Saving Money Without Too Much Pain

A few years back, it became popular to reduce the interest expense of a home mortgage by dividing the monthly payment in half and making two payments each month. This also helped those on a budget align the timing of their expenses and with the timing of their paychecks. While I don’t hear about this approach as often these days, it’s still a good idea, so I thought I’d explain how it works.

Intuitively, you must wonder: if I pay the same amount of money each month overall, but just split the payment into two installments, how can that save me thousands of dollars over the life of the loan? It basically comes down this: you’re making one additional payment each year.

If you have a 30-year loan of $100,000 with a 4 -percent interest rate, your regular monthly payment would be about $480. At the end of 30 years if you make 12 payments per year, you’ll end up paying back the $100,000 loan plus another $72,000 in interest. If instead, you pay $240 every two weeks, you’re paying the equivalent of $520 per month because of the timing of the payments adding one full payment per year. The higher payment means you’ll pay the loan off sooner—in this case, four years sooner for a net savings of  $11,000 in interest over the life of the loan. As the interest rate goes up the savings increase geometrically – at 6 percent (a 50 – percent rate increase) you save more than $24,000 (a 127 – percent increase).

For most conventional home loans, you can pay up to 20 percent of the loan value each year without pre-payment penalties. This allows you to save interest over the life of the loan, but does not obligate you to make the higher payments. Of course, it’s a double-edged sword: if more immediate spending options lure you away from your long-term financial goal of paying your mortgage off early, no one is there to force you to stick to your original plan.

Another way to achieve a similar result (that forces you to make the higher payments) is to start with a 15-year loan rather than a 30-year loan. This has two advantages: you pay off the loan more quickly and the loan can usually be obtained for ¼-percent to ½-percent lower interest rate.

Whether you choose this approach should depend on alternative uses for your money. If the higher mortgage payments make it impossible to send junior to college or replace your 15-year-old clunker, this may not be a good option for you right now.

There is a way to get the best of both worlds: take the 15-year mortgage (if you can pay more in the short run), and as equity in the property increases through the down payment, appreciation of the property or amortization of the loan, talk to your local bank about a home equity line of credit (HELOC).

A HELOC allows you to put more money toward your mortgage while still maintaining your access to cash if you need it. All of this assumes you’ve maxed out other investments with higher returns than your mortgage, like maximum contributions to your retirement account, for example. The HELOC option is a good idea if your budget will allow a higher payment. But do make sure you’re wise about it. If you have a rotating credit card balance getting charged at 22 percent, pay that off first. That interest is much higher than a home loan and isn’t tax deductible.

If you’re in the process of buying a house, your realtor can explain the ins and outs of a 15-year versus a 30-year loan. Don’t hesitate to ask!

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

What’s It All Mean? Real Estate Definitions

Real estate, like many industries, has a whole language of terms and definitions that make sense to those of us who live and breathe real estate, but that can leave homeowners in the dark. So I thought I’d shed a little light on the subject.

Licensed Real Estate Agent – someone licensed by the California Bureau of Real Estate to transact otherwise restricted business transactions, including the listing and selling of real estate, under the supervision of a broker

Realtor– licensed real estate professional who is a member of the National Association of Realtors, which requires adherence to a strict code of ethics

Licensed Real Estate Broker – someone licensed by the California Bureau of Real Estate to transact otherwise restricted business transactions, including the listing and selling of real estate and the brokering of real estate loans.

Single Family 1-4 – this is how we refer to the category of real estate that includes single-family homes, duplexes (2 living units), triplexes (3 living units), and four-plexes (you guessed it—4 living units)

Financial Institution – in this context, an organization in the business of making loans secured by real estate

Underwriting – process of determining whether to make a loan whereby a lender or his representative reviews a property and all of the borrower’s qualifications to purchase it

Conventional Loan an institutional loan usually secured by a single family 1-4

Conforming Loan usually a loan that meets specific underwriting requirements and includes a minimum of 20 percent down and (in this area) a maximum value of $417,000

Owner-Occupied – a single family 1-4 owner will occupy one of the units or anticipates occupying it within 12 months. This is a requirement for most loans.

