELOCs are usually restricted to whatever equity you've built beyond 20%, so that your combined LTV remains at 80% or less. They also usually require a recent appraisal, so even the no-fee HELOCs aren't entirely cost-free to set up.

To me, though, this benefit of paying down principal isn't a major selling point, as evidenced by the fact that I do not have a HELOC. For emergency funds beyond my cash on hand, I would rely on loans from my family. I haven't formalized that line of credit in any way, and maybe I should do so rather than taking it for granted. At the same time, I can make sure my family knows that I would be there for them, too.

I view principal reduction as an investment that returns a savings in interest payments. Unfortunately, the rate of return on that investment isn't always just the interest rate of your mortgage. I included a simple calculator in my post on your effective mortgage interest rate, but that doesn't give a complete picture of your investment.

First, just as in my discussion on S&P 500 growth, values were not inflation adjusted. When it comes to the returns of the S&P 500, you have to subtract the inflation rate to get an inflation-adjusted return (approximately, anyway). Your mortgage works much the same way except that inflation helps debt, so you get to subtract the inflation rate from the interest rate you pay and get an inflation-adjusted interest rate. You get a benefit now (the home) and pay for it with less and less valuable dollars. Not a bad deal for the purchase, but it lowers the rate of return on principal payments. For the default values in the calculator above, the effective interest rate is 3.75%. After adjusting for inflation by subtracting 3.3% (though recent inflation has been lower), you're left with a nice low 0.45% inflation-adjusted effective interest rate.

Second, paying down principal now takes off interest from the very end of the loan. Your minimum payment doesn't go down and you can't readily access that money except through a HELOC. It is definitely a long-term investment, and the rate of return is locked for that entire period. It's similar to buying a multi-year CD with a rather - even ridiculously - low rate, given the current interest rate environment.

Third, paying down principal really shows the nature of compounding. Every payment that goes by, the principal you pay down saves you one fewer compounding of interest. Take a look at a monthly amortization schedule (my favorite calculator). You'll notice that the principal you pay goes up each month, while the interest paid goes down. Where you are in the schedule depends entirely on the principal outstanding, so to move up the schedule by a month (and in effect take a payment off the back end), you just have to pay the principal for the next month ahead of time. Thus, the extra payment required to gain a month goes up each time. The rate of return doesn't go down, but the time horizon is shortened and the compounding reduced. If that shortening of the time horizon is your goal, there are definitely diminishing returns.

As mentioned above, paying principal takes money out of your pocket. Whether or not paying principal is a good investment really depends on which pocket the money comes from. If it's coming from a cash account, chances are good that you will get a larger return by eliminating interest. If you are paying extra principal instead of making an IRA or 401(k) contribution or otherwise investing, then you are missing out on what is very likely to be a higher return in the stock market. Remember that it is important to compare inflation-adjusted rates to each other, and non-inflation-adjusted rates to each other. Mixing and matching is not a valid comparison.

Basically, as near as I can tell, prepaying principal doesn't make financial sense unless mortgage interest rates are over ten percent or so. I don't think many people today would pay down their mortgage if it weren't for the psychological benefits. Being in debt just doesn't feel very good - especially when it's tens or hundreds of thousands of dollars and can result in being homeless. Conversely, there's no feeling quite like knocking another month off the end of your mortgage. It's also a lot of fun to reduce your principal by the first $1,000; the first $10,000; the first $100,000 (I imagine). I'm also really looking forward to the day (soon, I think!) when my various investment and cash accounts could pay off my mortgage if I liquidated them. That would mean I could pay off the house if I had to, significantly lowering my monthly expenses so that I could live off a minimum wage job, for example. However, when I get close to the end of my mortgage, I imagine that I will pay it off simply for the monthly cash flow improvement, whether I need it or not.

In the end, I pay a couple hundred extra each month despite the logic behind investing it instead. I guess that's the price I put on the psychological benefits above. Pretty cheap therapy, actually.

Q&A: What's My Effective Mortgage Interest Rate?

When you sign and initial the hundred or so times required to purchase a home, chances are good that you wind up with a mortgage to go along with the property. That mortgage has an associated interest rate that is used to calculate how much you're charged each month, but it isn't always an accurate measure of how much you pay, in the end. (The mortgage also has an advertised APR that includes points, lender fees, and any applicable PMI thanks to the Truth in Lending Act. Honestly, I've never found the APR that helpful, and it definitely isn't helpful in this discussion - we need to look at the base interest rate.) The net interest you pay depends on your tax situation, and results in what I call your effective interest rate (not to be confused with the more official effective annual interest rate - new name suggestions are appreciated!).

