Author Topic: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???  (Read 11758 times)

briangood

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Hello Mustachians,

I'm hoping to get some feedback on my scenario...my background:

I am 36 w/ wife and 1 daughter (son's coming in a couple months!)
we own a house in SF, but still owe $885K. It's split between my family and my brother and his wife who live downstairs. Our current mortgage is adjustable (based on 12 month Treasury Avg + 3.075% margin...so it's great right now cuz it's at 3.25%). Problem is I had to go thru a Ch 13 bankruptcy (I don't believe details are important as to why, but if they are I can explain) and no lender will talk to me for at least 3 years (most are 5 years, but from the mortgage brokers I've talked to some will possibly allow a refinance after 3)....my 3 years will be up Dec 2015.

Between me and my wife we make pretty good money (take home around $9500 on average) and we don't spend very much going out, on clothes, etc.

We have a pretty good retirement built up already ~ $435K (IRA/Roth/401k/Annuity - non-qualified that wife was put into before we met).

So I've stopped contributing to my 401k completely (no company match and no index fund to contribute to and the fees are high once you factor in the admin/mgmt./etc fees), but I still max out the Roth IRA and Traditional IRA for myself. The company I'm at also contributes a year end bonus into our 401k. Wife collects a small paycheck and does get some income from side jobs.

So what I've been doing the last few months and am planning to continue doing is putting every dollar I can towards my mortgage (principal). I still plan on maxing out my IRA's (just to have some $ going towards retirement), but because I'm afraid when the time comes that I can actually refinance interest rates are going to be higher and I don't know if we can afford the payment on 800K at 5% or 6% or 7% or whatever it'll be when that time comes. But I know we can probably afford the payment if it's on a 600K loan even if rates do climb to 7% or more.

I know if I was in a 30 year fixed rate that putting the extra money into the mortgage wouldn't make as much sense. And I know that I can't predict or time the stock market, but doesn't it feel like it's at the top of where it should be? I did put a little extra into the IRA's when it dipped in January and that worked out well, but again I'm not trying to time the market, but to me getting the principal down seems like a smart move.

your thoughts????

SnackDog

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #1 on: March 03, 2014, 05:28:10 PM »
Your mortgage payment is far higher than you can afford even with your brother paying half.  Instead of refi, I would sell and buy something you can afford when your credit is good enough to borrow again or rent. You should also consider an emergency fund in case any of the three (four?) mortgage payers loses their job.

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #2 on: March 03, 2014, 05:42:34 PM »
How much equity do you have in the house? And is the house in solely your and your wife's name (so brother pays rent... I hope!) or is it owned by all of you? Finally, how many bedrooms and baths does it have, and is there room--in the house, the basement or a garage--to add a third unit? I'm not asking if a third unit would be legal, just if there's room.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #3 on: March 03, 2014, 05:50:58 PM »
I've thought about that, but in this area there really isn't anything better when you consider that our half of the mortgage is only $442K. Rent in the SF Bay Area is ridiculously expensive, and I do get paid well enough to cover the mortgage at this current rate. I believe rates should stay low for at least another year.

I do have an emergency fund ~ 22K plus whatever I've put into the Roth IRA...I'm even thinking that some of that 22K should go towards the mortgage or maybe a taxable account.

and let's call it 3 1/2 incomes since my wife isn't working very much right now (she will eventually go back to work once the little man is a few months old...also wife's mom is coming to stay with us so we have family looking after both are kids and no daycare costs).

Also, i have no other debt.

thanks for the feedback...anyone else think i'm doing something right or wrong?

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #4 on: March 03, 2014, 06:00:56 PM »
Equity is actually pretty good...County assessed it for $1.25M (realtor friend said i might be able to get it up to 1.3M with proper staging). House is solely in my name...brother's credit wasn't very good when we bought in 2006.

To be honest we shouldn't have been able to get a loan on the place, but back then it was easy to get into bad loans and I didn't know then what I know now. But it's a fantastic place and I want to hold on to it if at all possible and it seems like I should be able to.

One scenario i've been thinking of also is to rent it out once i know the rent would cover the mortgage/insurance and semi-retire somewhere cheaper...this could be maybe within 5 years from now if I stay aggressive with paying down the mortgage.

it's technically a single family home, but when we bought the place we converted the downstairs into a separate unit. the previous owner converted it from a 2 unit back into a single family home (w/o permits) and then we converted it back (w/o permits...yes i know i'm a bad homeowner). so the upstairs where me and my wife live is a 2br/1ba approx 1600 sq ft and the downstairs unit where my brother lives is a 1br/1b approx 900 sq ft.

There is a garage and an unfinished basement, but because we live on a slope half of the basement is sitting on bedrock. I've definitely asked a few of my contractor friends how/what they would do to make the space usable and i've heard everything from doing the quick/easy (drywall and insulation to only encompass the non sloped portion) to the major construction (taking out the bedrock and reinforcing) to make it a 3rd unit (ballpark cost was $200-$250K, but would add more in value based on square footage added).

thanks for any feedback!
« Last Edit: March 03, 2014, 06:07:40 PM by briangood »

dragoncar

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #5 on: March 03, 2014, 08:23:05 PM »
Your mortgage payment is far higher than you can afford even with your brother paying half.

Yeah, I don't think that's true.

Anyways, I'd wait and save up your cash elsewhere.  See what happens when your bankruptcy drops off the books.  If the rates start to climb, you can make the choice to put that saved cash towards the morgage... but even if you do so you might not be able to afford the higher rates.

MDM

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #6 on: March 03, 2014, 08:42:03 PM »
Hello Mustachians,

...

So I've stopped contributing to my 401k completely (no company match and no index fund to contribute to and the fees are high once you factor in the admin/mgmt./etc fees), but I still max out the Roth IRA and Traditional IRA for myself. The company I'm at also contributes a year end bonus into our 401k.

...

your thoughts????

Ok, I get that your 401k is not as good as some other companies offer - but is it really that bad?  Tax deferral on $17.5K/yr still has advantages.

Would need other details, e.g. how fast are you paying down the mortgage now (30 yr? 15 yr?), risk of job loss(es), risk of brother moving, overall income/expense cash flow, etc. before venturing a guess on "best" answer.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #7 on: March 03, 2014, 09:18:00 PM »
@dragoncar
Save up the cash and put it where? You thinking a taxable account? I wouldn't argue with that, but at least by putting it towards the mortgage I know I'm getting at least around 3.25% (and yes I know some of this is reduced due to mortgage interest deductions). But for the short term can we be certain the index fund I would be purchasing will be up more than what I'd be saving vs paying off the mortgage. And I'm only thinking short term until I can refi...long term I understand this strategy is flawed (and I realize it might be flawed even in the short term). But putting it in a taxable account will have it's own drawbacks such as taxes/commissions/etc. and the 401k is flawed with the account fees/mgmt fees/etc.

I believe between me and my brother we can pay an extra $4,000 towards principle (and this is after putting in 11K in my IRA's). In 2 years if the Treasury 12 month average stays at current levels or close to it (it's at .13% right now and has been about .15% for the last 2 years, but it was about 5% in 2007....link shown here to where I found this info   http://www.moneycafe.com/personal-finance/12mta-and-12mat-12-month-treasury-average/).

If we were able to pay the extra $4K in 2 years we'd be down to about 750K and if rates jumped to 5% (8% after margin added) our monthly payment would be about $5500 (doesn't include prop tax/insurance). If we just pay the regular monthly payment and assuming the same 8% we'd be at 853K and our monthly would be about $6300.

I guess we could afford the worse case scenario in my above scenario, but I'm still leaning towards putting the extra $ towards principal. I guess even if I'm wrong it's still going towards reducing debt...maybe it's not the best return, but it's not being wasted either.

I really appreciate the feedback...anything else I may be missing?






