Home     Forum     401k     401k Rollovers
    Register   Login   Members   Search   FAQs     Recent Posts    




Mortgage Advice

Reply to topic
Money Talk > Credit & Loans

Author Thread
kellen2811
Member


Cash: $ 5.20

Posts: 24
Joined: 06 Aug 2009

Mortgage Advice  Reply with quote  

I need a little advice from the board. We are in the process of getting a construction loan to build a house in our home town.

I have a few options and would like to know what you guys would do in this situation.

Assumptions - Total Loan 337,600
Interest Rate is variable for one year during construction after which it will be turned into a fixed rate of whatever the interest rate will be in 1 year from now.
This is a construction project done by me and my father the hous estimate is going to come in around 350,000. We expect to be able to build it for less then 300,000 but have budgeted for overruns.

Option 1: 10% down 3.75% interest for the construction year. Closing costs 10,176. PMI 150.00 a month

Option 2: 5% down 3.75% interest for the construction year. CLosing costs 10,176. PMI 250.00 a month

Option 3: 10% down. 3.88% interest for the construction year. Closing Costs 14,614.00. PMI-150.00

My initial thought is to take the 5% and put the 16,000 into the market to allow it to compound and just take the initial hit for the first few years paying the PMI. The payments a month are affordable either way I go. Just wondered what everyone elses plan would be with a scenario like that. THanks

Kellen
Post Fri Feb 22, 2013 7:56 am
 View user's profile Send private message
smk
Preferred Member


Cash: $ 37.05

Posts: 183
Joined: 12 Dec 2012

 Reply with quote  

not sure i understand. you want to effectively borrow 16k for 1 year at 3.75% and pay an additional 100/month in pmi to invest it at something like 0.75%? where is the advantage?

Steve Kanney, CFA
http://www.integratedfinancialny.com/index.html
Any comments made are designed to help you make your own decisions and do not consititute investment advice.
Post Fri Feb 22, 2013 4:31 pm
 View user's profile Send private message
kellen2811
Member


Cash: $ 5.20

Posts: 24
Joined: 06 Aug 2009

 Reply with quote  

We would not be borrowing the 16,000. It would be from our down payment that we have saved up. The investment would not be in a regular bank account. It would be in a mutual fund and stockmarket.
Post Fri Feb 22, 2013 4:55 pm
 View user's profile Send private message
coaster
Senior Advisor


Cash: $ 1626.30

Posts: 7990
Joined: 11 Oct 2005
Location: Wisconsin
Re: Mortgage Advice  Reply with quote  

quote:
Originally posted by kellen2811
put the 16,000 into the market to allow it to compound

"allow it to compound" ???? And if it goes *down* 15%, which is just as likely as it will go up 15%???? It sounds like you're assuming only one direction????

~Tim~
Post Fri Feb 22, 2013 5:16 pm
 View user's profile Send private message
kellen2811
Member


Cash: $ 5.20

Posts: 24
Joined: 06 Aug 2009

 Reply with quote  

No I realize that there is risk involved and accept that but over time say I leave it in for 30 years the risk of it being less then when I started is lower. I have a long time frame to invest.
Post Fri Feb 22, 2013 8:21 pm
 View user's profile Send private message
smk
Preferred Member


Cash: $ 37.05

Posts: 183
Joined: 12 Dec 2012

 Reply with quote  

the risk of it being lower than the cost of the loan actually goes up over time, not down. so in 30 years the risk of loss is much greater. the idea that the risk declines over time is a common myth circulated by people who try to encourage others to buy stocks.

as far as suitability is concerned, i don't know your personal circumstances. but if a financial institution proposed borrowing to buy stocks, which is the actual position you are looking to put on your balance sheet, they could only pull it off if they already had little or no stocks to begin with. otherwise their regulators would be all over them...

Steve Kanney, CFA
http://www.integratedfinancialny.com/index.html
Any comments made are designed to help you make your own decisions and do not consititute investment advice.
Post Fri Feb 22, 2013 8:37 pm
 View user's profile Send private message
littleroc02us
Moderator


Cash: $ 382.90

Posts: 1884
Joined: 09 Feb 2009

 Reply with quote  

quote:
Originally posted by kellen2811
No I realize that there is risk involved and accept that but over time say I leave it in for 30 years the risk of it being less then when I started is lower. I have a long time frame to invest.


So your not using the 16k as a downpayment? I'm confused. So first you stated that it's a down payment on a house and then you say you want to invest it for 30 years possibly. Please explain.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Fri Feb 22, 2013 10:15 pm
 View user's profile Send private message
oldguy
Senior Member


Cash: $ 732.85

Posts: 3563
Joined: 21 May 2006
Location: arizona
 Reply with quote  

quote:
My initial thought is to take the 5% and put the 16,000 into the market to allow it to compound and just take the initial hit for the first few years paying the PMI. The payments a month are affordable either way I go.


I like that choice. Ie, retain the use of your $16,000 and pay the extra $1200 for the use of it. When you transition to the fixed rate 30-yr loan a years from now, one goal is to lock in as much fixed rate <4% 30-yr capital as you can, ie a 'keeper' loan.

The $16k in reserve gives you the option of paying down the loan if rates move against you - or using the $16k if required for construction.

