Why a Home Should Be Your First Investment

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Real estate has been described as the basis of all wealth. Without considering income or investment property, buying a home to live in is an incredibly powerful way to build wealth or financial net worth.

A home is an asset measured by the size of the equity. Equity is simply the difference between the value of the home and the amount owed. There are two powerful dynamics at work to increase the equity which include appreciation and amortization.

Appreciation occurs when the fair market of the home increases. The shortage of available inventory coupled with high demand has contributed to an 18% increase in value in the past year on average for homeowners in the U.S.

Most mortgage loans are amortized with monthly payments that include the interest that is owed for the previous month and an increasing amount that is paid toward the principal loan amount so that if all the payments are made, the loan would be repaid by the end of the term.

A 30-year mortgage at 3.5% interest on a $400,000 loan amount would have a principal and interest payment of $1,796.18 every month for 30 years. After the interest is applied from the first payment, $629.51 would reduce the loan amount, thereby, increasing the owners’ equity.

Each succeeding payment would have an increasingly larger amount applied to the principal and a decreasingly lower amount applied to interest.

Recently, CoreLogic reported that homeowners with mortgages have seen their equity increase 29.3% since the second quarter of 2020. Equity rich is defined as when combined loans secured by a property are no more than 50% of estimated market value. ATTOM reported that 42% of mortgaged homes in the U.S. are considered equity rich as of the fourth quarter of 2021.

Another advantage of this powerful asset is that borrowing money against the equity of your home is a non-taxable event. Regardless of whether it is a refinance or a home equity loan, the borrowed money is not income and not taxable.

A homeowner could stay in the home for years and as the home increases in value due to appreciation, they could borrow against their equity as many times as the value will justify. They could continue to pull money out of their home for decades and under the current tax law, they could die and will the home to their heirs who would receive a step up in basis and the taxes would never have to be recognized.

Lastly, let’s consider the home as an investment by looking at the rate of return. Obviously, it is a personal asset that the homeowner will be able to live in, enjoy, raise a family, and share with their friends. In calculating the rate of return, we consider a $375,000 home with a 3.00% 30-year FHA mortgage with a 3.5% down payment. Using an annual appreciation of 3% and normal amortization, the $13,125 down payment in this home turns into a $148,062 equity in seven years. The rate of return calculated is over 40% per year for the seven-year holding period.

Even if you discounted the ROI by half for all the unforeseen other expenses that may affect the real equity, it is still a 20% return on investment which could easily justify why purchasing a home should be your first investment.

It is challenging, particularly in some markets with low inventory, multiple offers, rising prices and increasing interest rates, but the advantages of owning a home are significant. Would-be homeowners need the facts about their market and how to get into a home. Start with downloading the Buyers Guide and make an appointment with a trusted real estate professional.

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Paying Points to Lower the Rate

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Two commonly known ways to lower your mortgage payments are to make a larger down payment especially if it eliminates private mortgage insurance and improve your credit score before applying for a mortgage.

Another way to lower your payment would be to buy down the interest rate for the life of the mortgage with discount points. A discount point is one percent of the mortgage borrowed. Lenders collect this fee up-front to increase the yield on the note in exchange for a lower interest rate.

A permanent buy down on a fixed-rate mortgage is available to borrowers who are willing to pay discount points at the time of closing.

Let’s look at two options on a $315,000 mortgage for 30 years at 4% interest with no points compared to a 3.75% interest rate with one-point. The principal and interest payment on the 4% loan would be $1,503.86 compared to $1,458.81 on the 3.75% loan.

The $45.04 savings is available because the buyer is willing to pay $3,150 in points. By dividing the monthly savings into the points paid, you can determine the breakeven point. In this example, if the buyer is planning to stay in this home for at least 70 months, they would recapture the cost of the points and each month after that would be savings.

Another interesting thing to consider is that lower interest rate loans amortize faster; in other words, they build equity faster by paying off the loan sooner. If the buyer stayed in the home for 10 years, their unpaid balance in this same example would be $2,117.38 lower than the 4% mortgage. Combine that with the $2,259.29 in savings from the breakeven point to the end of 10 years and the buyer, in this situation, is $4,372.67 better off buying down the mortgage by paying the additional points.

For a person buying a home, it may be difficult to come up with the extra amount for the points but one benefit is that the points paid are considered interest by IRS and can be deducted in the year paid.

A rule of thumb commonly used is that one discount point lowers the quoted mortgage rate by ¼% or 25 basis points. A lender may quote X% + .6 points for a mortgage. Using this scenario, to lower the mortgage rate by .25%, the buyer would need to pay 1.6 points. It is important to note that each lender determines the pricing of points for the loans they make.

