Simon

Embarrassed about the numbers

I am actually still waiting on the appraisal (should know early next week).  This is a quiet time to crunch numbers and prep for the closing on the loan.

I wanted to blog about bank loan numbers and how I made my decisions (in case it is helpful to others), but I am a little embarrassed about how much I plan to spend and about how the new house will be double the size of my current one.

We live well within our means.  We buy used cars and my current one is 14 years old, we don’t own any fancy electronics (we don’t have an i-anything), my wife has a 3 year old laptop and a free flip phone with a minimal plan.  My computer and cell phone actually belong to my work, etc.  We do not try to “keep up with the Joneses.”  On the other hand, I do have a good job with a good salary and regular bonuses.  And the house needs to be large enough to have an office (because I work from home), school room (since we plan to home school) and room for visitors (since our guests come from far away and usually need to spend the night)…

Anyway, my solution is to pretend that I am going for a $100,000 loan so you can see the relative amounts without thinking too badly of me.

Here is the mortgage situation…

In the aftermath of the housing bubble, a lot of banks were severely burned.  The first thing they stopped doing was making construction loans to crazy people who wanted to build earth sheltered homes, especially if they wanted to be their own GC.  There may be a few more doing it now, but back when I was shopping in 2009, there was only one company willing to do it,  GreenStone Farm Credit Services.  They had not played the games and were in very good shape after the crash. We used them to buy our land and now we are just a few days from hearing back on the house appraisal to see if we will get our construction loan.

The Construction loan starts with a 4.25% variable interest rate.   That is normally not something I would risk, but it is only for a year and it has been 4.25% for a very long time.   I would get a line of credit and monthly payments would be interest only (no principle) on the money I already spent.  In June of 2015, the loan would automatically convert over to a 30 year mortgage at a fixed rate without any additional closing fees (they are built into the upfront fees).

There are two problems.

1) Green Stone charges higher interest than anyone else I can find.  At the time of writing, the average mortgage rate for a 30 year fixed, 0 point mortgage is 4.44%.  Greenstone’s rate for the same mortgage would be 5.15%  That makes a big difference in terms of your monthly payment and total interested paid.   When I called them up and asked them why I should pay such a high rate for their loan, they said they offer better service (which is true), and that they wouldn’t be selling my loan to anyone else (which doesn’t bother me).  They also mentioned the patronage program, which has paid about 0.5% back over the past few years, which made their rate half a percent better than it appeared.  They didn’t say it, but I guess they know I am not going anywhere right now anyway.

2) The second problem is uncertainty because we don’t yet know what the interest rate will be 1 year from now when it kicks in.  My insurance guy is pretty sure it will go up, but that is because he wants to sell me something called a “Rate Commitment Fee”.  This fee is 0.75% of the total loan amount and would allow me to fix the rate where it currently is.  We are talking thousands of dollars betting that the interest rate will go up…  I had to crunch the numbers.

Using my fictitious $100,000 loan amount, the “Rate Commitment Fee” would be $750.  So I looked at what the 30 year mortgage would be at the current 5.15%.  I put in a column for monthly payment and one for total interest paid (if I paid for the 30 years).

Of course, I also ran tables for how much quicker it could be paid off if I tossed in an extra few bucks a month (I did a full table with a row for each additional amount).  I totally plan to do that, so I hopefully wouldn’t get hit with the total interest numbers shown here…  I also compared with the lower rate for the 15 year loan which would save even more money, but we decided that while that was doable now, it could make things more difficult if I lost my job (its not flexible enough)…

Then I considered what could go wrong…  I created rows where I increased the interest rate to 5.5%, 6% and 6.6%.  I looked at how that affected the monthly payment and the total interest paid. Then I calculated how long (in months) it would take me to pay off the “Rate Commitment Fee” as well as the total savings for each scenario…   The chart looked like this (rough no formatting ;^)

So, what this is saying is that if I pay the 0.75% “Rate Commitment Fee” and the rate only goes up by less than half a percent, I would still end up better off in less than 3 years and I save a considerable amount of interest (nearly 10 times the fee) in the long run.    If it goes up by almost a percent (which is the most that I really think is possible without a major world shift), the fee would be paid off in 14 months and I would save more than 20 times my investment in interest…   In other words, if I think there is any chance that the interest rate will go up, the good bet is to pay the Rate Commitment fee…

So, is there a chance that the interest rate will go up?   I don’t think so.  Obama is working to raise the minimum wage. The natural effect of that would be inflation which would automatically lead to higher interest rates…  But there is nothing natural about an election year.  Obama and the Democratic party will be working hard this year to make sure that the Republicans don’t get to say, “I told you so.” about an inflation until after the election.  Eventually, I expect the interest rate will go up based on market forces driven by a decent economy and increased minimum wage.

So, I do NOT plan to pay the Rate Commitment fee.  But I will want to lock in to a fixed rate before the economic forces to kick in in 2016.

Hedge my bet?

After my construction loan is complete, I will have a normal mortgage on an existing house. There will be lots more banks that would be happy to talk to me.  The “Rate Commitment Fee” is close to the amount I would spend on refinancing my mortgage if I decided to go with another bank…  Other banks are more than 1/2 a percent lower than Green Stone.  So…

If rates go up in a year, I can use the money I didn’t spend on the “Rate Commitment Fee” to pay closing costs to another bank to get a mortgage at a lower rate…  Even if they don’t go up, I may still want to do that…  I’ll do that math when the time comes.