My Mortgage Dilemma - Prepay or Invest

Those look like nice homes It’s not quite so easy as it sounds. To some folks, they can immediately answer one way or another. If your interest rate is below 8.5% (I learned this by reading Pinyo’s analysis of prepaying your loan vs. investing at Moolanomy), depending on things like inflation and how well the stock market does, you’ll almost always come out ahead investing your money. Read that article and all the ones he links to at the bottom and you’ll get a real education on prepaying vs. investing.

At first, reading that article made me kind of depressed. Until early this year, I was paying an extra $100 toward the house payment each month. I didn’t stop paying it because I knew it would be better to invest the money, instead I stopped paying it when I realized it didn’t make sense because Melissa and I had already committed to buying a new house. That extra hundred went into investments in preparation of the new home.

But now, after reading all those articles, and doing some more thinking myself, I don’t feel as bad about my prepaying the mortgage. Sure, I could have made even more money if I hadn’t spent years investing that extra monthly $100 into the house. But sometimes personal finance is more than just seeking the absolute highest returns, or the absolute best interest rate, although I do see those as fantastic goals. At some point, you need to balance this with your personal level of acceptable risk, and balance it with your personal values.

Because we are moving (hopefully before the end of the year if the house is finished), I have to face this decision again. The financial part of me says invest anything you might have otherwise considered paying toward the principal. But there is another part of me that says that the house is a physical asset that can’t be taken away from me once I own it.

I’m going to have find a balance between my desire to own my house outright, and my desire to increase my net worth so I can retire early.

Even though something can make so much sense when you “do the math” or “look at the numbers”, it doesn’t always calculate when you take all the factors into consideration. What If I lose my job? That puts my house at risk because I don’t own it outright. What if we go through a bad recession? That could reduce the amount of return I’d make on my investments. What if we experience high inflation rates? Again, this can affect my savings and investments, but real estate tends to fare better against inflation.

Because we are getting an 80-10-10 loan (we are paying 10% down, getting one loan for 80%, and another loan for 10%), I am considering paying down the 10% loan aggressively. It will be at a higher interest rate and therefore costing me more in interest. Once the second loan is paid down my overall house payment will immediately drop. This extra money will go directly into investments. I think this way I can balance my desire to pay down my mortgage more quickly (even though I’ve still got 30 years left on the 80%), and my desire to invest more of what I bring home.

Image source tofslie

Our Plan To Remain Debt Free

Been there buddy! At the beginning of the year, we were able to declare ourselves “debt free”. This was no easy task I can tell you. We still have our mortgage, but we don’t consider it debt exactly. Certainly, it is debt, but it’s at a decent interest rate, we get a tax deduction for our interest payments, and if it’s our only debt, to me that’s “debt free”.

We managed to pay off both of our car loans early. We also eliminated all of our credit card debt this year. We did both of these primarily through some major changes in lifestyle (especially our eating habits - dining out can cost a fortune!)

Now that we are debt free, we have no intention of going back. We’ve made several changes in our life to help us not slide back into that “bad place”. Some of these changes include:

A strict budget - Not so strict we have to beat ourselves for an overage, but a guideline we shoot for with appropriate flexibility in certain areas. The budget helps ensure we live below our means, and that we plan for savings.
Our non-emergency emergency fund - This ensures that we never have to maintain a balance on our credit cards even when we go over more than our flexibility allows (up to a few hundred dollars).
Our emergency fund - This way we can handle even those big cases where we have an emergency. We’re very strict about this being used only for emergencies. Our goal is to eventually build up 6 months living expenses (bare minimum living expenses).
Delaying gratification - Like the iPhone incident of last weekend - I’m no longer going to just indulge myself. All of my upcoming purchases will be planned, and will require taking part of the budget and setting it aside for purchase in the future. This also ensures that when I do indulge myself, it’s not impulsive, and it’s something I’ve researched and know that I want. Oh, and that I find the best deal.
We will drive our cars until they can drive no more - Consumer reports says that can save up to $31,000. For me, a car gets me from a to b, and doesn’t need to be anything fancy. It felt weird typing that, but that’s how much I’ve changed recently. I used to want a flashy car, but now I’d rather save and invest my money.
Find the best deals - I want to understand how much something costs, where I can get the best deal, and make sure I’m not getting ripped off. In the past, I didn’t always bother to research and find the best deal, and convenience was usually the motivating factor. There isn’t anything wrong with convenience, but now I will measure that against other factors.