Mortgage interest is tax deductible, which is great in theory, but it doesn't always help very much, if at all. Individuals get a standard deduction of $5,700, and married couples filing jointly get $11,400. If your mortgage interest isn't greater than whatever standard deduction applies to you, then the mortgage interest deduction doesn't help you on its own. You may have other deductions like qualified medical expenses, 401(k) contributions, charitable giving, and the like. If you have a mortgage, chances are good that you have an income and pay state and/or local income taxes, and chances are even better that you have property and are paying real-estate taxes, both of which are deductible. With these deductions, the mortgage interest deduction can be more beneficial.

My medical expenses are well below 7.5% of my adjusted gross income, so those are not deductible. My 401(k) contributions go into a 401(k) ROTH account, so they are not deductible. I have some donations and the occasional miscellaneous deduction, but my main deductions are the state income and property taxes I pay. In the end, most of my mortgage interest winds up being deductible. That means I pay a lot of state and local taxes, though, so that's not entirely a good thing.... It doesn't apply to me this year, but your deduction can also span tax brackets, making the calculation that much more complicated. Some of the deduction may save you 28%, while some may save you 25%, for example.

The amount actually deducted (we can call it the effective deduction until a better suggestion comes in) affects the effective interest rate you pay. For a 5% mortgage with outstanding principal of $200,000, your interest payments will be around $10,000. Say you contribute to a 401(k) and so can deduct all your interest and are in the 25% tax bracket. You effectively reduced the interest paid by 25% * $10,000 = $2,500. You are now paying a net of $7,500 for an effective interest rate of around 3.75%.

Because I'm such a fan of calculators, I just couldn't resist making another one!

Interest Rate (%):
Interest Paid ($):
Interest Deducted ($):
Tax Bracket (%):

Favorite Time of the Month

I look forward to the beginning of the month. It's a very special time for me. My mortgage payment goes out at the beginning of the month. This prompts me to... wait for it... update my spreadsheet!

My budget spreadsheet is the first I created with multiple worksheets. It has nine (one of which goes unused, and the other just has information used in calculations on other sheets)! I've always been a long-term thinking/planner. While I like the idea of tracking things monthly, like Jonathon does over at MyMoneyBlog, I think I'm content with updating things monthly but tracking things on a yearly basis. You can look at my spreadsheet as a long term planning item, and Mint.com as my monthly tracking place. Alternatively, you can look at Mint.com as my monthly history, and my spreadsheet as my yearly outlook. It's really not much of a budget, I guess.

Recently, I haven't been using much of the spreadsheet besides the Retirement Planning tab. (I may have to look at what this says about my current job satisfaction at a later time.) This tab isn't so much of a plan of how to get to retirement - my 401(k), Roth IRA, other savings, and house are my retirement plan already being taken care of. The Retirement Planning tab lets me know when I can retire and live forever off of my accrued savings. I compute the live forever part of that by determining if the growth of my investments will outpace inflation.

By my current assumptions of 3% inflation, 7% retirement portfolio return, and $70,000 (in 2006 dollars) yearly withdrawals, I can retire permanently at age 56. Now, $70,000 seems like a ridiculously large amount of money to spend in a year, to me. However, I would like to have a wife, and I don't want to underestimate those associated expenses... Seriously, though, that should allow for most travel plans I can think of, charitable giving, and regular living expenses, with hopefully enough left over to handle unexpected expenses, or temporary-ish ones like college costs for children.

Even though I don't use most of the parts that I programmed into it, updating the spreadsheet is still a very fun activity. Very few things are better than a large table of numbers.

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This was supposed to be posted nearer to the beginning of the month, but my main computer was having issues. Chkdsk seems to have sorted them out, though. It took a few hours, but it completed. I was fooled a few times by long periods of no screen updates and the keyboard not working. That is, I restarted the process more times than necessary, I think. For future reference, the Num Lock and Caps Lock keys don't work when chkdsk is running, and it's apparently normal for some operations to take an hour without updating the screen.