« Last Edit: March 03, 2014, 09:34:48 PM by briangood »

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #8 on: March 03, 2014, 09:33:25 PM »
@mdm
it was actually a 40 year mortgage which kinda helped since it's kept my payments spread out (lower).

the firm that manages our 401k charges about .6% and the funds offered were in the ballpark of 1.7-1.8% so total is almost 2.5% being taken away...i understand that there might be other hidden fees as well.

i would say low risk of losing my job, and low risk of brother moving out, but even if he did i could rent out his unit for about what he is paying.

overall income is $9000 - 9500 take home (wife's pay is less now so prob closer to the $9K amount, but this is temporary as she is pregnant and working less) with brother adding $2700. our overall expenses are around $6500 - $7000.
« Last Edit: March 03, 2014, 09:35:14 PM by briangood »

MDM

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #9 on: March 03, 2014, 11:44:12 PM »
@mdm
it was actually a 40 year mortgage which kinda helped since it's kept my payments spread out (lower).

the firm that manages our 401k charges about .6% and the funds offered were in the ballpark of 1.7-1.8% so total is almost 2.5% being taken away...i understand that there might be other hidden fees as well.

i would say low risk of losing my job, and low risk of brother moving out, but even if he did i could rent out his unit for about what he is paying.

overall income is $9000 - 9500 take home (wife's pay is less now so prob closer to the $9K amount, but this is temporary as she is pregnant and working less) with brother adding $2700. our overall expenses are around $6500 - $7000.

Ouch, that is high on the 401k.  Seems worth a conversation with your company's benefits department - it would benefit the benefits folks themselves to find better options.  Don't know the population distribution of 401k plan fees across companies (does anyone? - a quick Google search was unhelpful) but yours seem high.  At this point, by law there should be no hidden fees - you may have to look in the fine print but they should be all there.  See http://www.cbsnews.com/news/how-to-find-hidden-401k-fees/

And yeah, you are highly exposed on your mortgage if the rate adjusts up much.  I'd guess you have something similar already but if not (and if you use Excel), see http://office.microsoft.com/en-us/templates/loan-amortization-schedule-TC001019777.aspx?CTT=5&origin=HA001034640 and get a nice what-if tool.  I tend to agree with your "leaning towards putting the extra $ towards principal."

SnackDog

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #10 on: March 04, 2014, 06:57:53 AM »
What is the total monthly cost of the house (note, PMI, taxes, insurance and maintenance)? How much could you rent it for?

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #11 on: March 04, 2014, 10:41:22 AM »
@MDM
I mistakenly reported a higher mgmt. fee by the fund (was going off memory)...it's more like 1.5% instead of the 1.7%. And the I always thought that there were "hidden fees", but it looks like based on the link you sent these have gone away?

I have brought up the 401k issue with the company administrator, but didn't get a lot of interest. Kind of an old school guy that's about to retire, so maybe when he leaves I can bring it up again. Company is on the smaller side.

I do use excel for tracking monthly expenses and my loan servicer does have a decent mortgage calculator program that allows me to play with the what-if scenarios.

@SnackDog
monthly cost of house is:
$3800  mortgage payment (though this can fluctuate because it's adjustable)
$1253 property tax (appealed this amount w/ county assessor, but haven't heard back yet)
$91 house insurance (set deductible at $5K...didn't save very much putting it at $10K)
$0 - PMI
$500? maintenance (try to do as much of this myself and really haven't had any house issues lately, but $500 a month on average sounds about right?...might even be a little high)
other bills just for reference:
$140 sewer/trash
$350 gas/electricity/propane/tank fee
$55 cable (I know this isn't mustachian and this will go away once the wife isn't pregnant...she has requested this stays until after little one is born).
$120 water
$60 internet
$206 prop tax on cabin
$700 food (groceries and eating out once a week...yes I know we could prob save even more $)
$50 gas
$70 car insurance
$1000 retirement
$500 misc


some of these bills are split in half so they aren't as bad as it seems at first glance...Also some of the utilities are high because they also factor in a cabin that was left to me and my brother when our dad passed away. At this point we are trying to hold on to it, but would sell it if $ ever really became an issue. We try to rent it out a little bit to cover costs as well.

I believe we can rent it out for $4200 - $4500 a month.

thanks! any other details you need/want let me know...
« Last Edit: March 04, 2014, 10:51:08 AM by briangood »

bugbaby

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #12 on: March 04, 2014, 12:22:43 PM »


I believe we can rent it out for $4200 - $4500 a month.


^ do you mean 4-4.5 k for the cabin or for the house? coz if the cabin i'd rent it out yesterday.

the idea of stashing the cash is that you may be able to refi at a fixed low interest within the next 1-2 years. if you keep looking around you might find a bank to do this... or the adjustable rates might not increase significantly at all. in the end it's a gamble either way and it will depend on your comfort level.

 myself I'd do a bit of each. throw an extra 2k @mortgage and save/invest the other 2k to hedge my bets.  My 403b plan w/Principal has a fixed income option that yields 2.8 to 3%. have you reviewed all your plans?

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #13 on: March 04, 2014, 02:00:32 PM »
the $4200-4500 is for the house not the cabin.

I know that no lender will refi until at least 3 years have passed since the CH 13 bankruptcy was dismissed (of course I haven't called them all, but pretty much every lender/mortgage broker has given me the 3-5 year window with no chance of it happening before 3 years).

I do feel like I'm hedging my bets by putting $1000 into retirement accounts ($917 into mine and $100 into the wife's) so that paying extra towards the principal isn't a bad idea for the short term. Once/if I'm able to refi in Dec 2015 then I can go back to putting more into the retirement accounts. I don't know for sure how easy it'll be to do a refi with a CH 13 bankruptcy in my history. Lenders/brokers tell me 3-5 years minimum, but is the 3 year timeframe only for the "perfect candidate" or is it fairly easy to qualify if my income is still good/credit score is decent/no other debt/etc.

I am rebuilding my credit and have gotten decent scores recently (about 700 depending on which of the 3 reporting agencies you look at).

My worry is that I won't be able to refi, interest rates will climb (as they can only go up from here) and then I'm stuck paying the adjustable rate for years and years and a high principal.

I understand stashing cash or investing makes sense for the long run, but it seems the bigger dent I can make in my principal will cover any interest rate spikes especially if I can't refi like I am planning/hoping.

does this make sense? and even if I'm wrong and I miss out on the market jumping up 20% this year I still have a decent nest egg in the market and am still contributing some.
« Last Edit: March 04, 2014, 02:02:22 PM by briangood »

foobar

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #14 on: March 04, 2014, 02:18:30 PM »
Have you looked in to FHA loans? They do loans 1 year after chapter 13 but the limit on single family homes is like 650k.  They allow more for duplexes but I am not sure if you qualify. Maybe some combo with a home equity loan?

I would be a bit concerned that anything you do is going to have a higher interest rate than your current amount.

irononmaiden

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #15 on: March 04, 2014, 02:22:25 PM »
I have no idea what the best financial advice would be. But I also have an ARM, and we've been paying it way the hell down.

Our rate has been 2.875% for the last couple years, but it could go as high as 12% in the future. I feel way more secure with a lower balance.

Poorman

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #16 on: March 04, 2014, 03:33:03 PM »
If you can invest in something that yields higher than 3.25% with minimal risk of losing principal, then do that and hold onto the cash until the rate adjusts.  If not, then paying your mortgage is probably the best option.

FHA loans for a 2-unit only go up to $800k, but you would need to get the 2nd unit permitted otherwise they wouldn't approve the loan anyway.  FHA is notorious for being strict about code violations, permitting, etc. 