So, with these things in place, and barring any serious emergencies (like something medical), I think we can remain debt free. We have to remain strict and follow this plan. We cannot allow ourselves to fall back into the “old ways”.

I’d love to hear from other folks who managed to get out of debt. Do you have a plan to remain debt free?

Image source :Daquella Manera

The Sub-Prime Scrutiny Spares No Score

Freaky closeup of a $20 bill The sub-prime fallout has finally hit close to home.

When we decided on our new to-be-built home we got pre-approved for loans by 2 different mortgage companies. We knew we would have to go through the process again when we approached closing, but this was just to show the builder we could afford it. Getting pre approved was simple. They didn’t even want to see pay stubs.

Both of the loan officers approved us on the spot for our 80-10-10 loans and gave us excellent rates. We knew we would do just fine on everything. Our only concern was that we could appear debt heavy by holding the current home and the new home for a time. But it turns out we were still safely in the right percentages. With both of us having credit scores over 800 we thought we were golden. And based on our pre-approvals we were.

Fast forward to today. We get a notice from one of the brokers requesting that we submit a bunch of paperwork (basically an actual loan application with proof of income, assets, etc). Attached is a note saying they are no longer accepting “stated income” approvals. We never wanted a stated income loan in the first place but they wanted information on everybody because of the sub-prime mess. What a hassle.

The other loan officer says that although we will likely qualify without an issue, most of their lenders now want 80-20 loans and are pulling out of the exotic loans. An 80-10-10 is exotic now? Oh boy.

We will be getting new good faith estimates in November or December. Let’s see what happens then. We have started exploring our options in case the 80-10-10 is no longer a good plan. We already have our 10% down, but putting 20% down by December will be difficult, and we really want to avoid private mortgage insurance (PMI).

It makes you think. If we are facing potential difficulties with a loan with our scores, what in the world are people going through with scores below 700?

Image Source: AMagill

The Sub-Prime Mortgage Solution?

Now, if I can only find 6 roommates… President Bush spoke this morning about helping homeowners through the sub-prime mortgage situation by making it easier for some borrowers to refinance their failing sub-prime mortgage through the Federal Housing Administration (FHA) program, cutting down on predatory lending, and creating more transparency in the lending process.

As we’re currently in the process of having a new home built, this was welcome news. The recent sub-prime “crisis” actually did make me wonder about how many people would be buying homes, and if our homebuilder would be able to weather a downturn.

I do have some concerns about how this is going to affect the economy. I fully support helping out homeowners who were mislead into getting bad mortgages. If a lender mislead them into getting into something they could never have afforded without using some exotic loan mechanism and then not fully disclosing that, for instance, their loan payments would nearly double when their ARMs readjusted, then I believe those folks should get some help. Buying a home is no easy process. The mountains of paperwork can be confusing and overwhelming for people who aren’t prepared or don’t understand the process. They can even be confusing for those who do understand the process.

On the other hand I’m a little concerned about helping out those that maybe lied on their loan applications, or overstretched themselves expecting that the real-estate market would just continue in a never-ending increase in value. What kind of message does the government help send out here? Although this isn’t a bailout, it might still be sending the wrong message to those who got themselves in over their heads and may do so again. There is a cost to everything. Someone (the American taxpayers) will wind up footing the bill here.

The good news is that this isn’t a complete bailout. This seems to help a small number of people, and it’s targetted at those who need the most help. I think this is probably the right approach to resolving this issue.

Cutting down on predatory lending obviously sounds good. Who wants predatory lending practices? But what does this ultimately mean? Will any legislation that tries to cut down on predatory lending have an effect on lending in general?

For me, the big news is providing more transparency in the lending process. I haven’t seen any details on what this means yet, but it certainly sounds promising. I can only hope that something that will benefit us gets passed before we have to go through the process for our upcoming home. I’m very interested to hear more about what this will mean.

Read some more about the announcements at CNN Money. More information on the FHA program can be found at Bloomberg and at MoneyWatch .