Speaker 0 00:00:02 <inaudible>
Speaker 1 00:00:08 What's up, everyone. Welcome to the finance for physicians podcast. I'm your host, Daniel Raimi. Join me as we dig into what it looks like for physicians to begin using their finances as a tool to live better lives. You can learn more about our
[email protected] let's. Jump into today's episode. Last week, we talked about capitalizing on low interest rates with your student loans. Today, we're going to be talking about how to capitalize on this with your mortgage. Maybe you've heard rules of thumb, like always refinance your mortgage when you can cut at least 1% off your rate, but you're unsure if this is really the best way to look at it, or maybe know that refinancing can make sense when rates are low, but how do you actually compare all these mortgages and the options when you start to incorporate closing costs and all the complexities, if you've ever seen a closing cost breakdown, you know what I'm talking about, or maybe you've heard from lenders that it definitely makes sense to refinance, but you're hesitant to take their advice given that they're heavily incentivized to say this, we're going to be talking about all these sorts of questions and others, and ultimately talk about how you can navigate this potential decision and make sure that you're capitalizing on these low rates were in mortgages can be tricky to compare and analyze.
Speaker 1 00:01:18 I'll give you a good example. We had two clients recently in our planning firm, both had mortgages with existing 5% interest rates. So if you compare this to the market, it's a very high rate. Now, if you use the 1% rule of thumb, both would want to refinance because they could easily get a new rate below 4% or less. But what actually played out was one definitely needed to refinance and it was a home run and the other did not need to refinance. So we'll talk more about those in a minute, but as you can see from this example, it's definitely not quite as straightforward as just looking at the rates. So we're going to talk about why that occurred and dig into the factors so that you can better navigate this type of decision. So what is a mortgage refinance? Well, let's get started with a basic, so you can find a new mortgage and most common reason to doing this is to better the rates.
Speaker 1 00:02:13 So a mortgage refinance is when you find a new mortgage and, uh, set up that new mortgage and agree to the terms and the new mortgage basically pays off the old existing mortgage. And so you close on the deal and you now have the new mortgage. It can be the same lender. It can be a different lender. Sometimes you don't have to bring any new money to the table. Other times you have to pay some out of pocket, but it really kind of depends on the specifics of the deal. So what drives mortgage interest rates? Well, there's a couple of factors. Uh, first let's talk about market or economic factors. These are mostly out of your control. Uh, rates tend to move for mortgages with the 10 year treasury rate. There's also some supply and demand that can play into the situation. If you look at 30 year mortgage rates, for example, I'll link to a history of mortgage rates in case you're curious, but if you look at the 30 year rate history or for average rates in 1983, I was born in 83.
Speaker 1 00:03:18 So I looked at 83, 1983. The rates were 13% range for mortgages, which is kind of crazy to think about. In 2005, they had gone down to 6% since the 2008 housing bubble or market crash. They'd been in that, uh, pretty much in the three to 5% range for 30 year mortgages. And then in 28, 21, if we look at January 80 average was 2.71%. So definitely it's been a downward trend. And right now is about as low might be the lowest ever, definitely close to it. They're extremely low rates, right, right now, as of this recording, the other piece of the puzzle is your situation. So there's a few different factors to consider there. You've got your credit score. So a better credit score or higher credit score is going to typically translate to a better rate on a mortgage. There's often like a point where that does not help anymore.
Speaker 1 00:04:18 And that's usually in the mid seven hundreds range. So if your credit score is above that level, it no longer improves your rate. So you definitely want to make sure your credit score is as high as possible, or at least above that, that a, that rate threshold second factor would be the percentage of equity that you have in the house. So equity is what the house is worth minus how much you owe on the mortgage. So if you have a a hundred thousand dollar house and you owe $80,000 on the mortgage, then you have 20% equity. So the more equity or value you have in the house, the better typically for rates, uh, most lenders have kind of a threshold there as well, where they no longer give you better deals as long as you're at least at that threshold. So, uh, commonly it's like 20 or 25% equity.
Speaker 1 00:05:16 So as long as you have, you know, at that 20 or 25% level, they are going to give you the best rates they have to offer. The third big factor in your situation would be debt to income ratios. This is kind of like a line in the sand. It's like, if you cross it, they're not going to give you the loan. And really none of you guys should be running up against this. That's kind of, if you're running into that line, you shouldn't even be considering that sort of a home at your income level. It can sometimes come into play when you're kind of transitioning and income's going up. So it can be a factor, but, uh, that's kind of like a deal or no deal sort of factor. The fourth big factor is the term. So that's how long you're going to pay off the loan, how long the schedule is for the loan to be paid off.