Mortgage Refinance Completed

On Wednesday, May 20, 2009, I completed my first mortgage refinance using United Home Loans. I stayed with a 30-year fixed mortgage, but was able to reduce my interest rate down to 4.625% and save $176.51/month on my monthly payment. The process will have increased my principal by ~$5000, but a lot of that is the interest for the month of May that I rolled into the new loan, a quarter point for waiving escrow, plus some money back to ensure that I didn't have to mess with getting a cashier's check. The closing costs were comparable to the other places I looked, and the rates were quite competitive.

Most importantly, yesterday marked one of the worst days in the MBS (mortgage-backed securities) market, which resulted in rates climbing into the 5.25%-5.5% range. I timed my closing pretty well! The site I follow, Mortgage News Daily, seems to think rates will come down again this year, but it's a whole different feeling to follow the MBS market when I have no direct financial stake in the matter.

A couple people have expressed surprise that I decided to waive escrow, seeing how it cost me .25% of my loan amount. I did some number crunching before coming to this decision, and in my case it definitely made sense. First, I had just paid property taxes, and my insurance doesn't have to be renewed until December, yet they were going to collect 6 months worth up front, or about $3000. I don't think I'd like to pay $3000 out of pocket now if I don't have to, which means I probably would have rolled that cost into the new loan amount. A $3000 loan equates to $15.42/month in extra payments, which means I will recoup my escrow payment in about 3 years directly. That .25% is listed as a discount point, though, which means its tax-deductible. I also get some interest on the $3000 that can stay in my savings account (I actually used it to max out my Roth IRA for the year, so hopefully that will result in even better returns). I also keep the flexibility of scheduling my property tax payments. This gives me the opportunity to shift my tax burden between years a bit by paying either half or all my property taxes in December. Mostly, I don't like the idea of giving my money to somebody and getting nothing out of it, so there is psychological value for me in waiving escrow.

Some of the closing costs are offset by not making a payment in the beginning of June (at the cost of increased principal, of course). This will mean $1500 extra into my pocket this month. I think I will lower my payment to $1400/month on my new loan, however. This will mean an extra $100/month for me, but still be prepaying my mortgage faster than I was on my old loan. Here, I'm fighting the strong psychological benefit of paying off debt with the intellectual knowledge that prepaying on a 4.625% (tax-deductible) loan almost certainly is not the best use of my money. I just love seeing the balance jump down!

Taxes 2008

This post is analogous to last year's tax post.

Taxes for 2008 turned out to be much simpler than last year for the following reasons:

• I only lived in one state, and so did not need to split my income.


• I closed one of my accounts to pay for the down payment on my house in 2007, so I no longer have to worry about all those forms and trades. That account had tons of trading activity.


• I was familiar with which sites I needed to log in to in order to get various 1099 forms - mainly Countrywide.


• TurboTax imported last year's return so I didn't have as much data entry on my personal information.

I was actually fairly pleased with TurboTax. It still had a few problems (there was no official way to enter short sales [such as cash-secured puts], so I'm not sure I did that right, but the total profits/losses are correct), but was improved from last year overall.

In addition to TurboTax, I used Kansas' WebFile page to e-file my Kansas return. I basically just entered things in line by line from the form TurboTax generated, but didn't have to print it out or mail it. I think that will be the more environmentally friendly route, plus get me my refund sooner.

Speaking of refunds, I get big refunds! From the federal government, I get $5397 back, and I get $854 from Kansas. Governments, you're welcome for the 0% loans over the last year! Please place money in my savings account soon.

What will I do with all that money? Well, you should read this post on things I want to buy, and this post on mortgage refinancing, all while keeping in mind that a cash reserve is nice to have and build.

Why was my refund so large when I owed so much last year? Another list:

• This was my first full year of paying my mortgage, which means a full year of mortgage interest deducted.


• This year sucked for investments, so I had no realized capital gains. I'd rather pay taxes than not be building wealth, though.


• This was my first full year of paying property taxes, which are deductible.

Refinancing Calculator

I'm actually pretty proud of the utility of this calculator. I hope you find it as helpful as I have in finding the interest rate needed to make refinancing make sense.

Loan Balance: $
Lender Fees: $
Fixed Costs: $
Points:
Total Closing Costs: Your javascript is disabled.

Finance Closing Costs:
Final Loan Balance: Your javascript is disabled.

Current loan information:
Monthly payment: $
Current rate:



Show rates:
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Your javascript is disabled.