It may be beneficial to a buyer to pay points depending on how long they plan on being in that home. To help you determine whether paying points should be considered, use this Will Points Make a Difference and download the Buyers Guide

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I wish I knew then…

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We have all heard this expression that implies that had a person known earlier in life what they know now, they would have done things differently. The subject possibilities are endless While no one has a crystal ball to see into the future, it may be possible to learn from people who have experienced similar situations.

In the late sixties, mortgage rates hit 8.5% but before the decade had finished, the rates had come down to 7% where they stayed for some time. Homeowners who purchased at the higher rate, could buy a larger, more expensive home for the same payment if they could get out from under the obligation of their existing mortgage.

FHA and VA mortgages, up until the late 80’s, could be assumed by anyone, regardless of credit worthiness. Since these homes were purchased one or two years earlier, the sellers didn’t really have much equity in them, and many homeowners were willing to “give” them to investors so they could qualify on a new, lower rate mortgage.

It was a fantastic opportunity for investors who could afford the negative cash flow because the homes wouldn’t rent for the payment. As the 70’s economy, started heating up, so did inflation. Most people consider inflation an undesirable thing but for people who owned rental property, it meant the values were going up and so were the rents.

Soon, the rentals no longer had negative cash flows and the investments turned the corner. If you talk to investors who purchased those homes during that period, you’ll very likely hear, “I should have bought more of them.”

If we could fast forward into the future to see how people will be talking about the period we’re currently in, we might see an even greater opportunity in our present time. Interest and mortgage rates have been on a downward trend for thirty years. In the past ten years, they hit an historic low. They are trending up currently and it appears they will continue to do so.

Homes are in short supply which has caused the prices to go up. Builders haven’t returned to the number of new units needed to meet demand and that has been going on for over ten years. Even when the supply does increase, it will take a long time to catch up with demand.

Combine that with supply chain shortages due to the pandemic and prices look like they are unaffordable. Many millennials and some Gen Xers believe the “window of opportunity” has closed.

For tenants, rents are continuing to increase due to the same causes that home prices are increasing. Buyers, by acting now, can lock in their mortgage rate and the purchase price of the home. As prices continue to increase and the amortization of the mortgage pays down the unpaid balance, homeowners’ equity increases and so does their net worth.

Unfortunately, for tenants, the rents will continue to rise, along with prices which will make it more difficult in the future to purchase. Their rent is used to pay the landlord’s mortgage who benefits in the principal reduction for each payment made.

The market is changing and people who don’t own a home currently must find a way to buy one. The longer they wait, the harder it will be to buy one.

People wanting to purchase a home in today’s market must educate themselves with facts and not hearsay. There are all sorts of programs available to address low down payments, varieties of mortgages, credit issues and other things.

It starts by meeting with a real estate professional who can recommend a trusted mortgage professional. Download our Buyers Guide and check out your numbers using the Rent vs. Own.

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Your Home is a Hedge Against Inflation

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The concern about inflation is the sustained upward movement in the overall price of goods and services while the purchasing value of money decreases. Tangible assets like your home consistently become more valuable over time. In inflationary periods, your home is a good investment and a hedge against inflation.

Money in the bank loses purchasing power due to inflation and the interest you may be earning is almost always less than inflation.

Home prices are going up but so is rent. With mortgage rates near historic lows, the interest is, generally, less than the appreciation the property is enjoying. Combine this with the leverage that occurs using borrowed funds to control an asset and your equity is most likely, growing at a faster rate than inflation.

A 90% mortgage at 3.5% for 30-years on a $400,000 home that appreciates at 4% a year will have an estimated equity of $220,000 in seven years due to appreciation and amortization. That is a 27.5% annual rate of return on the down payment. That is a significant hedge against a current inflation of 4%.

If a person were to put that same $40,000 in a certificate of deposit that earned 2%, it would be worth only $45,947 in seven years. If it was invested in the stock market that earned 7% annually, the $40,000 would grow to $64,231. The equity in the example for the home would be almost 3.5 times larger.

The assets that are considered to be good bets against inflation include some bonds, gold and other commodities and real estate. Another distinct advantage of investing in a home is that you would be able to live there with your family and enjoy it which is not possible with bonds and commodities.

There are certainly other considerations in a comparison like this such as maintenance, but it could be offset, at least partially, by the cost of housing being less than you would be paying for comparable rent. And with the shortage of rental units available, the rent will certainly continue to increase annually where your housing costs are fixed with the exceptions of increases in property taxes and insurance.

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Why is the APR higher than the interest rate?