Primary Residence – the owner-occupied unit where the owner spends 50 percent plus one day each year. Single-family, owner-occupied, primary residences typically secure the best loan terms

USDA, FHA, VA, CalVet – these are large government loan programs. The United States Department of Agriculture offers loans to families in rural areas who don’t make too much money; the Federal Housing Authority offers limited loans to those with good credit; the Veteran’s Administration offers loans to U.S. veterans, and CalVet offers loans to vets who want to purchase a home in California.

GSEs – Government-Sponsored Entities are institutions that buy loans from loan originators on the secondary market with the goal of providing lower housing costs and better access to financing. The big players are referred to as Fannie Mae, Freddie Mac and Ginnie Mae. They are actually the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Association (FHLMA), and the Government National Mortgage Association (GNMA)—which is actually part of the US Department of Housing and Urban Development.

Pre-qualified a loan representative has given you the likelihood of loan approval based on information you’ve supplied.

Pre-approved – a loan representative has reviewed documentation, verified income and employment, confirmed the source of funds for the down payment and closing costs, reviewed credit, and made all determinations to arrive at a monthly payment for which you qualify; leaving only the property and its value in question.

Debt-to-Income Ratio – compares overall debt to income. Front-end ratio: the ultimate loan payment divided by net income. Back-end ratio: all debt expense (car loans, credit cards, any other recurring debt) divided by income. A lender will use both to determine the loan amount you qualify for.

Escrow – neutral, third-party depository where the buyer, seller and lender place money and/or appropriate executed documents. When all escrow conditions are met, the escrow holder (usually the title company) will record the documents and distribute them and the funds to the appropriate parties.

Funded – usually means the lender has deposited net loan proceeds into the escrow account.

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com.  If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

 

What Is Seller Financing And What Should I Watch For?

When a buyer wants to purchase a property but doesn’t want to pay the whole price in cash, and the seller wants to sell the property but doesn’t need the whole amount in cash, an opportunity exists for both to get what they want through seller financing.

The buyer can acquire a property that may be worth more than he or she has in cash (or the buyer may want to reserve cash for other uses like improving the property after purchase). The seller is able to sell a property that may be hard to sell for cash because it is not attractive to institutional lenders, or the seller can get a higher price because he or she will carry the financing. The seller may also want to provide financing because he or she earn a favorable rate of return as well as favorable tax treatment.

If all the stars align and both buyer and seller agree to seller financing, here are some do’s and don’ts to consider. As the seller, you should require a reasonable down payment, usually a minimum of 20 percent. Less is risky: if the buyer (borrower) misses the first payment and you need to foreclose, you will lose money by the time the foreclosure is done. Foreclosures take time and money, and at the end you still have a property to sell. Depending on the situation, you may need to spend time and money repairing the property, as well as marketing it for sale and paying brokerage fees to do so—all this time you’re losing interest income. So, get 20 percent up front. The more specialized the property, the more important a large down payment is. While it’s relatively easy to sell an office building, selling a church, school, or hospital, for example, is significantly harder.

As a seller, you should also be cautious about a buyer who plans to do major work renovating the property. At first, it may sound great. But if the buyer doesn’t know what he’s doing, you may end up with a mess. Unfortunately, I speak from experience. I sold a property and carried the financing; six months later, after the buyer gutted the buildings (down to the concrete walls), the buyer ran out of funds. I foreclosed and had to complete the renovations at my expense.

As with most agreements, things work best when both parties get what they need. The loan’s interest rate should work for both buyer and seller, and the payment schedule should be realistic for both. The buyer needs to be able to afford the monthly payments, (mortgage payment, taxes and insurance) and the seller needs to receive enough income. Be aware that the new Dodd Frank Act, may pertain to your transaction. In most cases, seller financing is exempt, but talk to your realtor to be sure you’re following the rules.

The overall term or length of the loan may need to correspond with other expenses, like sending a child to college. If the seller carrying the loan suddenly needs cash, all is not lost. The loan (or mortgage-backed note) can be sold on the open market. The value of the note depends on the loan terms, the value of the property, and the borrower’s payment record. Having carried financing, I highly recommend title insurance on the note. It reduces your risk by protecting you against buyer fraud. If you’re carrying the financing, I also recommend that you make sure property taxes are paid, the property is covered by hazard insurance, and that you report interest income to the government so the buyer can deduct the interest paid. That keeps everyone happy including the IRS.

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.