Unless you can pay down $85k in principal, get the 2nd unit permitted, and hope that the FHA limits aren't lowered any further, you're going to be getting a jumbo mortgage for sure.  The lowest rate at the moment is 4.25% for a 30 year fixed.  I don't know if 40 year terms are available yet, but I would expect them to be in a couple years because mortgage products in general are expanding right now.  However, if the 40 year term doesn't become available, you'll have payment shock from both the higher interest rate and the shortened mortgage term.

dragoncar

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #17 on: March 04, 2014, 04:50:05 PM »
Do you mind telling me which neighborhood you are in?  I'm a bit surprised that you couldn't get the rent above $4k on 3br/2ba in SF.

I would still do the stashing, but I agree there is no home-run answer.  I like to have liquid cash... it's just my style. 

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #18 on: March 04, 2014, 06:26:18 PM »
@foobar
FHA loans in SF qualify for the higher limit - single family $729K, 2 unit is $934K. My house will not easily qualify as a 2 unit. Lots of unpermitted work and the conversion process in SF is lengthy. Also, if I start the process and bring out inspectors any issues they see will need to be brought up to code (even if i don't convert it to a 2 unit). Then I'd have to apply for the condo conversion. Rules are changing, but I know I'd need to wait at least a few years to qualify...so this doesn't appear to be an option.

@ironmaiden
our cap is at 9.95% so at least i don't have to worry about the real high rates from the 80's (up to 17-18%?!?!?) that my parents had to deal with. but i too am feeling better about having a lower principal even if it means not possibly missing out on better returns elsewhere.

@Poorman
see above for why FHA probably won't work. the nice thing i have for me is my loan is adjustable for the remainder of the loan (32 years remaining) so there isn't a big shock from a shortened term and the rate shouldn't move very fast. it's based on the Treasury's 12 month moving average (MTA) + 3.075% margin (from the lender) and the MTA has been hovering around .15% since 2012. Even when/if it does creep up it generally doesn't move very fast. recently it's only moving a .05% or less up/down and not more than .20% from month to month over the last 10 or so years.

So even if it does climb .10% a month for 12 months the 12 month avg will drag slowly behind it (because obviously it takes time for the lower rates to be offset by the higher rates). It might not make sense to refi when i'm able just because like you mention the best 30 yr jumbo rate right now is 4.25%, but what will it be in 2 years when i'm possibly able to refi (maybe 5-6%?). it might make sense to just stay in the adjustable until the MTA + margin go higher than the jumbo rate OR maybe if i'm aggressive with paying down the principal i might be able to bypass the jumbo mortgage and qualify for a conventional loan.

and i wouldn't argue finding an investment that would yield 3.25% or better as a better option if there was minimum risk for not losing principal. But worse case scenario is i don't get the 3.25% and interest rates climb and then i got the double whammy.

@dragoncar
the $4200-$4500 was just for the upstairs unit where me/wife/daughter stay (2br/1ba ~ 1600 sq ft). this doesn't include the downstairs unit that my brother stays in.

« Last Edit: March 04, 2014, 11:09:50 PM by briangood »

SnackDog

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #19 on: March 04, 2014, 07:13:52 PM »
The split back and forth is confusing everything. Sounds like the total cost, for everything is about $5153 per month, $5500 or so if we throw in annual maintenance.  That is more than half your take home pay, so it is way too high. But you rent part out to your brother, and I think you said he pays half, so you only pay about $2600/mo? That's reasonable. And the portion for which you pay you. Old rent out for up to $4500/mo? That's pretty good too. You could rent it at profit of say $1000/mo.

If it were me I would save in the stock market and plan to weather the interest rate increases as they came. There is at least some upside there.

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #20 on: March 04, 2014, 07:45:15 PM »
I would not throw money at the mortgage expecting to refi soon, because if I understand correctly you filed for bankruptcy in 2012. That's going to stay on your credit report for 10 years, dragging down your score. Yes, lenders will talk to you after 3 years, but I'd be really surprised--someone correct me if I'm wrong--if you can get a reasonable interest rate only 3 years out from a BK.

In theory it might be possible to refi at a good rate if you refi solely I your wife's name (if she wasn't involved in the BK, has great credit and will have a high enough I come to support the loan). I know people who have done that, though none of the ones I know did it in a community property state like CA, so whether it's possible to do that in CA would be a question to ask if your wife meets the above criteria.

If she doesn't, or if that's not possible in CA, then you should probably make your financial decisions based on the assumption that you're not going to be able to refi at a rate that's feasible for you in 2015.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #21 on: March 04, 2014, 08:16:30 PM »
@SnackDog
I know I prob didn't explain exact numbers very well, but the average income (me/wife take home + brother's rent) is about $11,500 and avg costs just for my portion are around $6500 - $7000.

my portion of housing costs would be covered by renting it out, but then where would i live? we'd have to then rent a place which would obviously offset the profit i was making by renting it out. i could theoretically move to the cabin, but neither me or the wife are thinking that's an option.

@Daleth
that's what i was afraid of. i know it'll stay on my record for 10 years and i've asked brokers/lenders how a BK would effect my refi chances and really haven't gotten a straight answer. most just say you have to wait 3 years, but does that mean i'll be eligible but really won't get a good rate (kinda what i'm expecting). maybe i haven't asked the right people, but i really haven't gotten the yes or no answer i was hoping for. i've actually ran my credit and been hovering around the 700 score, but i know there's more to it than just the credit score...the BK has got to bring me down right?

wife does have good credit and wasn't involved in the BK, but won't have the income to do it on her own. I'm not sure if she co-signs will help our chances? ultimately the BK is lingering...i really don't know how bad this will effect my refi chances.

and it was dismissed in 2012 (filed in 2011) by me, but that doesn't matter in lenders eyes...only thing that matters is that the process was started.

so to circle back around...if i shouldn't plan on getting the refi it seems to strengthen my strategy of paying it off as soon as possible so that when interest rates climb my adjustable rate will be going towards a lower principal.

thanks for the perspective...these are all things i'm trying to figure out and knowing different angles to approach this might just guide me to the best option.

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #22 on: March 05, 2014, 12:31:43 PM »
If your credit score is currently 700+, that’s a hopeful sign. That being said, it still does not look to me like aggressively paying it down is necessarily your best move. I’m going to do some rough guesstimates and math below that someone can correct if they think correction is required, but here’s what it looks like to me. Long story short, it makes WAY more sense to find a contractor who isn’t on crack (i.e., isn’t estimating $200k) and use the money you would otherwise spend paying down the mortgage to build a third unit. Either that or invest in an index fund. Skip to the end if you want to see why.
 
So,  you currently owe $885k on a house you bought on a 40-yr adjustable mortgage in 2006, which is currently at 3.25%. (I’m guessing this means you bought it for about $1 million in ‘06). You are thinking of refinancing in late 2015. Let’s call it 2016 just to make a nice round number, ten years from when you bought it. At that point 30 years will remain on your original 40-yr mortgage. So basically, you have two years until refi. How much can you pay down the mortgage in two years? Just by regularly paying your mortgage between now and then you should pay off about $30k, bringing you down to $855k. But let’s say you get very aggressive and manage to pay off an additional $100k over the next two years. So, $755k is where you’re at when you have to refinance.
 
How much money does that save you? Let’s run the numbers with some possible interest rates (note that I am *not* adding the half a percent or so that you will get whacked with for needing a jumbo loan—that is something to factor in; loans over $650k have higher interest rates):
-          $755k at 4.5%: a 30-year mortgage would be $3825/mo, not including property taxes or insurance, and would cost you just over $622k in interest if you took the full 30 years to pay it off. A 40-year mortgage would be $3394/mo and would cost you just over $874k in *interest alone*. This is important: look at how much it costs you to go with a 40-year rather than a 30-year mortgage! Over $250k, even at this low interest rate! (Not to mention, a 40yr loan will have a higher interest rate than a 30-year, just as a 30-yr has a higher one than a 15-yr—I’m just using the same rate in these examples for easy math.)
-          $755k at 5.5%: 30-yr, $4287/mo and just over $788k in interest. 40-yr, $3894/mo and over $1.1 million in interest.
-          $755k at 6.5%: 30-yr, $4772/mo and just under $963k in interest. 40-yr, $4420/mo and almost $1.4 million in interest. So going with a 40-yr rather than a 30-yr would cost you almost half a million bucks.
 