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Annual percentage rate is a calculation to accurately reflect the cost of the mortgage considering the note rate of interest, financing fees and charges based on the term of the mortgage.

Annual percentage rate, APR, calculates the interest rate and loan fees over the life of the loan expressed as a rate. A mortgage has a quoted interest rate plus a specified number of points which may be paid at closing or rolled into the loan, in some instances.

For example, a $400,000 loan amount at 2.98% interest for 30-years with 0.7 points would have an annual percentage rate of 3.0349%. While the mortgage rate is quoted at 2.98%, the borrower must additionally pay 0.7 points or slightly less than one percent of the amount borrowed as a fee to the lender in consideration of making the loan.

This increases the yield to the lender on what they are earning by making this loan and is expressed as the annual percentage rate for the benefit of the buyer.

Since the lender is required to include all the loan fees being charged in the APR calculation, if the seller is paying some of those fees on behalf of the buyer, the APR would not accurately reflect the cost to the buyer.

The lender is required to disclose the APR to the borrower in the Truth in Lending document referred to a TILA. Your mortgage officer will be able to answer any specific questions regarding what is included.

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There’s more to it than you might think

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There is more to selling a home than you might think. Superficially, a person might think that it will sell itself currently because, nationally, homes for sale receive 3.6 offers and they sell within 18 days.

Any business student can probably list the four Ps of marketing: product, price, place, and promotion. It may appear that there isn’t much to selling a home: put a price on it; photograph it; put a sign in the yard; and, put it in MLS but, on closer scrutiny, there is a lot more that the best agents provide.

Long before the home goes on the market, the agent will create a detailed value and pricing study based on similar homes in size, price, proximity, and condition. An overpriced home will sit on the market longer than it should. The longer it stays on the market, buyers, as well as other agents, begin to wonder if there is something wrong with it.

The agent will develop a staging and declutter plan to make the house show at its best because first impressions matter and this type of effort provides a neutral canvas for buyers to start imagining their things in the home.

The marketing plan is a comprehensive strategy to consider every aspect of selling the home with the focus being to maximize efforts to get the highest possible price, in the shortest time with the fewest unanticipated events.

The individual marketing materials need to present the home in its best light. It begins with professional photos because today’s buyers will most likely, first see the home online and if the pictures don’t make the property look good, they may decide not to see it. In addition, those photos will be used on the brochures for the home and just listed announcements, as well as social media. They are crucial.

Among the most important value the agent brings to the table is their negotiation experience. Every phase of the sale involves negotiation and the position of third-party negotiator eliminates an uncomfortable situation for sellers having to deal directly with buyers, other agents, appraisers, inspectors, and lenders. Your listing agent will be your champion.

The following list includes typical things that most professionals will provide. When interviewing an agent, feel comfortable to ask questions regarding their position on these items. Another item you might find helpful is our Sellers Guide.

Listing Presentation

  • Create Value/Pricing Study
  • Staging/DeClutter Plan
  • Develop Marketing Plan
  • Document Preparation

Marketing

  • Professional photos
  • Property Description
  • Lockbox
  • Sign
  • MLS & Portals
  • Flyers
  • Showings
  • Open Houses
  • Answer phones
  • Just Listed/Just Sold
  • Prospect for buyers
  • Weekly Follow-up – Seller
  • Inquiry phone calls
  • Pre-qualify buyers
  • Maintain files

Negotiations

  • Meet with buyer’s agent
  • Write & Review contract
  • Net sheet
  • Present offer
  • Negotiate

Pending

  • Inspections
  • Appraiser
  • Resolve Issues
  • Review Escrow Statement
  • Track buyer’ loan progress
  • Coordinate closing
  • Documents Review
  • Attend final inspection
  • Attend settlement
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Will Soft Inquiries Hurt Your Credit Score?

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Soft inquiries, sometimes known as a soft credit check or a soft credit pull, do not impact your credit scores because they are not attached to a specific application for credit. They can occur when a credit card issuer or mortgage lender checks a person’s credit for preapproval purposes.

Examples of soft inquiries are when you check your own credit or one of your current creditors checks your credit. If you are concerned about the negative impact on your score, specify to the lender that you want a “soft pull” to see if you qualify for preapproval.

Soft inquiries may appear on your credit report but should not adversely affect your credit score.

Consumers are entitled to one free copy from each major credit bureau, Experian, Equifax and TransUnion, once every twelve months available at AnnualCreditReport.com.

Hard inquiries occur when a borrower makes a new application for credit. These will impact your credit score and will remain on your credit report for about two years. The impact is usually minimal and scores tend to rebound within a few months if no new negative information appears.

