Real estate is a part of just about every financial plan I see. Whether real estate is synonymous with a home or an investment, it typically starts with a loan. The focus of this blog is on how individual homeowners should be thinking about their debt, given the historically low rates. To be clear, how you go about financing your home is not a one size fits all approach.
This is about caring for the financial decision of a lifetime
Whether you are financing the purchase of a home or looking to refinance, how you go about it can have a lasting financial impact (good or bad). There are many considerations, including the rate, term, how much to borrow, and where to acquire the loan. But one thing is for sure, that there is not a one size fits all approach for a new loan or refinances. As such, working within a successful decision-making framework will increase your odds of a positive loan outcome.
Step 1: Create your financial framework
Start by looking at your overall financial plan. Think about your checking, short-term savings, emergency fund, and the amount you have invested in cash and bonds. These are essential considerations when looking at a loan. As an example, if you don’t have a savings account or an emergency fund, maybe you should put off that home purchase until you have a safety net of cash. Also, if you are looking to refinance and your savings account is flush, you may want to consider putting extra money into your home. Doing so may rid you of unnecessary private mortgage insurance or enable you to get a better rate because you have more equity in your home. By starting the process within the context of your overall financial strategy and plan, your outcomes can improve, and bigger goals than just one to reduce your payment can be achieved.
After considering the bigger picture, start looking at your goal or objective for getting the loan or refinancing in the first place. A target could be, “through financing my home, I hope to get a loan that enables me to pay off my loan as soon as possible.” If that is the case, a loan with no pre-payment penalty and a 15-year term could make much sense. At the same time, if your objective for the loan is to “use some of the equity I’ve built-up to increase the home’s value through a kitchen remodel,” then a simple line of credit could be the best approach. Once you’ve looked at your loan within your broader financial picture and established goals and objectives for the loan, it is time to look at the rates and fees for the new loan.
Step 2: Shop for the right loan
In my 24 years of advising, I have learned a lot about loans and incentives for the people that sell them. My view is that the majority of individuals should go to their local credit union and find a loan from them. Credit unions are non-profit and member-owned, so their incentives are to keep rates low when borrowing, and rates higher when you deposit money. As a side note, the majority of my employees who have purchased or refinanced their homes have used a local credit union. We have had particularly good luck working with Rivermark Community Credit Union. You can find their rates here. Regardless of where you go to get your loan, it is essential to look at a few different options.
Step 3: Prioritize getting Good Faith Estimates
Getting a good faith estimate (GFE) is a critical part of the loan process as it helps you compare one loan versus another. Closing costs can be as much as 10% of the loan amount, and with different lenders charging a variety of fees, it is wise to get a GFE from at least two lenders on the same day. Because rates can bounce around, getting the GFE on the same day provides the most accurate picture of pricing, rates, and terms. Getting a GFE is so important and an area where many decide to get lazy. I like the saying, “trust but verify”, and the GFE is a great way to both trust the people you are talking to but verify their results.
A real-life example: Saving $170K over 15 years
Recently, I was speaking with a client who is in the real estate business. She was aware that mortgage rates had been dropping, so she wanted to look at refinancing. Having a solid understanding of her financial plan, I then asked her what her overall goal was for the refi. Was it to lower her rate, or reduce her payment? In the end, those were important considerations. Still, even more critical was the goal of having no house-payment by the time she was 60.
Consequently, we decided to invest some of the cash from her investment account to pay down her loan from $300k to $240k. We shifted from a 30-year term with a rate of 4% to a 15-year loan at 2.5%. Her total payment was approximately $170 more per month. The shift allowed her to save around $170k in interest over 15 years—a significant return on her investment. Importantly, the new loan is in line with her bigger picture goals outlined in her financial plan and consistent with her desire to be debt-free at 60!
Establishing an easy to follow process for making financial decisions can pay dividends for years. Looking at your broader financial goals (financial plan) is a great first step. From there, identify specific financial goals you’d like to accomplish (be debt-free by 60) and the objectives for each (restructure home loan). Then, establish a process for comparing rates (good faith estimate) and engaging a trustworthy financial partner. Following these steps for financing (or refinancing) your home can have a substantial impact on your net worth, cash-flow, and ability to retire.