Let’s compare that to where you’ll be if you just keep paying your mortgage normally. In 2016 you’ll have a mortgage of about $855k, with 30 years left on it, at whatever the interest rate adjusts to then.
-          Let’s say it’s 4%. That would put your monthly payment at $4082, or about $250/mo more than if you pay it down to $755k and refi at 4.5%. (Remember, you’re not going to refi at a better rate than what your mortgage will have adjusted to—a fixed-rate mortgage is always going to have a higher interest rate than an ARM that’s available at the same time.)
-          At 5%, the $855k would give you a monthly payment of $4590, or about $300/mo more than if you paid it down to $755k and were able to refi at 5.5%.
-          At 6%, the $855k would give you a monthly payment of $5126, or about $254/mo more than if you paid it down to $755k and were able to refi at 6.5%.
 
So as you can see, paying your mortgage down aggressively—to the tune of $50k a year on top of what you’re already paying down with your regular mortgage payments—would only reduce your mortgage payment by $250-$300 a month. So you would have spent $50k a year for two years in return for saving somewhere between $2700 and $3600 a year. That is a return of only 5.4%-7.2%. It’s great compared to a CD or a savings account, but that return will be temporarily wiped out by the cost of refinancing: 1% loan processing fee (so… like $7500!), application fee and doc prep fee (another $1000 probably), points, appraisal… 
 
I would think bare minimum your refi would cost around $10k, which would wipe out 3-4 years of the savings on monthly mortgage payments. Which means that somewhere around 2019-2020, you would actually start saving money… to the tune of $250-$300/mo. In other words, between your 2016 refi and let’s say 2026, your average ROI, in return for all that aggressive paying down of your mortgage, would be equivalent to about $1800/year, or 3.6%.
 
So personally, no, I wouldn’t sink $100k into the mortgage over the next two years. I would probably put that money in an index fund, which, chances are, is going to do much better than 3.6%, and if there comes a day when it’s clear that staying in that house is the best move for you guys, then maybe you can take a lot MORE than $100k out of that index fund and throw it all at the mortgage at once.
 
Or as an alternative, you can call some contractors who are NOT on crack and get a REASONABLE quote for adding a 1BR/1ba to your house or garage (don’t mess with the bedrock!). I know it’s not properly zoned for a third unit, but I also know some Bay Area contractors could not care less; they’ll build it nicely and to code (electrical/plumbing code) without permits. Or just get a permit for adding a bedroom and bath to your existing house, and when the inspector is gone, throw up some drywall to separate the new unit from the downstairs unit. That would add a cool $1500 (or whatever 1BR’s rent for in your neighborhood) to your monthly income. Let’s say it cost $100k to do that and took six months… you would then have an extra $9k in income this year, and an extra $18k for every year to come—an ROI of 18% a year. Obviously far superior to an ROI of 3.6%! And if you’re concerned that one day you might want to sell or refi and the illegal third unit might complicate the appraisal, build it so that it’s easy to reconnect it to your ground floor (all you need are stairs and a door), and you’re ready to refi or sell.
 
 
« Last Edit: March 05, 2014, 12:34:24 PM by Daleth »

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #23 on: March 05, 2014, 03:24:17 PM »
@Daleth

sorry for long response...you can skip to the end if you'd like...

Very helpful info. I think there are a couple typos/corrections (i.e. the 6% rate at 855K savings would be ~$350 not $250, the yearly savings would be $3K - $4200, which means the return would be 6-8.4% when comparing to the potential fixed rate, and in the SF area I'm almost sure the conventional limit is $729K), but overall your points are well taken. I was not factoring in some of your info into my original analysis so again very helpful (which is exactly why I was throwing my situation out there to you smart folks!).

Unfortunately the basement is the only location in the house to expand because of the hillside the house sits on.

So if I did decide to invest into an index fund in a taxable account I would have to worry about capital gains taxes (short and long) year after year and when I would sell. An ETF seems to be generally protected from capital gains tax until being sold. Both however seem to be hit by capital gain taxes on dividends. So there is still some risk/costs going this route based on possibly wanting to get the $ in the short term, market could go down, and taxes.

I'm still not sure if the 5-7% (i come up with 6-8.4%) you mention is so bad...especially in the short term. Markets are at or close to an all time high and any taxable account will have some taxes so i don't think that's the best spot...any refi costs will still cost around 10K whether I pay down the principal or not so your point against that really doesn't seem valid. also if the loan processing fee is 1% than paying down the principal would theoretically save 1% (if principal is 850K when i refi it'll be $8500 vs $7500 if i agressively pay down mortgage to 750K)?

ultimately I'm feeling like a fixed rate will be better than staying adjustable...even though the MTA is really low and over the last 10 years it hasn't moved any more than .20% from month to month so even if worse case scenario happens and it increases .20% every month for 12 months the most my interest rate should go up one year from now is 1.2% (.2% 1st month - 2.4% 12th month for an avg of 1.2% 1 year from now). i will have to watch the numbers to see if/when refi makes sense with my situation.

i think 401k or construction or paying off principal are the main choices, not a taxable account...not sure it makes sense to have any larger emergency fund as MMM points out in one of his blog articles...and construction might be out of my budget. so it's back to the 401k vs paying off principal. and again with 2% fees from 401k, market at/near all time high, and maxing out both IRA's i'm still kinda leaning towards paying off principal. i realize this might backfire slightly on me, but it still seems logical to me.

the big thing is the risk i'm avoiding...let's just assume:

i apply 50K extra toward principal and 3.25% rate for 5 years (just for easy math) - new total is $539K
i apply regular mortgage payment at 3.25% for 5 years - new total is 800K
after 7 years the 2 #'s would be 385K vs 761K

then let's say BK won't allow for refi, or fixed rates outweigh the adjustable rate i have, or etc and now my best option is to stay in the adjustable and then rates jump to 5%/6%/7% (very likely looking historically...in 2007 my adjustable would have gotten to 8%).

5 years after extra 50K principal:
so 539K at 5% = 3035
at 6% = 3363
7% = 3707

5 years after reg mort payment:
800K at 5% = 4504 ~ $1469 more per month than if i had applied the extra principal
6% = 4992 ~ $1629
7% = 5503 ~ $1796

7years after extra 50K applied toward principal:
385K at 5% = $2251
6% = $2481
7% = $2721

7 years after regular mort payments:
761K at 5% = $4449 ~ $2198 more per month
at 6% = $4903 ~ $2422
at 7% = $5379 ~ $2658

i know i'm simplifying numbers here but i think you can see my concern. the BIG thing is i don't know if i will be able to refi with good terms...i feel like i have to be prepared to ride this adjustable out for a while...i have not had much luck dealing with lenders so far. and if i just am aggressive for 5 years with paying down the mortgage it won't matter as much that interest rates rise. sure i might miss out on bigger returns in the market, but that's the lesser risk.

Can i be absolutely certain the market will be up enough to cover capital gains taxes if i need access to this $ to cover the higher mortgage payment. I think everyone agrees interest rates are not going to stay so low for much longer. and with my history (BK) and the fact that my brother's rental income is only partially counted...i don't look good on paper to lenders...so i must be prepared to have to ride the adjustable out.

let me know if i am calculating something wrong here...

thanks again for your input...I know it took some time to put it together...really do appreciate it!