Borrowers may be concerned about multiple inquiries when they are shopping for rates or even approvals. Scoring models have algorithms to account for this situation if the inquires take place in a 14 to 45-day period.

Even a hard inquiry should not necessarily concern you and probably, will only play a minor role in your score. Soft inquiries, regardless of how many you may have will not impact your score.

Working with a trusted mortgage professional and sharing your concerns in advance of the “hard pull” is valuable. This mortgage professional may even be able to advise you on some things that could improve your credit score which may actually improve your score which could result in qualifying for a lower rate that could save thousands and possibly, tens of thousands of dollars over the life of your mortgage.

Your real estate professional can recommend a trusted mortgage professional to you.

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Paying Down Your Mortgage

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When the situation arises that you have a lump sum of cash to pay down your existing mortgage, there may be different options available. Pre-paying principal on a fixed-rate mortgage shortens the term of the mortgage but the payment stays the same.

Conversely, recasting a mortgage with a lump-sum principal payment lowers the principal and interest payment but leaves the term intact with the same payoff date.

The interest rate on the mortgage will stay the same regardless. Prepaying principal can be done at any time but may not be applied until the next payment date. Recasting cannot be done within the first 90-days of a mortgage.

Pre-paying principal is like driving faster on a trip to a specific destination to get you there sooner. Recasting/Re-amortization gets you to the destination at the same estimated time of arrival but using less fuel.

Most loans allow you to pre-pay principal, but recasting is not allowed on FHA, VA, and GNMA. If you have a conventional loan, check with your lender to see if it is possible.

Contact your mortgage servicer for specific information on pre-paying or recasting your mortgage before acting.

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In Search of a Big Mortgage

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The Fannie Mae and Freddie Mac loan limits are adjusted annually to keep up with cost of living but with the appreciation experienced in many markets, it may not be enough. When the conforming loan limit is not enough, qualified buyers can turn to a jumbo loan.

The maximum loan limit on conforming, conventional loans for 2022 is $625,000 for a single-family home but is increased up to $937,500 for designated high price areas. The underwriting guidelines for conforming loans are consistent with regards to things like minimum down payment, private mortgage insurance, debt-to-income ratio, minimum credit score and cash reserves required.

Jumbo loans are loans more than the FNMA maximum limits and are considered non-conforming loans. This allows lenders to set their own requirements on maximum loan amount, minimum required credit score, maximum debt-to-income ratio, and minimum down payment.

The rates paid on the jumbo loans may be the same as conforming loan rates. It might sound logical that a larger loan would have more risk and therefore, be priced higher. Lenders do not sell jumbo loans to FNMA which saves them the guarantee fee normally required. This makes the jumbo loan more profitable. Borrowers are encouraged to shop the rates.

A minimum credit score of 700 will probably be required together with a debt-to-income ratio below 45%. While many borrowers seeking a jumbo may be putting 20% down, it is possible to find a lender who may only require 10% down payment. Lenders may be more lenient with regards to mortgage insurance.

Lenders may also require six to twelve months of cash reserves due to the increased risk of the larger loan amount.

It is a common practice for banks to make jumbo loans to attract other business that the borrower might be able to influence like company, corporate, or investment accounts.

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Credit Utilization Affects Your Score

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Credit utilization reflects how much of your available credit is being used at a given time. Lower credit utilization indicates that a borrower is not heavily relying on their credit and that they are using their credit responsibly.

Is calculated by dividing your total credit card balances by your total limits. The higher the percentage, the higher the risk which adversely affects the credit score according to most of the companies. It is recommended that your credit utilization be under 30% to positively impact your credit score.

If the available limit on a credit card is $12,000 and their normal monthly balance is around $3,000, they have a credit utilization of 25%. If for whatever reason, the borrower’s available limit was reduced to $6,000, and their long history of having a monthly balance of $3,000, the ratio, then, increases to 50% which will likely lower their credit score.

For borrowers who use more than 30% of their available credit and regularly pay off the bill each month, they should consider making payments toward the balance more frequently, like every two weeks. This keeps the balance lower, and, in many cases, the card issuer will only report the credit activity once a month to the credit bureau, usually on the monthly closing date of the account.

Another option may be to use multiple cards, if they are available, for the purchases during the month. Based on the limits of each card, this could result in lower utilization on a single card.

You could also ask for your available credit to be increased. Assuming you have a good history of paying on time, this may be an easy fix. Before doing this, ask if it could negatively impact your credit score because it will be reported as a hard inquiry on your credit.

If you are trying to improve your score to qualify for a mortgage, consult with a trusted mortgage professional who can advise you specifically for your situation. If you would like a recommendation, please contact mePeteDotyDenver.

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