First off, I apologize for any style issues. Using blogger has it's drawbacks, especially when putting scripts or styles in a post - the formatting has to be unreadable or the automatic line-breaks-to-br-tags conversion makes them not work at all. I also can't make the table any wider without really screwing things up, apparently. Now, on to the explanation:

Hopefully all the columns are self-explanatory except the last few. The "Monthly Savings" column refers to the difference in total payment amounts. The adjacent "Months to Recoup Costs" column uses this value to figure out how many months it would take before your out-of-pocket costs are back in your pocket. Thus, this column is best used when you are NOT financing your closing costs as part of the new loan.

The "Monthly Interest Savings" column is how much less (or more) interest you pay per month as part of your monthly payment. When you finance the closing costs, then, the last "Months to Recoup Costs" column shows how many months it will take to get the new loan balance back to your current loan's levels.

Any comments or suggestions on how to improve this post? Barring blogger limitations, I will do my best!

Mortgage Refinancing

I submitted my info to LendingTree.com a couple days ago and have been talking with mortgage people all yesterday. At the moment, the best rate I can get is 5.125% with 0 points. My current rate of 5.75% is already a decent rate, but refinancing would lower my minimum monthly payment by about $100, while increasing the amount of principal I pay each month. I would recoup my refinancing costs inside a year, but I'm still not sure if it's worth it.

The worsening economy hints that interest rates may fall further, but every month I wait, I'm effectively adding $100 to my closing costs. I'm not sure if refinancing works the same way as a first mortgage, but with my first one, it was best to close at the very end of the month to reduce the amount of prepaid interest you have to pay. Sometime next week I think I might be going to the Community Home Lending offices and discussing the timing of everything. It may be that I have a few weeks to think about it just waiting for an optimal closing date.

What are other people's thoughts on refinancing? Any questions I should definitely ask?

Mortgage fun

My mortgage is a standard 30-year fixed. I have the option to pay extra against the principal at any time, and I do so every month. I don't prepay a lot, but I do round my mortgage payment up to the nearest hundred. One of my favorite things is seeing my loan period drop by an extra month. That is, while I have 29 years and 1 month left in the 30-year period, I will have fully paid for my house after 28 years and 11 months. This month's extra payment finished off another month's worth of mortgage interest.

It's a small victory, I know, but it makes me happy. As my income increases, I do hope to increase my monthly prepayment further. As fun as it is to watch my mortgage figures every month, I definitely look forward to not having to make that payment. Maybe I'll finally win the lottery tonight.

Managing debt

I grew up thinking that debt was a bad thing. Why buy a car when you can't afford it outright? I understood that houses required mortgages, but why put things on credit cards when you can pay cash? Managed properly, debt, even in credit card form, can be a good thing.

Spending

A lot of proper debt management depends on a realistic assessment of your spending habits. I, for example, don't tend to buy things. Or, I didn't until I bought a house and needed to put things in it. I have no expensive hobbies (compared to my brother who buys guitars and related equipment quite often) and I keep my monthly spending constant within a couple hundred dollars, in general.

In short, my spending habits are well defined and I track them informally. I also have a pretty stable job. IBM is a $160B company and people seem to like what I do there. Thus, I have a demonstrated discipline when it comes to spending and a pretty solid income. The risk of me not being able to pay my monthly bills is fairly low, so debt shouldn't be an undue emotional burden.

Interest Rates

The rest of debt management is interest rates. Most debt is pretty simple, actually. The interest rate is advertised directly. Some interest is tax deductible, though, in which case you need to multiply the advertised interest rate by (1 - your tax rate). For example, if you're in the 25% tax bracket and have a 6% mortgage, you're effectively only paying 4.5%.

If you can beat the interest rate determined above through investing, you can actually make money by going into debt. Even with the recent downturn, The S&P500 index has seen annualized growth of 9.516% over the last 5 years. That pesky tax rate works against us a bit, here, though. Interest income and short term capital gains are taxed as regular income, while long term capital gains are taxed at a 15% flat rate. For a worst case scenario, we can assume everything will be taxed as regular income. We need to now divide our effective interest rate from above by (1 - your tax rate) to get an rate of return goal. That 4.5% becomes 6% again. An 18% credit card interest rate becomes a 24% goal. Whatever we invest in, we need to beat this final rate in order for the debt to be profitable.

Over the long term, an 8% annualized return is fairly achievable. If you can invest money borrowed at 6% (effective) or lower, it is likely that you will be able to make money on money you don't actually have. This whole argument only applies if you have the money available to invest, though. If you borrow money to buy things, then that money isn't working for you.