« Last Edit: March 06, 2014, 07:17:20 AM by briangood »

SunshineGirl

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #24 on: March 05, 2014, 03:40:02 PM »
How much do you presently have in non-retirement savings? How much of an emergency fund?

What's the cabin worth?

Personally, I would keep your money liquid and not put it toward the house, because there's a chance, no matter how slight, that you could lose the house, and everything you've put in it would be gone. The wild card is what interest rates are going to be, and you can't know that, so if I were in your shoes, I would build a large e-fund and consider selling the cabin, unless you use it all the time and your brother doesn't want to, in which case, could he buy out your half of it?

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #25 on: March 05, 2014, 03:54:48 PM »
@SunshineGirl
Pretty much zero in non-retirement funds. $22K in cash/emergency fund (and whatever I've put into the Roth could be taken out in emergency...prob another $15-18K).

cabin is worth about 200K.

I'm not too worried about losing the house because of the equity that's in it (prob worth $1.25 - 1.3M and owe 885K). SF housing will prob not go down that far so any $ I do put towards principal is unlikely to be lost.

we don't use the cabin all the time...maybe 1-2 times a month...my heart doesn't want to sell the cabin (lots of memories), but honestly selling it prob makes the most financial sense, but I'm not really struggling to pay bills at this point. it's just trying to figure out how best to put my extra $...whether it's towards principal, a taxable account, or a 401k. And yes my main issue is not knowing what interest rates are going to do!!!!! What I don't want to happen is interest rates really climb and in 4 years I'm paying 8 or 9% on a high principal and then not being able to afford the payments. again if I put my extra $ now into 401k it's not really accessible. if I put it into a taxable account there are taxes and risk of market not performing well in the next few years. but putting it towards principal isn't a great return on investment either.

Brother can't afford to buy me out yet, but it's a possibility in the future.

Emg03063

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #26 on: March 05, 2014, 10:38:57 PM »
If paying down the principal buys you peace of mind, I say have at it.  You could probably do better in equity markets, but at the end of the day, there's a lot to be said for knowing you can afford to stay in your own home.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #27 on: March 06, 2014, 08:23:33 AM »
peace of mind is part of it (maybe a big part). but even financially I think it makes sense. if I had to guess I think equity market prob will outperform me paying down principal, but I can't be 100%. if over the next 5 years equity market drops, stays flat, or even goes up 3-5% I will be worse off if my adjustable rate rises. only way to have the $ liquid is to put it into a taxable account so then you have to figure out how much does the market have to be up to offset capital gains taxes vs adjustable rate raising 1% or 2% or 3%. there are a lot of what if scenarios for sure and it'd be hard to plan for them all.

again let's say I put 250K into index fund over 5 years instead of paying down principal and the index fund stays flat or maybe goes up 5% and adjustable rate climbs to 5% or 6% or higher even. you can see this could put me into a very bad spot. Worse case scenario is I need the $ to help pay for mort payment and I'm forced to sell when market is flat, also paying potential cap gains taxes over the 5 years, AND 5 years of paying interest on a higher principal. you can see my examples a little more clearly in my response to @Daleth.

I think the risk vs reward is still telling me that the safe option is paying down the mortgage. True it might not get me the best return on investment, but at least I won't have a worse case scenario. And I still have a nice nest egg in retirement ($435K between me/wife) and I'm still maxing out Trad IRA/Roth IRA to have some exposure to the market.


Emg03063

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #28 on: March 06, 2014, 10:28:13 AM »
Based on your stated income, I'm assuming your marginal tax rate is 25%, which means the effective after tax cost of your mortgage is currently 2.43% (3.25% * 75%), so that's how much your alternative investment would need to net you in order to be the better financial choice.  If you put it into the market and it returned you 3% gross, you would net 2.55% as long as you were paying the  15% long term capital gains rate, so financially speaking, that would be the better option.  Your break even return is 2.86% in the equity market (2.43%/85%), but if you're concerned about the market underperforming that and want to pay down the principal, I wouldn't argue that that's a bad decision.  Being able to stay in your house is a plus, and you haven't stated any benefit of having a few extra bucks in your bank account with respect to your financial goals, so there is the utility of the money to consider in addition to its absolute value.  Earning 3-5% in the equity markets + worrying about a down market / interest rate spike < Earning 2.43% after tax + sleeping well, IMO.

Zaga

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #29 on: March 06, 2014, 10:29:34 AM »
I'm surprised nobody else has mentioned this - you can only contribute $5,500 TOTAL to all IRA's each year for one person.  You cannot contribute the max to both a Roth and a traditional.  If you've been doing this, go back and fix it, seriously.

Now, you can contribute for both you and your wife, regardless of who earns the income.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #30 on: March 06, 2014, 11:43:44 AM »
@zaga
I can't believe I didn't look that up...I just assumed you could max out both. looks like I screwed myself for last year, but will fix going forward. thanks for the heads up. so dumb of me to not look!!! I spend all this time looking at my options and miss this important detail!?!?!

@Emg03063
I think your math is a little off, but it is still useful for giving me ballpark numbers to work with...(technically I think the last year of my investment would fall into short term capital gains tax if I had to sell and you're assuming that the adjustable rate stays flat at 3.25% for 5 years). If it jumps up to 5% in year 3 and/or 7% in year 5 then the breakeven points would be higher. I can't guarantee anything, but I think very few people believe interest rates will stay flat over the next 5 years.

And I admit that the market probably would outperform paying towards principal EVEN if my adjustable rate climbs, but it has happened where there's been a 5 year lull in the market where it has not met this bare minimum 2.86% breakeven point you have calculated. If you start factoring in the higher adjustable rate then the breakeven point might rise to 5%.

Worse case scenario where market is flat and adj rate climbs and then mort payment is potentially unaffordable (maybe I lose my job in 5 years, or brother loses his). other worse case scenario is market goes crazy and is up 30% over 5 years and I miss out, but with a decent nest egg and contributing to IRA's I would still not totally miss out. Middle ground is I pay off principal take my minimum 2.43% true return (or could be as high as 6% if rates climb to 8%) and just sleep well at night.


I would assume the market would win, but for peace of mind and the risk factor I still feel paying off the principal is the smart move.

Zaga

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #31 on: March 06, 2014, 01:17:05 PM »
Call the company you invested with, tell them what you did, and ask what to do to fix it.  You don't want this hanging over your head.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #32 on: March 06, 2014, 01:55:21 PM »
@Zaga

I'm on it. doesn't sound like a huge issue...thanks again for pointing that out.

Zaga

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #33 on: March 06, 2014, 03:09:24 PM »
@Zaga

I'm on it. doesn't sound like a huge issue...thanks again for pointing that out.
You're welcome, I just didn't want it to bite you in the ass at the worst possible time (which, of course, it would have).

Melody

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #34 on: March 06, 2014, 04:03:18 PM »
If your ARM went up can't you just pull your money out of your investments and make one big payment against your mortgage? That's common for people do here in Australia where all mortgages are ARM or can be fixed for an absolute max of 5 years. The only risk of this is the index find taking a dive at the same time as the rate going up, but even then hopefully you've had a number of years of growth in the fund and the dive is more than offset by the growth.

I would also say as someone from a HCOLA, $446K mortgage on a $9500 monthly income (with more earning potential from the couple in the future) doesn't seem that alarming, although I would of course consider the gap between rent and repayments. It doesn't make sense to pay a huge premium over renting to buy.

Also can you rent out the cabin? That way its still there for you in the future, but paying it's way for now :)

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #35 on: March 06, 2014, 05:17:55 PM »
@Melody

my half of mortgage is 446K, my brother owes the rest, though technically it's only me on the loan...it's just an agreement me and my brother have.

here's some interesting info I found online (not verified with a second source but let's assume it's correct for this conversation).

