I love my new house but hate my new mortgage

I’m a financial advisor that made a questionable financial decision. My family and I moved last year, becoming one of the few homeowners to willingly swap out of our 3% mortgage for a new, 8%, one. This article will shed some light on how we made the numbers work and what went into our decision to buy in a high interest rate environment.

How the numbers changed

My wife and I bought our first house together in a suburb of Chicago in 2016. We paid $300,000 (with 20% down) and had a 3.75% fixed 30-year mortgage rate. Our monthly/yearly household costs looked like this:

We sold this house for $415,000 late last year and bought a new house for $610,000 (with 33% down, rolling everything from the sale into the new house). Our new mortgage rate is a 30-year fixed at 8% with monthly/yearly household costs that look like this:

Our household costs went up by about $2,250 per month, or $27,000 for the year. This is obviously no small amount, but we took some steps to help soften the blow.

How we made the numbers work

In order to lower our monthly mortgage payment, we did a rate buy down. Doing this gave us a temporarily lower rate in our first two years of the mortgage. Our mortgage rate is 6% in year 1, and 7% in year 2. Then, the rate will revert back to 8% for the life of the loan beginning in late 2025 (2 years after purchase).

This buy down was attractive for a few reasons:

1. We lowered our monthly payment by $500 in year 1, and $250 in year 2
2. We can refinance anytime within the first 2 years at no charge
3. The seller paid for the buy down, reducing our total cash to close

With the buy down in place, our year 1 and year 2 numbers look like this:

So now, in year 1, our total costs are $6,000 less than they would be with our regular 8% loan. This is a nice savings that definitely helps on cash flow. Ideally, we will try to refinance our loan later this year once we get close to the end of year 1, when our rate will move up to 7%. But that will only make sense if rates are below that 7% threshold. Otherwise, we’ll wait until the middle of year 2 and see where rates are at.

As a part of our rate buy down, the lender offered a “no fee” refinance. If you explore a buy down for yourself, make sure you get stuff like that in writing and review the closing documents closely with your attorney.

The rate buy down itself cost us $10,000, but we were able to get our sellers to pay for it by including it in our purchase price. Instead of paying $600,000 for the home (original list price), we paid $610,000 with the sellers contributing $10,000 for our buy down. The seller didn’t mind because the net effect on their sale proceeds was the exact same; they effectively sold for the $600,000 they intended to sell for from the beginning.

This was a good option for us because the buy down cost was rolled into our loan. In other words, we didn’t need to bring an extra $10,000 cash to close in order to pay for the buy down.

Our local market is too strong for us to have asked the seller to pay for the buy down outright. But if you’re a home buyer in a softening market, you may be able to ask the seller to pay for a buy down as leverage against walking away from a deal. In any case, definitely inquire about buy down options in this high interest rate environment.

Dealing with taxes & insurance

Our property taxes and insurance costs also increased by about $365 per month ($4,375 per year) with our new house. We took some steps to better manage these increases as well. First, we shopped our insurance aggressively with an independent insurance agent who was not affiliated with any big-box type insurance firm.

Second, we opted out of escrow with our lender. This meant we didn’t have to pay our property tax bill monthly. Instead, we will pay our property tax bill ourselves when required by the state of Illinois (one half payment in June, one half payment in August).

Opting out of escrow saves us $1,250 per month from September to May each year (until payments are due in June). This is $11,250 in cash that I’m not having to spend for 9 months out of the year. I still have to save that money and be ready to spend it when the first property tax bill is due in June. But, with that $11,250 in my pocket instead of an escrow account, I can invest the money and earn interest on the amount. In my case, at a 5% risk-free rate, I will earn about $420 in interest from this money.

Here’s a secret too: investing your monthly property tax payment is exactly what your bank is doing with your escrow account. Why should the bank be the one who earns the interest? The property tax payments aren’t due until they’re due, so you may as well make money on that money until then. Of course, this strategy requires financial discipline. You cannot confuse the extra cash you have from not paying property taxes each month as discretionary money to spend.

Lastly, on the topic of opting out of escrow, this strategy can be ideal for people who have lumpy or variable income throughout the year (such as bonus, commission, stock grants, etc).

Rates are what they are

In 2022 we were thinking about moving but rates had just gone from 3% to over 5%, so we were tepid. In addition, our local housing market was still rife with bidding wars, so it just didn’t feel like the right time to make a move. Yes, we’d be getting a good price on our house versus what we paid, but we were “trading up” — so the price we were paying was more important than the price we were selling for.

Fast forward a year later and rates were in the 7-8% range, but we noticed our local market had slowed down dramatically. The bidding wars were gone and prices had moderated. We knew our new monthly payment was going to be much higher no matter what, but we felt we were also getting a nicer house at a better deal. Most of the comparable sales for the house we were buying were in the $650,000-$700,000 range, but they had sold in 2021-2022 when the market was much hotter.

When we bought our house we ran all of our numbers based on monthly costs associated with our 8% mortgage. We did not buy with the assumption that we can refinance (though it will be nice if we can!). It is definitely a bit cringe-worthy knowing how much our costs went up. But our household happiness has gone up even more.

Our kids LOVE our new house and it really suits our needs in such a more efficient way than our old house did. So I can quantify that our household costs went up by 93% versus the old house, but I can also say our living situation feels a million times better. You can’t put a price on that.