Credit Cards

When there is something you need to buy, credit card debt can still be a good thing (even a card with an 18% interest rate!). The key is to not keep an interest-bearing balance. Pay the credit card off completely each month and you've basically borrowed money for 30-50 days interest free. You can keep that money in a high interest savings account and earn an extra few dollars by using a credit card instead of cash. Even better, you can get a credit card with additional cash back like the Chase Freedom card and/or Citi Dividends card.

Keep in mind that interest-free financing isn't a free pass to go on a spending spree. You still have to pay the purchase price. However, a store's 0% financing credit line can actually be better than cash back credit cards. I'll leave it as an exercise for the reader to determine a formula based on bank account savings rate, b, financing period, t, and cash back bonus, c, that calculates the break-even surface.

Mortgage payment

I mailed off my first mortgage payment yesterday. Assuming it arrives on time, I will be almost $300 closer to being debt free. Hey, that's more than 0.1% of my debt!

I've really spent a lot of money over the past month. I bought a house, refrigerator, washer, dryer, kitchen table, 6 chairs, a TV stand, a 65" TV, and 4 bar stools. And that's just from Nebraska Furniture Mart! The problem, though, is that I'm slightly cash poor right now. Not severely so, but enough that I feel nervous about investing any more of it right now.

I wish I could remember all the things I've been meaning to write down.

House Closing

So, on Monday I signed a whole bunch of papers. Before that, there was a bit of excitement. My homeowners insurance wasn't officially processed yet, so I had to run down to their office and get everything sorted out. Plus, I wasn't told until about 9:30am what amount to get a cashier's check made out for. Incidentally, I don't think Bank of America charged me for my cashier's check. That made me slightly happy. Anyway, I was a few minutes late to my 10:00 meeting.

After another 15 minutes of waiting, all the paperwork was printed off, and I was ready to sign. That took quite awhile, but it was relatively painless. Finally, I went to get my house key, do a quick walk-through, then head back over to the insurance place to work out car insurance. And eat lunch.

So, the gist of it is that I now own a house, and a sizable debt on said house.

What's surprising, though, is how unexcited I am. I was quite excited during the offer/counteroffer/acceptance stage, but that has worn off. It is surely difficult to maintain a high level of excitement for most of a month, and I've had plenty to keep me busy in the meantime. We'll just have to see if the moving process brings a whole new period of excitement.

On a completely unrelated note, my serious little blog here has been flagged as possible blog spam by Google. I guess most people don't have such boring blogs primarily discussing mortgages. But, I have a mortgage, so there's little reason to talk about it anymore. I'm sure this means my blog will become ever so much more interesting...

Prepaying Mortgage vs Investing

I've been debating on whether or not to buy points on my mortgage, and then whether I should pay extra on the principal or not.

Let's tackle the second question first. There are many issues that disappear when you properly phrase the question. So, we'll have the goal of maximizing net worth at the end of the mortgage term.

House Appreciation: No matter how much of the house you own, it will appreciate at the same rate. Paying down the principal does not affect the value of your house. The only time paying down the principal helps with regards to house appreciation is if you sell it earlier or refinance the loan. You will then get more money from the sale or have to finance less. In my case, where I'd be more likely to keep the house and rent it out after I move, this is completely irrelevant to my final net worth.

Rate of Return: The rate of return on an investment makes all the difference. If the interest rate on the loan is 6% (as mine is likely to be), then paying down principal is effectively a 6% investment. This beats CDs and high-yield savings accounts, and is a guaranteed rate of return. However, the stock market in general tends to beat an 8% rate of return. For instance, last year I made about 14%. Currently, my E*TRADE account has earned 8.88% for the year (which is not a balanced account, and so fluctuates wildly).

Tax Considerations: Money invested is subject to income tax or capital gains tax. Assuming a 25% effective tax rate, my investments must earn a (.06/.75) = 8% rate of return. Well, my investments usually do earn 8% or greater! Plus, paying down principal reduces the amount of interest you pay, which increases your tax burden (interest being deductible).

Points: Buying points is an investment in a lower interest rate and a lower monthly payment. What is its rate of return? The value of a point varies over time and over the interest rate scale. For instance, currently moving from 6.125% to 6% costs .375 points, while moving from 5.875% to 5.75% costs .75 points. At 6%, my $232,000 loan has a monthly payment of $1,390. At 6.125%, it goes up to $1,410. 0.375 points costs me $870, and saves me $20/month, or $240/year. This is effectively a 25% return on investment. Given this new outlook on the value of points, I will need to talk to my mortgage guy again and figure out what is going on in more detail. Not every company has the same point scale, so it may just be that right now E*TRADE happens to have a favorable points system.

