15 vs 30, tricks with PMI, buying down your interest rate and when to lock in
As I start these episodes, I'm reminded of the encouragement I got from an employee of mine. He told me that I give a lot of great advice and have been blessed with much wisdom in my field... that it's a shame to not have it all written down somewhere for others to learn from. It's for that purpose, I've been intent on including in this blog advice I give to my clients, team and business partners during my time as a loan officer.
The Email
This 1st Episode originated from an email I got from a client. I have modified the email to keep the author anonymous.
Hi Rick,
Thanks so much for helping my husband and I with gathering information for mortgage lending. My Uncle had really good things to say about your company and his experience with my cousin. My husband and I would be very interested to hear more about your business model. We're also very much still learning about what to be focusing on when looking for a mortgage lender and such. We're gathering quotes from a few lenders around here and will ultimately be comparing things.
It would be great if, whenever you have the information you need from us, if we could see a few different models from you. Both 15 and 30 year fixed. We are currently planning on putting down 20% on our home, but are curious how the interest rate may change on a loan if we adjust that amount up at all? Also what options may there be to buy down interest rates?
Once we have our quote from you, how long are the interest rates guaranteed?
Great email with 4 great questions inside. A more structured version of my response is contained here.
15 Year vs 30 Year Rate
The 15 year rate will be much lower than the 30 year (about .5% or so), but obviously the payment goes up drastically since the time you have to pay the loan back is reduced. It's my opinion, that unless you are already financially set for retirement, there are better places to invest your money than the plowing it into the brick and mortar of your home. Putting extra money in the home equity only lowers your ROI. Your home will increase or decrease in value regardless of how much you throw towards the principal. The only thing that principal curtailment saves you is the interest on that money, but again... there are better places to put your money seeing the mortgage interest is mostly tax deductible. My two cents. Note: I address the ROI in greater detail in this blog post.
20% down? Or is less worth it?
20% down is not quite the benefit it was once before. In fact there are little tricks you can play with PMI to get better terms on your mortgage. When a lender has “PMI” on a loan it translates to being a lower risk loan. There is an insurance policy that the lender can cash in if you don't pay. That means you actually get a better rate by putting less than 20% down. Weird huh? But then we have to deal with the PMI don't we? So here are some not very well known tricks to pull with PMI.
- Put down 19.99% and get PMI for one month. After the month is over your loan drops below the 80% mark and therefore doesn't need PMI. With my company, it would drop off with the push of a button. With PMI at the outset, the price of your loan will actually improve! Yes, by simply putting down .01% less and you get better terms. Here's the math. Putting down $10 less than 20% down and paying one month of PMI saves you .25% x amount financed. That's $1000 on a $400,000 for paying a one time PMI payment of $53.33. Not a bad deal eh?! Note that this only works on conforming loans since this .25% pricing adjustment is an agency thing.
- You put down 10 or 15% and finance the PMI cost. This is not a higher rate nor a monthly PMI payment, but something akin to the VA loan. The VA loan has no PMI, but does require a “fee” to remove this requirement. It allows the borrower to pay this fee by financing it in the loan. Conventional loans allow the same thing, it’s called “Financed MI". Simply put, the lender negotiates to “pay off” the PMI company by cutting them a check up front, and then allows you to finance that amount in the new mortgage. Paying the PMI company to "go away" works out WAY better than monthly PMI and definitely better than the typical way lenders do it, which is just raise your 30 Year rate! Yes you will finance the cost up front thereby owing more, but your lower payment will break you even within a very short period of time. Simple math is Cost of PMI Financed divided by the monthly PMI you would have paid. That's your break-even.
Buying down your rate!
As far as rate buy downs go, I'll make a long story short. Buying down the rate is not always beneficial and it's not linear. Meaning every .125% in a lower rate doesn't have a fixed cost associated. It's a curve. With that said, there is normally a “best rate” on the rate board depending on the market. (see below example of an old rate sheet) -- The lower the rate, the higher the cost… higher rate, lower cost. Red is a charge and black is a credit. My job is to find the “sweet spot”, the Goldilocks of rate/point combination... one that's "just right".
How long are rate locks good for?
Rates aren’t locked until you have a property solidified for the transaction and have decided on a lender. At least that’s how I do it. There is no true “lock and shop” for clients. Meaning you can't just lock with one lender and hedge your bets while you try to get something better. Please don't do that. Now, there are such things as locking in the rate and then shopping for a home; however this is mostly used as a trap-tactic. The lender strokes the notion of rising rates and gets you to lock. You fork over a deposit which is non-refundable and get a higher rate for the lock term with the promise of a float down which isn't even at a market rate. I personally stay away from these since at a minimum you lose your bargaining power and a market rate should things not change drastically.
After getting your contract ratified (or verbally agreed), the loan officer will typically quote a rate that extends through the closing date; however what I like to do is pick the best time to lock. Now this may sound like I'm playing with hundreds of thousands of dollars... well yes I am, but i'm doing it strategically. I believe the biggest mistake borrowers make is locking with the lender having the lowest rate quote after shopping all day. I wrote an article on this topic: 6 costly mistakes made when shopping for a mortgage.
The big key is that knowing when to lock is always better than choosing the lowest guy on a given day. It’s sort of like knowing when to jump in and buy a stock. It doesn’t matter the commission charged by the broker on the buy as much as it does that he bought at the right time and price. Make sense? Rates jump around quite a bit so I monitor this stuff daily and am pretty good about the “when” to lock. I am very thankful to my friend Barry Habib and MBS Highway who makes it extremely easy for me to follow the markets and provides the insight I need. Thank you Barry for teaching me so much over the years.
Sometimes locking is as simple as getting a rate “guarantee” from the loan officer and then waiting to get within a shorter lock term (i.e. 30 day lock is cheaper than 45 days which is cheaper than 60). Every "shorter" lock term saves you about .125% x loan amount.
I hope this helps! Please comment with any questions!
Rick Elmendorf