Speaker 1 00:05:59 So you've got, you know, 15 year and 30 are the most common, typically lenders will offer lower rates for shorter terms. So the 15 years, almost always a lower rate interest rate than the 30 year. Sometimes they have 20 year a rate breaks. And then the last factor I'll throw out would be the size of your loan. So sometimes jumbo is the most common example, jumbo loans. That's like a, a level where if your loan is above a certain balance, they call it a jumbo loan. I think it's around 550 as of this recording for most areas. But if your balance of your loan is above that threshold, in some cases that will result in a different rate schedule, typically it's higher. Like right now, jumper rates are higher. Now you can sometimes work around this by getting a physician loan where that's not in play, but when it's not a physician loan, that jumbo factor can come into play.
Speaker 1 00:06:56 So if you're comparing multiple mortgages, I think the key areas to focus on is really the cost, the true cost of the loan for you. So on your current mortgage, it's pretty straight forward. The cost to you is your interest that you pay every month. That's a portion of your monthly payment is interest. So everybody has that cost. Now, some people also pay what's called PMI that's mortgage insurance. Uh, that's typically charged if you don't have 20% equity and are not in a physician land. So I kind of think of that as like an additional costs to add to interest. And then when you're comparing to a new potential loan, you have to throw in a third cost, which is just closing costs. So closing costs are going to be like upfront costs. You're going to have to pay. Typically when you set up a new mortgage.
Speaker 1 00:07:48 Now in certain rare cases, you can get around these by refinancing with your existing lender. But in my experience, this has been pretty rare. So in most cases, when you're refinancing, you're going to have to pay those upfront closing costs. So the other factors we already just talked about your situation really plays into it. So when you're comparing those, when you boil it down, I think the two most important things to look at is the breakeven point. So that's the first thing is, is the breakeven point. So there's going to be a point. So if you're comparing your current loan versus a potential refinance, you know, the, the rates going to be lower on the refinance, otherwise there's no point. So the question is, um, when does that interest rate savings? So when your rates lower, you're paying less interest. So the question is when does that interest you save on, uh, each month, add up to where pays or exceeds the, uh, initial closing costs.
Speaker 1 00:08:46 So that's the break even point is that's the point when the interest savings of the new potential loan has grown to a level where it's the same as the closing costs, the interest savings should eventually get to a point where it pays for that. And if he wants to get to that hump, you're kind of, you know, gravy beyond that. So that's that point. Uh, you kind of just want to understand where that point is. That'll help you make a good decision. Um, you know, in the shorter break, evens generally are better, but once you hit that point, you're going to start kind of being on the plus side within the refinance, a factor to compare is just the kind of the longterm cost. So this would be the way I would look at it is this is kind of the most likely long-term scenario of one mortgage versus the other and what the cost difference looks like in that situation.
Speaker 1 00:09:35 So the breakeven is just kind of like, when do I get on the plus side? Like how soon, how many months the long-term is like in the event, keep both these for as long as I think I am. What's my cost benefit look like. So typically when you can look at those two factors, it'll give you a kind of a really good idea of whether or not it makes sense to refinance. So back to the two clients that I was hitting on, so here's what happened and why one should refinance and one should not. So the first client, um, just kind of a bit about what was going on in their setup. So they owed about 400,000 on their current mortgage. It was a physician loan that got several years ago and the rate was 5% on that. They were about three years into it.
Speaker 1 00:10:20 So they had, they had 27 years left on their original 30 year term. They had great credit debt to income ratios were non-issues and they're set up, they were planning to stay in the home for forever and ultimately pay off the mortgage at the normal pay off schedule. So, so since they got their mortgage, what has changed in their situation and with the market, uh, obviously rates have gone down. As we talked about prices in their area have increased as well. They've also been making their normal payments, which naturally, uh, reduces the principal balance and increases their equity. And then they've also made a few home improvements, which, which has also added to their equity. So the net of all this fast forward three years, they have well over 20% equity and can get into kind of those good, great deal setups. They also given the, uh, amount that they're paying, they could get into a 20 year term or, or maybe even a little bit less and still be at that same payment they're used to, and potentially get a rate break there as well.
Speaker 1 00:11:27 So back to the two big factors to focus on. So break even is the first one on those total costs. So in their situation, uh, the proposed deal, you know, we're going to have a lower rate, but when does that rate savings equal to closing costs? So with the, if they're going to get a brand new physician loan, just to kinda get that out of the way, typically that the reason they wouldn't just do that, the reason they wouldn't just refinance their current loan is because those have a slightly higher interest rates than a conventional loans or loans with 20% equity, they can also get a brand new 30 year loan just kind of restart. And that's what a lot of lenders will suggest. But, uh, the problem with that is they're not going to get the rate break there on potentially having a 20 year.