As Coaster says - the $16k could be anything at the end of one yr, the market often moves 50% either way. But no matter if you don't need it, at the end of 30 years the probable outcome is around $350,000. All of those +/- years have time to statistically average and converge on a more predictable outcome. (I know smt worries that 'time adds risk' but in my world, 30 yrs is an adequate basis for a prediction, 30 data points is considered 'statistically signifcant for a normal distribution'). There is risk of course - but no one ever became wealthy w/o taking risk.
Post Fri Feb 22, 2013 10:55 pm
 View user's profile Send private message
kellen2811
Member


Cash: $ 5.20

Posts: 24
Joined: 06 Aug 2009

 Reply with quote  

Ok please allow me to clarify. We have saved up enough for the 10% down payment I the loan ie the 33,000. Plus closing costs. We can make the 10% that is where my dilemma is. To either chose the 5% route and invest the 16,000 with the main penalty being 100 extra dollars of pmi and added interest charge from the extra financing. The mortgage will automatically convert to a fixed rate loan at the end of construction without any further down payment or closing fees.

My though is to keep the 16,000 and invest it for a 30 year period. While also adding in extra payment monthly. Using it as a start up for a taxable account.
Post Sat Feb 23, 2013 1:45 am
 View user's profile Send private message
oldguy
Senior Member


Cash: $ 732.85

Posts: 3563
Joined: 21 May 2006
Location: arizona
 Reply with quote  

quote:
My though is to keep the 16,000 and invest it for a 30 year period. While also adding in extra payment monthly. Using it as a start up for a taxable account.


Hopefully you mean adding extra monthly payments to the Taxable account, not the nortgage? Very Happy

That's what I did over the past 35+ years. I kept mortgages (refi's) on each of our rental houses and used that as seed money to fund our taxable account, plus regular additions from our income.
Post Sat Feb 23, 2013 3:40 am
 View user's profile Send private message
coaster
Senior Advisor


Cash: $ 1626.30

Posts: 7990
Joined: 11 Oct 2005
Location: Wisconsin
 Reply with quote  

How long do you continue paying the extra $100 PMI? I don't think that's clear. Or I missed it somewhere in there. If it's until you've got the loan paid down to 80% then it's going to be a lot more than $1200.

So long as it's clear in your mind it's invested money -- put it away and forget it's there ( well, ok, that's a bit of hyperbole, not an investing plan ) -- but at least not to be used in the next five years or longer, then I'm comfortable with your plan, if it was my choice to make with my own money.

~Tim~
Post Sat Feb 23, 2013 5:57 am
 View user's profile Send private message
kellen2811
Member


Cash: $ 5.20

Posts: 24
Joined: 06 Aug 2009

 Reply with quote  

Oldguy- Yes i mean adding the extra to the taxable account. I don't see a reason to pay the mortgage down faster if I go with the 5% option. How did your results turn out? Where they similar to calculations you did at the beginning? Was it successful in your opinion?

Coaster- From my calculations

PMI would be paid on the 5% option for 86 payments while on the 10% option it would be 58.

28 extra payments =7,000
58 payments of 100 dollars more then the 150 PMI=5,800
Total extra in PMI cost- 12,800

Interest Difference from the 5% to the 10%= 14,920 cost of the extra interest for the 5% down payment paid over the life of the loan.

Total extra cost to use the 16,000=27,720
Post Sat Feb 23, 2013 8:54 am
 View user's profile Send private message
coaster
Senior Advisor


Cash: $ 1626.30

Posts: 7990
Joined: 11 Oct 2005
Location: Wisconsin
 Reply with quote  

Kellen. Bingo.

(ya just gotta love a guy knows how to run his own numbers Laughing )

Now rerun, including the offset to the investment results.

And I offer this middle-of-the-road option for your consideration: Use the $16K now to reduce the total cost of the loan *and* start investing the $100 per month offset into a Traditional IRA. Include the tax benefit ( ie reducing the income you pay tax on by $1200 a year ) and assume an eight percent compound growth rate ( very conservative assumption ) and see where you end up at after thirty years.

Best wishes and good luck!! Smile

~Tim~
Post Sat Feb 23, 2013 6:41 pm
 View user's profile Send private message
smk
Preferred Member


Cash: $ 37.05

Posts: 183
Joined: 12 Dec 2012

 Reply with quote  

your breakeven internal rate of return is 11.44%. this puts the analysis in terms of the time value of money which you need to do to be fair. you calculate this by taking your payment on each loan and subtracting them from each other over the life of the loan. using 337600 and that less 16k at 3.75% for a 30 year period you get 1489.38 & 1563.48 respectively. then you add the pmi. if you have your tax rate you would be able to tax effect it. but without the taxes you would have a payment of 1639.38 for 58 periods and then 1489.38 for the balance and the same thing for 86 periods with the other appraoch. put them all in a spreadsheet and subtract one column from the next. in the first period you have additional payments of 174.1 and at the end the difference is 74.1. at the top of the column use put the 16k you take out from the loan. in the middle the additional payments are 324.1. then you use the formula =irr(.01,column with differences). this comes out to be 11.44% (annualized - (1+r)^12). This means if you earn 11.44% for stocks over 30 years you make nothing by doing this. another way to look at this is the first part of the loan is 3.75% (plus a little for closing). the additional loan for the 16k comes out at 11.44%...

Steve Kanney, CFA
http://www.integratedfinancialny.com/index.html
Any comments made are designed to help you make your own decisions and do not consititute investment advice.
Post Sat Feb 23, 2013 10:06 pm
 View user's profile Send private message
coaster
Senior Advisor


Cash: $ 1626.30

Posts: 7990
Joined: 11 Oct 2005
Location: Wisconsin
 Reply with quote  

Ummmm....is that a hint you were supposed to be on my Valentine's day list? Shocked

~Tim~
Post Sun Feb 24, 2013 6:50 am
 View user's profile Send private message

Goto page 1, 2  Next
Reply to topic
Forum Jump:
Jump to:  
  Display posts from previous:      





Money Talk © 2003-2016