Despite Bear Markets, Time Is On Your Side

The split between “up” and “down” time periods for the S&P 500 over the last 50 years (1958-2008) as measured by:
• Days:  53% “up” and 47% “down.”
• Months:  58% up, 42% down
• Quarters:  63% up, 37% down
• Years:  72% up, 28% down
• 5 Year Rolling Time Periods: 76% up, 24% down
• 10 Year Rolling Time Periods:  88% up, 12% down
The calculations above are based upon the raw index value of the S&P 500 and thus would not include the impact of any reinvested dividends. (source: BTN Research).

so the risk is there's a 25% chance that the market will be down 5 years from now. and there's a maybe 33% chance that the market will be up, but only slightly, and not enough to offset the gains I would have had if I had paid down principal. adj rate is 3.25% now, but it's likely going to climb. if rates stayed at 3.25% for 5 years the market would have to be up 2.86% to outperform me paying principal (thanks @Emg03063), but the math gets a little trickier once you factor in rates likely rising. Still I admit that there's a good chance that the market will outperform me paying down principal.

but worse case scenario is market being flat/down in 5 years, adjustable rate climbing, and mort payments skyrocketing upwards (or maybe I lose my job)...if the market is down I might not have the $ I need to pay for the higher interest rate. Let's assume the worse case scenario below:

Starting balance of 885K and rate stays at 3.25% for 5 years:
paying normal mort payment - balance is 800K
paying extra 50K principal - balance is 539K

then let's say in 5 years adj rate climbs to 8.5% (rate was over 8% as recently as 2007). and I know the rate couldn't jump from 3.25% for 5 years to 8.5% in 1 month, but let's just assume for easy math.

800K at 8.5% (27 years will be remaining in 5 years) - $6307
539K at 8.5% - $4250

a difference of $2057. now obviously if I had invested $250K into a taxable account I could take that $ and pay it towards the principal so I'm skewing numbers a little bit, but there is a chance that the original $250K turns into a little bit less, there would be some capital gains taxes, and I would have lost out on the positive 3-5% that I would have gained had I paid down the principal.

I hope the market keeps going strong. I still have my decent nest egg ~$435K and I'm still contributing to the IRA $11K into IRA's (now splitting this between mine and my wifes' - thanks to Zaga!) so if the market does keep going up I'm not totally missing out and i'll be paying off the principal and getting some positive return.

Again the risk of losing my ass by only putting $ in the market doesn't seem to outweigh the safe approach which is to pay down the principal.

we are trying to rent out the cabin (haven't done this just yet, but are working on it)...we even rent out our place on weekends when we head up to the cabin...anybody need a place to stay in SF? : )

Emg03063

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #36 on: March 06, 2014, 09:34:16 PM »
I'm not assuming your rate stays flat.  I'm assuming you will reassess when and if it changes.  You can always sell equities to pay down principal when and if that happens.  If you don't want to pay short term capital gains at the time, you could always open a HELOC and draw from it to make up the difference in your mortgage payments until you reached the 1yr holding period & then repay it.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #37 on: March 07, 2014, 09:10:16 AM »
@Emg03063

OK maybe you didn't say it would stay flat...but in your example the market needs to be up 2.86% to outperform principal repayment at 3.25%, but this only applies for long term capital gains and if rates stay at 3.25%. Short term cap gain tax breakeven point is 3.25%. I haven't been able to get a HELOC so it appears I do have to be concerned with the short term cap gains tax.

If adj rate goes to 5% new numbers for breakeven point would be 4.41% (long term cap gain) and 5% (short term cap gain)
at 6% - these numbers are 5.29%/6%
at 7% - 6.18%/7%
at 8% - 7.06%/8%

math obviously changes if you look at longer time periods. after 5 years only the last year would be hit at the short term rate...so if rates averaged                 5% over 5 years then the breakeven point would be 4.53% (4.41 % for 4 years and 5% for final year).
6% would be 5.43%
7% would be 6.34%
8% would be 7.25%

Bottom line is there is a chance the market is down and/or underperforms me paying off principal over a short time period (lets say 5 years). There is a very good chance interest rates are up from today's rate. The risk or worse case scenario doesn't outweigh the positives in my opinion. I hope the market continues to go up, but if it doesn't I have hedged my bet by getting a guaranteed return on principal. And again I'm still heavily in the market with my nest egg already and the monthly contributions into IRA. If I had nothing or very little in retirement my attitude would probably be different.

Also, the current P/E ratio of the S&P 500 is about 20 so this could be an indication that the market is slightly overvalued (MMM had an article that puts 16.4 as the breakeven point to where stocks are on sale vs overpriced). The Shiller P/E ratio is around 26 which is also showing an overpriced market. I'm trying not to be a market timer, but with the market at/near an all time high to me it makes sense to pay down principal instead of putting money in a taxable account.

I guess time will tell....I will periodically update this thread to see how it turns out for me.

3/7/14 at 8:20am west coast time - DJIA - 16,422.54   S&P 500 - 1,872.21

thanks everyone for all your input/suggestions/formulas/etc!!!!
« Last Edit: March 07, 2014, 09:21:36 AM by briangood »

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #38 on: March 09, 2014, 09:02:24 AM »
my half of mortgage is 446K, my brother owes the rest, though technically it's only me on the loan...it's just an agreement me and my brother have.

Wait, what? Whose name is on the deed? Is your agreement that you are actually co-owners (i.e. he is or one day will be on the deed, and/or when you sell he gets half the profits)? Or is it that you're the owner and his rent is supposed to pay half the mortgage? If he's sharing in ownership in any way, what will happen if/when you make a big payment against principal--that will lower your total mortgage payment, but will his "rent" change? Or will he keep paying the same amount, meaning you pay less because the total payment is less?

I think you said in one post that you AND him together could pay the mortgage down by an additional $4000 (a month? A... quarter? I don't know what time period you were talking about). So if he's helping pay it down, your payment won't go down as much as you might hope, because in fairness his payment should go down too, no? In any case, with just you on the mortgage and presumably just you on the deed, you guys are in a potentially tricky situation--and potentially expensive; he will need to be on the deed if you ever sell and plan to distribute money to him (or else the money you give him will look, to the IRS, like a taxable gift), but putting him on the deed may require you to pay transfer taxes--it would in my city, don't know about SF. Have you guys seen a lawyer about this setup?

Also, about this:

ultimately I'm feeling like a fixed rate will be better than staying adjustable...even though the MTA is really low and over the last 10 years it hasn't moved any more than .20% from month to month so even if worse case scenario happens and it increases .20% every month for 12 months the most my interest rate should go up one year from now is 1.2%

"Only" 1.2% is a lot when we're talking about a mortgage that's currently at 3.25%. It means the interest portion of your mortgage will shoot up by more than 1/3 (since 1.2% is more than 1/3 of 3.25%). On a $775k 30-year fixed mortgage at 4.45%, your payment would be $3904 (plus taxes and insurance, which in your case is $1344, so $5248/month). That's not a payment you're likely to qualify for on your current income. The easy loans banks made back in 2006 are not around anymore, so having qualified for a $3800-ish + t&i payment then isn't meaningful now.

You may be able to find a 40-year fixed mortgage, but if you need a 40-year fixed in order to stay in a house, that house is more expensive than you can afford. That 4.45% 30-yr mortgage will cost you the $775k PLUS $630,375 in interest. At 4.95% on a 40-year (a 40-yr will cost probably 0.5% more than a 30-yr), it will cost you $775k plus $1,006,460. In other words, more than $370k MORE than a 30-yr mortgage. Not to mention, you will still be making those payments when you're 75 years old!

And to top it off, the payment would be $3711 plus t&i, so $5055--still a tough one to qualify for at your current income. So either way, in order to refi you're likely to need someone else on the loan too--your wife and/or your brother--and for them to be on the loan they also have to be on the deed. I'm guessing you can add your wife to the deed for free since you're married, but if SF is like my city, that's not true for your brother. Whoever you add, they will need good credit and enough income to boost your application to where it needs to be.

