Lately we’ve been having a lot of conversations with clients related to the housing market. Here are some of the recent talking points:
- why you want to waive escrow in a high interest rate environment
- knowing your rate versus the market
- to prepay or not to prepay?
- how retirees can “beat the rush” in their plans to downsize
We’ll share some of the broader pieces of each of these conversations with hopes that it may benefit our readers or other clients.
The benefit of waiving escrow
When you put 20% or more down on your mortgage loan, you have the option to waive escrow. This can save you money each month and provide better cash flow flexibility. The trade-off is you have to make your property tax and insurance payments yourself. But is that so bad?
When you opt to escrow your property taxes and home insurance, you increase your monthly payment. In a high property tax state like Illinois, your property tax bill adds a significant amount of money to your monthly payment. One of our clients who is going through the home-buying process was slated to have a monthly payment of $3,400 per month. They didn’t realize that $800 of this payment was for property taxes.
By opting out of escrow, the client brought their monthly payment down to $2,600 per month, a monthly savings of 23%. Yes, they still have to pay their $9,600 property tax bill when it is due, but now, instead of the bank sitting on their extra $800 per month, they get to keep it for themselves.
This money can be set aside in a high yield savings account and earn 4% or more each month. Or, if your income is bonus heavy, this extra money can be invested long term (or spent on a nice vacation or home improvements), and then you can use the bonus to cover your property tax bill.
Waiving escrow will increase your monthly savings potential. You just have to be disciplined in preparing for the property tax payment you will now be responsible for on your own.
Know your rate versus the market
We were a part of a somewhat comical experience with a client recently where they were quoted a rate from a lender that seemed a bit high. We expressed to the mortgage lender that their quoted mortgage rate appeared much higher than the normal spreads we’re seeing quoted every day in the market. The lender came back with some BS answer about the rate volatility due to the bond market (which we’re well versed in).
We replied with a simple, “This doesn’t make any sense and we’ll be advising our client not to pursue this loan.”
The lender replied that because he values our client so much, he was going to reduce the rate from 7.375% to 6.60%. How nice of him!
The point is, you need to know where the market is at so you don’t get taken advantage of. And if you are being taken advantage of, call them out on it! Your mortgage rate might magically go down.
Another tip is to engage with at least two lenders. These lenders are hurting right now… their loan volume is down 30-50% compared to the 2020-2021 housing boom. They want your business and they want it bad! If they know you will go with someone else, they will sweeten the deal to earn your business. Make sure the lender(s) you’re working with know that they are not the only person you’re talking to.
Lastly, be sure to loop in your financial advisor on any email chain or text conversation. You’ll be amazed at how the numbers change once the lender knows you’re receiving objective advice from someone who understands the interest rate environment.
To prepay or not to prepay?
“I hate having a mortgage so I make extra payments to knock out that debt as soon as possible.”
This is a very common statement we hear from clients, especially those nearing or in retirement. While there’s an emotional component to the statement, it’s important to know the financial ramifications as well.
Here’s the simple rule: if you’re locked in to a mortgage in the 3% range, you should not be making extra payments towards your mortgage. If you are locked in at 6% or higher, you should be making extra payments. In between those ranges and the numbers become less black and white.
Let’s talk about why…
A 3% mortgage represents a debt level that is below the interest rate someone can earn “risk free” in Treasuries or CDs. Therefore, you’re better off financially investing any extra money to earn that higher return.
A 6% mortgage represents a debt level that is below the interest rate you can earn. This means extra money may be better off being applied to your mortgage. If the rate you’re paying on debt is higher than the rate you can reasonably earn on your investments, then choose to pay down the debt.
A note on prepay strategy
One quick mention on something we see a lot of when it comes to prepaying your mortgage… most people tend to make extra payments each month. For example, if their regular payment is $2,000 per month they may decide to pay $2,100 per month (or $1,200 extra per year). But again, in a high interest rate environment, this is not an optimal choice.
If you want to make extra payments on your mortgage, it is better to make one lump-sum payment once per year than it is to make smaller payments each month (assuming these amounts are equal). The payoff benefit will be the same but you’ll do two things that are helpful:
- You’ll have a little extra money each month which increases financial flexibility
- You can earn interest on that extra money if you set it aside in a high yield savings account
We encourage clients to think of optionality when it comes to your discretionary budget. Consider the hypothetical where someone makes extra payments from January-June, but then in July decides they need to stop making the extra payments. They can’t get the extra money they spent on their mortgage back. Someone who is setting the extra money aside with plans to make one lump-sum payment in December will have more flexibility if their financial plans change.
Beating the rush on your downsize
We came across an interesting article in the Wall Street Journal that talked about how many Baby Boomers are planning to sell their homes later this decade. The article pointed out that many Boomers live in similar styled homes, in similar settings (metro suburban areas). The premise was that if they all decide to sell at the same time, they may increase inventory in their local markets and get less for their homes than they expect.
We’ve linked an unlocked version of the article here so you can read it for yourself if it applies to you. If you are a baby boomer who has been thinking about selling your home, you may want to accelerate those plans. We know home prices are high today, but we don’t know if they will still be high tomorrow.
So whether you’re actively participating in the housing market this year or planning to in the years ahead, keep these tips in mind and let us know how we can help!
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