The other issue with points is that it also reduces the interest paid, and therefore increases your tax burden. Even still, the numbers above make it seem to be a solid investment.

Psychology: Even though paying down principal is logically a fairly conservative investment, there are a number of psychological advantages. First and most importantly, it feels good to not have so much debt, and to not have so many years left on the mortgage. Second, the more equity built, the more you feel like you have flexibility to sell or refinance. We'll see what I end up doing after my cash flow stabilizes (i.e., after I finish buying appliances, televisions, and furniture).

Mortgage options

I had a meeting with my mortgage representative on Thursday evening. It was a pretty standard meeting where he went over what he could offer, what all these papers in the loan application were for, and what I could expect in the next couple weeks. It looks like my closing costs will be slightly higher than what I can get online, but my interest rate will be on the lower end of the spectrum.

I don't feel too bad about paying a bit extra though, for a few reasons. One, and least importantly, he's my dad's friend and they have a group lunch every third Thursday. Two, I will have someone to work with in person. Three, he told me about closing at the end of the month instead of the beginning to avoid what would effectively be an interest-only payment on the first month. Four, he claims to be keeping an eye on the rates and corresponding market, and that he'll call me and tell me when he thinks is the best time to lock in the rate.

So, I've moved up my closing date to April 30th instead of May 3rd. I've officially applied for the loan. I should be getting 6% or less. It's one of those situations where I hate how the market only adjusts in 1/8% increments. I'm not paying for any extra points, as it would take me 8-10 years of saving the monthly payment reduction to break even on the cost. Given inflation and the like, I think I'm better off keeping the cost of the points where it is - invested in various things.

I'm hoping to do an analysis soon of whether or not you should pay extra every month in order to pay down the mortgage faster. So, look forward to that.

Offer accepted

One thing I forgot to mention last post was that the house sale was being handled by a relocation company. Being on the market for 132+ days meant they really wanted to get rid of it. They countered my offer of $280,000 with $292,500 at about 10:30 this morning. I countered back at $290,000, which they accepted.

I've been hopping up and down all day (on the inside, at any rate). I called up one of my financial advisers to close out an account to cover the down payment. That should be a pleasant check to get in the mail.

Now begins the search for a mortgage. Quite a few people have people I should talk to. IBMers get several discounts, so I need to look into those. Then I need to shop for a refrigerator and a washer/dryer set. I also need to do all the appraising, inspecting, and whatever else. Not a terribly fun-sounding set of activities, but definitely very exciting.

You know what else is really exciting? I'll be having a housewarming party! If you want to make sure you are invited, leave a comment!

My HOUSE!

Financial Benefits to Homeownership

I've been compiling a list of benefits to owning my own home. The list is a bit longer than I expected, actually.

• Interest paid is tax deductible. Based on a $300,000 home value, this will be about a $13,500 deduction, which is about $3375 in saved taxes. Of course, this benefit diminishes over time.
• PMI premiums are deductible. This will not apply to my house purchase, as I plan on putting a full 20% down, but it's an added bonus, if you have to pay for PMI.
• Home appreciation. When I first buy my house, I will own 20% of it. However, any increase in value becomes my profit as though I owned the entire house.
  
• Immune to inflation. My mortgage payments will end up being rather large, given $240,000 in debt. But, this payment will not change. As time progresses and money becomes less valuable, my mortgage payment just gets easier.
  
• Rental income. Being single, I have the flexibility to rent out rooms in my house. While this probably isn't as financially secure as having a wife with a second income, it certainly doesn't hurt anything.
• Credit building. Due to my parents including me on their credit cars for the past 8 years or more, I have an excellent credit score of around 794. I can claim virtually no credit in this achievement, but it's kind of cool. The point, though, is that making regular payments on time helps your credit score.
• As opposed to paying rent. When you pay rent, your money goes to the landlord (which I will be!). When you make your mortgage payments, you build equity. You become a little more your own landlord every month.
• Tax deductible property taxes. Yep, property taxes are tax deductible, too. Of course, you still have to pay them.
• Points are tax deductible. If you improve your interest rate, points are tax deductible. Which is kind of like getting 25% off the cost of points. Not bad.

Did I forget anything? I feel like I did. Leave a comment and notify me!