Before throwing money into the house, I would ask one of your bank friends to run the numbers and see what you could qualify for. Run them at the $775k that you think you could get it down to in two years, with your current income and credit score. Basically, find out what is likely to be possible in two years, or what changes you may need to make in two years to qualify (e.g., add wife to deed and boost her income--BTW she would need to have boosted it for at least a year prior to the refi). Find out about adding your brother to the mortgage and deed, including the cost, such as transfer taxes. Find out what loan costs there would be, if you (or you + someone else) could qualify. This is all info you kind of need in order to make a considered decision.
« Last Edit: March 09, 2014, 09:15:32 AM by Daleth »

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #39 on: March 10, 2014, 02:23:37 PM »
@Daleth

it's only my name on the deed and our agreement is that we are co-owners (i.e. he is or will be on the deed and will get half the profits when selling). If we pay down principal it does change the monthly payment he owes. Weird thing about the loan we have is that the month to month amount does change based on principal and the 12 month Treasury Moving Avg (MTA), but our payment amount is fixed for one year...so if interest rates drop then our monthly "fixed yearly amount" will be an overpayment and will only show up at the yearly adjustment. Same holds true if interest rates climb. Our yearly fixed rate would then not cover the interest/principal amount and would then reset at a higher principal at a higher rate and at a shorter time period.

The $4000 is extra per month. We haven't seen a lawyer about this recently, but I have been in talks with a tax advisor and bankruptcy lawyer previously. From what I have read there is a transfer tax for the city of SF (not for county) and that it's at .75% for homes in my price range. But I also know you can gift up to $14K per person per year (couples can give $28K to any individual and up to $56K for me/wife to my bro/wife in any year). I also believe that unless you plan on giving away more than $5.34 million you won't ever pay a federal gift tax. Even if you exceed the yearly limit you can "defer" to pay the gift tax and won't ultimately pay it unless you exceed the $5.34 million. Someone correct me if I'm wrong...

I agree that 1.2% would be a lot. I also know that my situation on paper isn't real good with getting a refi at current loan amount (bankruptcy, lack of income, etc). In CA I am allowed to use 75% of the "rental income" from my brother. They will not count 100% of rental income for generic reasons (that rentals will be vacant from time to time...though in my situation not really a worry)...so 75% of $2700 + my income + wife's income puts us in a decent spot in the real world (though not as good on paper to lenders).

I understand that putting my wife on the deed should be easy and I should be able to avoid transfer taxes by using an exemption. I also know you can file an exemption for waiving the transfer tax if it's a bona fide gift to a sibling, but ultimately it's up to the governing agency to accept/deny the exemption. You can appeal the initial decision as well.

But I hear ya...a lot of issues going on over here. I'm hoping to keep the house for a long time so hopefully I don't have to worry about the sale/gift tax issue. Also, if I can pay down the principal it will make it easier to qualify for a loan with just me/wife. For example, if we pay down 50K extra every year we will owe about $539K after 5 years and I should be able to qualify for a loan with my current income/wife's income/brother's "rent". I don't know what kind of rates I will be able to qualify for in a few years and it might not make sense to ever refi. Because of my history I might not get a fixed rate that is better than the adjustable rate I'm in...even if rates do climb.

Worst case scenario is my rate would go up to 9.95%...it can't go higher than that...and if it does it'll hurt, but hopefully I won't owe very much at that point and would be ok with the mortgage payment.

and you're right about playing with the scenarios...I have been doing that, but will need to keep doing it.


 
« Last Edit: March 10, 2014, 02:39:10 PM by briangood »

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #40 on: March 10, 2014, 06:39:18 PM »
From what I have read there is a transfer tax for the city of SF (not for county) and that it's at .75% for homes in my price range. But I also know you can gift up to $14K per person per year (couples can give $28K to any individual and up to $56K for me/wife to my bro/wife in any year).

0.75% on a $1.25 million home is around $10,000, and it will creep ever higher as the house's value increases. That's a chunk of change! You guys should come to an understanding on who will pay that. It might be fair to split it; it might be fair for him to pay it all (depending on the reason he wasn't on the deed and loan in the first place and whether you guys have put equal amounts of money into the house). It would not be fair for you to pay it all unless there was some unusual situation going on, like he helped you buy the house by paying more than half of the down payment (i.e., half the down payment + $10k or whatever the transfer tax ends up being) or something.

I hear that you can seek a waiver in the case of a bona fide gift to sibling, but I would question whether you can get such a waiver, because your sibling has been *paying* for the house--helping you pay the mortgage every month, I mean--so you giving him equity is not a gift. I don't know the SF rules, so this is something to talk to a local lawyer about... but typically in the law, something that someone has paid for is not considered a gift to them.

I don't see how that $14k/$28k/$56k a year gift tax exemption helps you when it comes to the transfer tax, since those are two different taxes--the city of SF doesn't care how you transfer it (gift, sale, etc.), they just care that you transfer it. But you might want to talk to a lawyer knowledgeable in tax issues to figure out which option makes more sense: (a) drawing up a contract in which every payment by your brother grants him equity (subject to the existing mortgage, obviously), or (b) just continuing as-is until it comes time to refi or sell and give him his share (or if you refi, put him on the deed and loan).

How's his credit? Can he be on the loan without hurting it? In my experience banks give you interest rates based on the lowest credit score on the application. Your 700+ score is no use if your co-borrower's score is 550. That would be something to ask your banker friends, though--do they handle it that way? Note, you won't be able to use his "rental" payments as income when you refi if he is a co-borrower; instead they will use your income plus his income, and measure the whole monthly payment against your combined monthly income. Long story short, you and your brother should probably go see a lawyer to get clear on how exactly to do what you've agreed to do (give him equity in the house) with minimal tax impact and without jeopardizing your ability to refi if you need to.
« Last Edit: March 10, 2014, 06:42:54 PM by Daleth »

MarciaB

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #41 on: March 10, 2014, 07:08:20 PM »
About the cabin- I understand completely about the memories and the sentimental value of this asset. Hear you.

My thinking though is that you may be able to swing some sort of hybrid between owning and using it. Meaning, sell it to someone and get their agreement to rent it to you a certain number of times per year. That way you (and your brother) would have a lot of cash in your hands (after taxes of course) and could pay to rent the cabin when it suited you.

You're financially way better off with a scenario like this.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #42 on: March 12, 2014, 09:33:04 AM »
@Daleth

we would split any transfer taxes if it comes to that. I'm hoping that we can use the exemption to avoid the transfer tax (“This is a bonafide gift, transfer between siblings, and there is no consideration involved, R&T 11911”). Yes my brother has been paying rent, but it's been a "gift" to me and my wife. I've been gifting a free place to stay. I know we need to talk to a lawyer cuz it's prob not entirely legal what we've been doing.

I am hoping that if we do ever split ways we can do it in a way that saves us both taxes. For example, we could "gift" my brother and his wife the max amount in December ($56K) and then could theoretically gift him another $56K in January. This could make for a nice down payment on their own place. Over time I could buy ("gift") him out. Now I don't have $100K just sitting in an account, but if I know a year ahead of time that we'd be splitting ways I could probably save up $50K or maybe be able to pull from a HELOC or ???. There are also inheritances that will be coming in eventually (especially wife's father...having more and more health issues). So there is or should be money coming in from all angles.

If I don't get the exemption on the transfer tax to my brother then the gift tax (up to $56K each calendar year) is how I might make things right between us.

I also know that when I get my wife on the deed I will be able to take $500K tax free on the sale of our house...something way in the future hopefully, but also something to consider.

