Basic Rules of Thumb for Mortgages

Hello, this is Matt with EWA. Chris with EWA. Today we are addressing the basic rules of thumbs when purchasing a house and specifically when taking out a mortgage. So first topic, Chris, how should a client determine on how much to put down when purchasing a house?

That’s a great question. Generally, the rule of thumb that you’ll hear if you research is 20%. The reason for this is because typically, this is the cutoff where you won’t have to pay PMI or private mortgage insurance.

So private mortgage insurance essentially is a wasted cost that you would be paying until you get up to 20% inequity in the home. Chris, that’s a great point. What are ways to get out of PMI other than putting 20% down? Are there any exceptions to that rule?

It’s a great question. There’s certain instances, for example, if you’re a physician, there’s products out there called physician mortgages that allow you to sometimes put as little as 0% down, up to 5% down and pay no PMI.

Excellent. And do those come with any catches? Are there a higher interest rate versus if that is the same physician where to put 20% down? Yeah, typically it is a slightly higher interest rate, but given where we’re at just on a macro level in the interest rate environment now, we’re in strong favor of putting as little down as possible, simply because we can get a better rate of return elsewhere with our money.

That’s a great point. So I think two other considerations for that are tax ramifications and then also asset protection and ramifications. So asset protection is obviously a state -by -state specific, but in general, if a state recognizes tendency by the entirety, that’s one way that you can own your house to have it better protected than not.

And some states such as Texas have very good asset protection laws where the majority of your house will be fully protected in the case of a lawsuit, but some states include lower homestead exemptions, which mean you have a lower amount will be protected in the lawsuit.

So actually having a bigger loan and lower equity, if God forbid you’re sued and having your money stored somewhere else where it’s asset protected could be an asset protection strategy. Chris, talk to us about the tax ramifications from what’s deductible on the mortgage itself.

Yeah, that’s a great point. So from a tax perspective, if you itemize your taxes, you can deduct any interest on the mortgage, but that mortgage limit is 750 ,000. So for example, if you have a mortgage of a million dollars, only 750 of this would apply for that deduction.

Excellent. So Chris, how does someone determine what length of mortgage they should have? So for example, you could do a 10 year, 15 year, 20 year, 30 year. How would someone determine the duration of their mortgage?

Great point. That really comes down to individual circumstances. Our rule of thumb from a budget standpoint is to keep all home costs within 30% of your net take home. So say for example, you’re earning 10 ,000 per month net of taxes, we’d wanna keep that within $3 ,000 per month.

And if you’re making 20 ,000 a month, you could go up to 6 ,000 per month. With any financial decision, Chris, we always talk about three factors that should come into play. Rate of return. So typically with mortgages right now, with interest rates being low, rate of returns would favor more investing versus paying down debt.

But the two other factors are your time and peace of mind. So some clients just don’t like debt. So if having debt is gonna create any stress in your financial plan, regardless of the rate of returns, money is there as a support system for your life by design.

It’s there for peace of mind. And if debt does not give you, if debt keeps you up at night, then regardless of rate of returns or the interest rates being low, we’d recommend just to pay it off as quickly as possible or to enter, for example, someone retirement, simplify and not have a mortgage payment.

But Chris, what if someone wants to refinance their mortgage? Are there any general thumbs or for example, time frames, to refinance and then leave within a couple of years? Is it worth it with closing costs? Give us a breakdown of the landscape of refinancing.

That’s a great question. We’ve actually been doing this for a lot of clients in the past year or so. Generally, there are some closing costs that are associated with refinancing a mortgage. really important that we’re evaluating the time frame here.

So if you plan on moving in the next couple of months, it probably wouldn’t make sense to refinance just because you have to stay in the home long enough to break even. So just a quick example, generally our rule of thumb is around three years to stay in the home where it would make sense to refinance.

So let’s say you have a mortgage of $500 ,000 and we’re able to lower the interest rate by 0 .5%. That would be $2 ,500 per year of interest savings, but let’s also assume that the closing costs to refinance are $5 ,000.

So in this case, there would be a two -year break even. If you were planning on staying in the home under two years, obviously would not recommend to do that, but we could also explore ways that there are ways that you can refinance without closing costs.

Yeah, that’s a great point, Chris. So cash out refinances or someone that has a really old interest rate that wants to refinance to lower interest rate or someone that’s in a variable interest rate, or let’s say a seven -year arm, they’re in that six -year wondering should they refinance to a fixed rate, walk us through some options to avoid closing costs.

What kind of products are available that there’s potentially no closing costs? A great point. So some banks have different products out there. For example, what’s called a home equity installment loan. This allows you to refinance all of the mortgage debt into a new loan.

The downside is you typically have to pay taxes and insurance out of pocket. So a little bit more heavy lifting on the budget than having this wrapped up into one payment like you’re used to. Awesome, but that’s a way, for example, if someone is not sure of the length that they’re gonna stay in their current home, then they could refinance, take advantage of lower interest rate and not pay any closing costs.

Other than paying taxes and insurance out of pocket would just be an extra check. They have to cut over a year. That’s a great point, Chris. So what’s our thinking when someone is in a five or seven or 10 -year arm and they’re coming up on that time period where it’s gonna go to a variable rate?

Should they wait till the variable rates in place or should they get ahead of it and go into a fixed product? Yeah, that’s a great question. So generally fixed rates are gonna be a little bit higher than variable rates. So if we wait to refinance, we’re gonna have to pay a higher fixed rate.

So in general, if you think that you’re gonna stay there in the house, it’s better to refinance before the rate shifts to variable. That way, except that we might be locking in a little bit of a higher fixed rate. So for example, if a variable interest rate is 2% and a fixed rate is 3%, we can lock in the 3% now instead of waiting until maybe the variable rate goes to 3% and now the fixed percent is four and then now we’re locked into a higher rate for the next 30 years.

So it really comes down to timeframe and important that you’re thinking about this stuff before that rate switches to variable. If you have any questions on purchasing a new house, what kind of mortgage you should take or refinancing your current mortgage along with cash out refinances, we are here to help and answer any questions you may have.

Thank you, Chris.