Speaker 1 00:12:13 It's also going to delay when they pay off their mortgage. So the best or the lowest rate deal in this setup was a 20 year term. And they can actually look at an 18 and a half year term to keep the payment right at about the same level that they're used to. That's another little side note. Most lenders are, a lot of lenders will allow you to request custom terms, but you have to ask for it so they can do an 18 and a half year term and keep their payment the same and get, you know, the best rate possible. So how does that all translate into dollars and cents for their situation? So the current mortgage, as I said, was, uh, was 5% interest rate scratch this last part from, so how does it all translate to dollars and cents? You can cut it off after I talked about the 18 and a half year section.
Speaker 1 00:13:02 Okay. So back to the two key factors. So breakeven point, I think easiest way to do this is to just run an amortization schedule, all LinkedIn, an easy calculator online to run these numbers for your current loan or potential loan. So you can just plug in the numbers. So in this situation, you just put in 400,000, the loan term is 27 years. Interest rate is 5% for the current loan, the new loan, you just plug in 400,000, 18 and a half years, and 2.5% into this little online calculator. So you can see here if you run the calculator, uh, on the current loan, the interest rate, if you look at the monthly schedule and that first year, or even couple of years, the interest rate is around 1600 or it's higher than 16. And then if you look at the second mortgage, it's probably an average of around 800 a month of interest that they're paying.
Speaker 1 00:13:55 So what that translates to is about, um, 800 a month of potential interest savings monthly. So if in this potential loan that they're looking at the 18 and a half year term, the rate on that was going to be two and a half percent. And the closing costs were going to be 4,000. So that closing cost, the total closing costs, uh, or the total pure costs of refinancing that 4,000 number, basically, they're going to, it's going to take five months of interest savings or $800 a month basically, uh, to recoup the 4,000 of closing costs. And that's, you know, that break even point is about five months for them. So at that point, you know, it's all gravy. And so since they're going to live in the house for the long haul, that's a no brainer. Now, if they were going to move like six months, then you're, you know, maybe you're like, ah, I don't know, is it worth saving, you know, $800, probably not.
Speaker 1 00:14:52 Now, if they're going to live in a house a year, it's still probably worth it in their situation to refinance, but that's why that breakeven point is really helpful. As you can kind of look, look at your specific time horizon and, and decide whether or not it makes sense given how long you plan to be in the mortgage. So that's the breakeven, the second, okay. Factor longterm cost benefit. So in the current loan, if you look at the total interest cost, which also shows that in this calculator, if you look at a total cost for it, it was about, it was a little over 329,000 and then in the proposal, and it was a little over a hundred thousand plus the 4,000 closing cost upfront. So dramatically less. I think the biggest savings though, in this example, well, is there saving eight and a half years of paying the 2252 of them?
Speaker 1 00:15:38 So that's, you know, a home run sort of a deal, especially cause they're going to stay in the house, the, in the longterm. So this, uh, analysis, the long-term benefit is helpful because you can really hone in on what the most likely cost benefit is in, in your situation. You can get a lot more technical with this long-term cost benefit analysis. Okay. And if, you know, you can go like do the same exact time horizon, you can kind of look at present value, you can compare it to an investment. So that's kind of that's for another day, we'll kind of keep this basic for today, but, but, uh, the key to looking at that is to understand what that longer term likely cost benefit is. So the second client I mentioned there they're the one with the a hundred thousand balance. They had a same interest rate, 5%, um, and they're able to get the same interest rate in the new loan two and a half percent.
Speaker 1 00:16:33 They also, you have great credit, great debt to income ratio, but what's different about their situation is they're paying off the loan aggressively and they have three years left. So they've started with a physician loan and since they've been paying it off so aggressively, they now have well over 20% equity. And so they're now in, also in the same position able to get that best rate set up. So too, yeah, half percent in this issue situation was the potential rate they were looking at. So going back to those two key factors. So breakeven is the first one. So in the current loan situation, we run the amortization schedules, plugging a hundred thousand three-year term on their situation, 5% interest rate. So when we look at their, their numbers in year one, you know, they're paying about 4,200 of interest and then 2,600 and then 955, then we run the potential refinance.
Speaker 1 00:17:26 We're looking at the a hundred thousand loan, 3%, uh, or three-year term two and a half percent rate. And the interest in this setup is 2100 1,346, $464. So basically they're saving about, uh, about 2000 in year, one of interest in about 1300, then year two, uh, by refinancing now closing costs in this deal. So that's where the breakeven comes in. So this loan was kind of an expensive loan. Uh, $3,000 was the closing costs for this rate. And so $3,000, uh, that basically takes just a little under two years to break even on those closing costs. And so at a two year break, even that's kinda, that's a really long time, especially when you're only going to take three years to pay it off. So, but they still could potentially, um, you know, they would benefit from a refinance from a pure dollars instance standpoint.