His credit isn't so good...and I'm pretty sure you're right that the lowest credit score on the loan is the one that determines terms. I believe my best bet is to get my wife on the loan and use his rental income. He's self employed which makes it an even bigger hassle (from what I've read) to get a loan.

I don't have all the answers yet, but will try to figure all scenarios/options before I make a move...which will ultimately be talking to a lawyer I'm sure.

@MarciaB

I never thought about trying to sell to someone but somehow get an agreement to rent it a certain number of times per year. Is that really done? If so that's a pretty good idea...might need to some research on that.

thanks!

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #43 on: March 12, 2014, 08:25:23 PM »
@Daleth

we would split any transfer taxes if it comes to that. I'm hoping that we can use the exemption to avoid the transfer tax (“This is a bonafide gift, transfer between siblings, and there is no consideration involved, R&T 11911”). Yes my brother has been paying rent, but it's been a "gift" to me and my wife. I've been gifting a free place to stay. I know we need to talk to a lawyer cuz it's prob not entirely legal what we've been doing.

What you've been doing sounds totally legal to me, but money is "consideration" under the law, so I don't see how that exemption could apply to you. You have not been gifting him an apartment, you've been renting him an apartment--or possibly you've been selling him a small amount of ownership interest each month in exchange for his rent. But however you look at it--as rental payments or as buying into the house--if someone is paying you money for what you're giving them, it's not a gift.

I don't get what you mean by this:

Quote
If I don't get the exemption on the transfer tax to my brother then the gift tax (up to $56K each calendar year) is how I might make things right between us.

The gift tax exemption doesn't help you get around the transfer tax. I'm no specialist in SF real estate law, but everywhere I am familiar with, you pay transfer tax no matter how you transfer the property. You would pay the same transfer tax if you gave someone a $2 million house as you would if someone paid you $2 million for your house.

You do need to see a SF real estate lawyer, because maybe there is some creative way to pretend that your brother's rent payments have nothing to do with your decision to give him equity in the house. That would surprise me a lot--San Francisco has seen everything, real estate-wise; it's not some podunk town with unsophisticated laws. In any case you need such a lawyer to draw up the deed and contract for you and your bro.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #44 on: March 14, 2014, 04:49:42 PM »
@Daleth

Agreed...before making any changes I will need to see a lawyer...I'm not too worried about it. One way or another I'm feeling like there will be a way to get him taken care of that won't break the bank...even if we do end up paying the transfer tax and it ends up being $10K...split 2 ways won't break us.

and yes I know the gift tax doesn't help us get around the transfer tax, but theoretically to avoid the transfer tax me/wife could gift brother/wife $ thru the years to make up for all the years he was paying...and yes I'm sure you're right that SF has seen this and probably will get theirs.

thanks again for all your input...need to bounce ideas off people and my circle just isn't well educated in these manners.

Daleth

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #45 on: March 15, 2014, 11:59:52 AM »
and yes I know the gift tax doesn't help us get around the transfer tax, but theoretically to avoid the transfer tax me/wife could gift brother/wife $ thru the years to make up for all the years he was paying...

I'm not sure how else to put it, but let me try one last time. The gift tax WILL NOT "theoretically" let you "avoid the transfer tax" in any way, shape or form. The gift tax is totally irrelevant to the transfer tax.

Gift tax is charged by the federal IRS when both of the following are true: (1) you transferred any kind of property (houses, jewelry, stocks, etc.) to someone else without them paying you the normal market price for it, and (2) the size of your gift (i.e., the whole amount if they paid you nothing, or if they paid you something, the difference between what they paid and market value) is greater than the annual exclusion (currently $14k per person). Keeping your gifts below $14k per person per year will enable you to avoid the gift tax--but not the transfer tax, because that's a totally different unrelated tax charged by a totally different entity.
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes

IOW, real estate transfer tax will be charged even if the amount of real estate that you transfer to your brother this year is only worth $14k. That's because transfer tax is charged whenever you transfer real estate, no matter how you transfer it. It's charged whether you transfer the whole property or just a percentage of the property. The city or county (whichever entity charges the tax in your area) could not care less HOW you transfer it, as a gift, sale, or whatever--whether you give it to someone as a Christmas present, sell it to them for market price, sell it to them for $10, or barter it in exchange for their Florida condo, their used Honda, or ten years of free massages, NOBODY CARES; how you transfer it and whether you get any money or other value from the person you transferred it to is totally irrelevant. The FACT that you transferred it is what triggers the tax.

Now, it so happens that SF makes an exception to that rule if the transfer is (1) a bona fide gift AND (2) to a sibling. This is your brother you're talking about, so you personally (but not your wife) can transfer ownership in the house to your brother (but not his wife) without triggering the SF transfer tax. But that only works if your transfer is a bona fide gift, which it sounds like it's not since your brother is paying you $$ and your agreement is that he will, in effect, over time, buy out half of the value of the house from you.

You need to talk to an SF real estate lawyer with knowledge of tax issues, because maybe there is some kind of loophole or way to view this transaction as a gift. I doubt it, but maybe. However, even if there is, the only part that's going to be exempted is YOUR (not your wife's) gift to your brother (not to his wife)--because your wife and his wife, and you and his wife, and your wife and him, are not siblings.

In your shoes I would budget, say, $1000 to talk to a lawyer about this and if it looks like you can't get the exemption, just move on with life and stop worrying about this future $10,000 tax.

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #46 on: March 18, 2014, 08:54:44 PM »
@Daleth

Let me try one last time...I understand the transfer tax and gift tax are separate. Enough said.

Here are a few ways one could theoretically get around the transfer tax by using the gift tax:

1. To "gift" my brother his half over the years. So if we decide to buy him out and the home is worth $1.5M (therefore his half is $750K) when we sell it we could gift him $56K for 13 years.
2. Or I could gift him my half of the cabin + annual gifts over the years.
3. Also, the way the law works is that you can give $14K each year to as many people as you want without paying tax and without it counting towards the lifetime exemption. But what most people don't know is that the lifetime exemption is $5.34M. What that means is that i could gift my brother $1M today and not pay any taxes on it...because I would defer the tax to my lifetime exemption. Each person is allowed $5.34M in a lifetime exemption. So if i did gift my brother $1M my lifetime exemption would be $4.34M when I die (the estate tax limit before i would pay taxes).

(here's an excerpt from the Forbes article I found):
A common source of misunderstandings is how the lifetime exemption amount relates to the annual exclusion. Here’s what you need to know: We can each give another person $14,000 per year without it counting against the lifetime exemption. Spouses can combine this annual exclusion to double the size of the gift. Don’t confuse it with the basic exclusion – that $5.34 million discussed above...

And how would anyone know that my brother is paying me to own? he's paying rent...that's our story. so a transfer to him still seems like an option. and yes i'm the only one on the deed so i should be able to transfer it to him as a bona fide gift. and if for some reason the transfer can't go thru then i have the gift tax exemptions to use...either annual gift tax over years or one time gift that counts towards the lifetime exemption or a combination of the two.

talking to a lawyer isn't a bad idea, but now maybe you see my options?
« Last Edit: March 20, 2014, 05:56:56 PM by briangood »

briangood

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Re: HAVEN'T SEEN THIS SCENARIO YET...PAYING OFF ADJ MORTGAGE or ???
« Reply #47 on: January 22, 2015, 04:36:18 PM »
*update

I have continued to pay off the mortgage and made a $91,000 dent in the principal ($119,000 total paid) over the last 12 months.

The DJIA stands at 17,814 as of closing bell 1/22/15...when I started the thread the DJIA was at...

3/7/14 at 8:20am west coast time - DJIA - 16,422.54 making it up roughly 8%.

of course I wouldn't have been able to put all $119,000 into the market on 3/7/14.

and I might be actually getting somewhere with my current lender...asked for a loan modification and have been given a trial modification that might actually lock me into a 30 year fixed rate.