Speaker 1 00:18:24 It's just going to take two years, a little under two years to break. Even then we look at the long-term cost benefit. So in the current loan, the total cost over the three years is 78 95 and change. And then in the proposed refinance, the total interest is about 3,900. Plus you had the 3000 closing costs. So net savings over that three-year time period is a little under a thousand dollars. So their situation they're like, they've, they've gone through, uh, financing alone before, and they're like, it's not even close to worth the effort of having to do the paperwork and have the meetings and all the back and forth, which I agreed with. And so the decision was definitely, definitely don't refinance in it and just kind of keep, keep with the plan just because of their very short time horizon. So the key though is to really incorporate both the external factors, like what are the market rates, and then also make sure to incorporate your situation.
Speaker 1 00:19:22 So when you're comparing the mortgages, you got to remember, you got to look at cost of one loan versus the other in your current loan. You're looking at interest always. And sometimes PMI. Those are the two, one or two big costs. You're going to look at, um, compare, you can run those numbers with an amortization schedule. I'll link to a really simple one online. And then in the potential refinance, you're going to be comparing interest, possibly PMI, and then adding onto that the closing costs. So the two key factors to remember when you compare number one is the break even point. So that's the point in time when the closing costs equal on the new loan, the closing costs equal the interest savings. So that's the point when it kind of like pays for itself and from then on, you should be on the plus side.
Speaker 1 00:20:09 And then it's always good to also run the longterm analysis and basically to understand the cost benefit of that most likely long-term scenario. So some other considerations all throughout, if you're, if you're looking at this or if you're thinking, you know, maybe my rate is higher than market rates, or maybe my situation has changed. Maybe I'll look at this. So there's a couple other things I'll, I'll, I'll throw out that you should think about. So if you haven't looked at a refinance in the past few months, six months or so, it's, there's a really, really good chance that, uh, rates are lower or have gone down since you set up your mortgage. So definitely worth at least kind of doing a quick online search to see what comparable rates might be. If you start going down that path of looking into refinance, it's always good.
Speaker 1 00:20:53 I think to talk to several lenders, I always suggest telling the lenders that you're talking to more than one lender, uh, first of all, so that everybody's on the same page and they're not assuming you're gonna work with them no matter what. And second of all, because a lot of cases, they will give you an extra discount knowing that the deal is competitive. And when you talk to the lenders you want to ask for, what's called a loan estimate. Sometimes they're hesitant to give you this. Um, I think mainly because it's kind of, it can be confusing and they're just, they don't, I think they just don't want to confuse people, which makes sense, but it's definitely the best way to compare different mortgages, uh, apples to apples, because it's a unified standard of how they, uh, add in or present, uh, loan rates and closing costs.
Speaker 1 00:21:47 So I would definitely emphasize that you want to get that loan estimate and compare it from the multiple lenders I'll link to a loan estimate, uh, explainer online. That's really good, it's it kind of walks through the different factors and that's the, the, uh, document you would use to extract out, first of all, what the rate is, but that's usually straightforward, but more importantly, what the closing costs, the total pure costs are of that potential refinance. Another side note on talking to multiple lenders, I think the most common, uh, concern people have is they don't want to hurt their credit by getting multiple credit checks. So just a note on that, if you're getting multiple credit checks, uh, as long as it's within 45 days, it shouldn't hurt your credit. I'll link to a, uh, an article that explains kind of how that works. And so you'll definitely want to compare that, uh, your current loan to the potential loans, for sure, but you also want to compare, uh, you know, the, all the potential refinance deals.
Speaker 1 00:22:48 If you're talking to multiple lenders, you want to compare those between each other as well, getting into the weeds of that. That's, that's probably for another day, but it's, it's going to be good to kind of compare those apples to apples. Also, uh, another note about how you structure the refinance, the tendency for most lenders I mentioned before is to show you a, a 30 year term and promote the, the, the, the monthly payment savings. Maybe they even talk about how you're going to have extra to invest. Um, that's a lot of times it comes up, but I would be careful with this approach. There's a lot of old people, uh, in our country that have 30 year mortgages still. It's like, they've kind of just been refinancing over and over again. And all of a sudden, they're old with a 30 year mortgage, and maybe they take some equity out sometimes.
Speaker 1 00:23:34 Um, but I think a better approach, especially if you actually want to pay off your mortgage, a better approach would be to consider at worst keeping the monthly payment the same as it was before. And by doing that, that's going to shorten your term even more than it was before. Also you can ask. So sometimes, you know, it doesn't fit into perfect box of like 15 year or 30 year mortgage. So a lot of lenders will let you do a custom term, but you typically have to ask for it. All right. So that's all I got for you today. I hope that this has been helpful. Uh, hit us up. If you have questions on any of this, uh, best of luck, uh, testing out the numbers on your potential re refinance, and we'll look forward to
Speaker 2 00:24:13 Next time as always, thank you so much for joining us today. If you found this valuable, please give us a review on iTunes and share with a friend. Also check out our
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