Buying Your Final Home: Payment versus the Rate/Cost Tradeoff

Hello, Mr. Melson,

I am one of your legion of fans of your www.searchlightcrusade.net website, having lucked into stumbling upon it by hyperlinking from another site. It is my goal to read EVERY ONE of your archived articles before I buy a house.

Yes, I wish you were here in DELETED, where I'd pay your going rate in a heartbeat to be my non-exclusive buyer's agent; but I must content myself with your archives to learn how to navigate this shark-infested swamp of BUYING A HOUSE. (Unless your services can guide me to such an agent here in DELETED.)

In hopes you can use this for a topic of one of your essays, yes, my husband and I are the proverbial "aging baby-boomers" looking to buy a house with his VA benefits and not interested (so as to be able to sleep nights) in anything but a 30-year fixed mortgage.

What makes us different from others in this category who might be writing to you is that we have no children, no family, no heirs but The Nature Conservancy; and we view our buying rural property as OUR LAST HOME with no relevant consideration for estate taxes, amortization, refinancing, ever paying it off, or any other usual
worries.

My question, should you be able to turn this topic into an article about Vietnam-era vets using their VA benefits to buy their final home with absolutely no intention of ever moving again and being able, through employment, disability benefits, and--soon--social security, to make the payments until we shuffle off this mortal coil,

WHY SHOULDN'T WE SHOP THE LOWEST PAYMENT WE CAN GET AND NOT THE TOTAL COST, AS WE HAVE LEARNED FROM YOUR ESSAYS?

Thank you from the bottom of my heart for your altruism in promoting consumer education on what has to be the most dangerous and confusing transaction any American consumer will ever undertake: BUYING A HOME.

Cordially,

Item the first, payment is trivial to lowball. Let's take a more or less standard example based upon rates a few days ago. I had a thirty year fixed rate loan at 6.00% for two points. Let's say you were buying a $300,000 home, and chose that 6.00% loan. $300,000 at 6.00% is $1847.16 per month. However, that transaction has closing costs of about $3500 in addition to those two points, plus the VA funding fee of half a point if you're not disabled. This gives a balance of $311,282. and a payment of $1866.30 (VA loans are allowed to roll up to 3% on top of purchase price into the loan). By pretending that $11000 plus doesn't exist, I could quote a lower payment, and most lenders do precisely because people do shop by payment. But you're either going to come up with it out of pocket or pay the higher costs. Actually, in this case, that's about $2300 cash you're going to need to make the transaction happen, that they conveniently neglected to mention because you're above the 3% "roll in allowance". Furthermore, these aren't the only games played with lowballing. Most people are amazed at how much it's possible to legally lowball a mortgage quote. Nor do the new proposed regulations change this. If you're shopping by payment, someone who writes an honest quote on the above is going to look like a more expensive loan than someone charging another point or so, who figures on cannibalizing your Good Faith Deposit and still rolling the maximum 3% into the loan, but pretends this money is going to come from out of the twilight zone. VA loans are just as subject to pretending real fees don't exist as any other loan.

VA do loans have another simplifying feature - they only come in fixed rate loans. I haven't kept close track, but last I knew, it was not allowed to get a VA guarantee on a ARM, hybrid, or balloon loan. This eliminates the trick of them telling you it's a "thirty year loan" while not mentioning that it's not a fixed rate for the entire time. And if you're looking for 100% financing, it's not like the lender is going to substitute something else, given the current lender fear of the market. But it has happened in the past that people were told they were getting a VA loan, but it turned out that wasn't the paperwork they signed.

Last issue on this point, there is the question of whether the rate was really locked, and for how long. Mortgage Loan Rate Locks are for a definite period. The longer you want to lock, the more it costs. So someone who knows it's going to take 45 days and quotes based upon a 45 day lock is going to be at a cost disadvantage to someone who pretends that a 15 day lock is going to be the same, and doesn't actually lock the loan, but lets it float. Six weeks from now when documents are ready, your rate is 6.75% because the market has shifted upwards and your loan was not in fact locked. Alternatively, they locked for 15 days and you ended up paying five or six tenths of a point in extension fees - significantly less that the upfront difference, which is usually about a quarter of a point.

Item the second: People refinance, far more often than most people believe or are even willing to admit. You think that if you get that 6.00% loan today you're going to be happy forever. But then rates go down to where they can get 5.5% for that same two points, and they refinance. Or somebody comes along and sells them on a 5.5% loan that requires three or four points. There are VA loan companies that go around selling these, and they've got presentations that make it look like a good deal - which they are if you're one of the rare individuals who can resist them in the future. Problem is, they're going to be just as appealing then as they are now, and it's going to be just as good a deal then as it is now - providing you can resist future sales pitches beyond that. Let's look at how much money you've wasted if someone comes along and sells you a refinance a year from now:

Your choices: 6% for two points (plus VA funding and $3500 closing costs) versus 6.5% for zero points (plus VA funding and $3500 closing costs). Balance on loan 1 after 12 months is $307,459 Balance on loan 2 after 12 months is $301,615. You did save $740 in payments with loan 1, or $1150 in interest. The VA streamline does not require an appraisal, and can roll another 3% into your balance, so let's say you can get 5.5% for three points, which means a minimum of 1.5 points out of pocket, but you figure it's worth it to cut your payments. Your balance is now $316,680, and you spent $4700 plus in hard cash, to boot. $21000 plus in financing costs, to keep your payment low. If you get the "no points" loan to start with, your financing costs are $10650 in your balance and about $100 less out of your pocket, or roughly $15,000 - a difference of $6000, which is roughly $35 per month forever.

People really do get into this kind of refinancing loop, and actually it's worse than this becuase most people roll a month or two of payments in, plus the impound account. They just spend the money from the payment check they don't write and the impound account as well. I once spoke to a guy up in Riverside County who bought for just under $160,000, and the costs of serial VA streamline refinancing had driven his balance up over $230,000. This is real money. If they had just refinanced less often, or for lower costs, their payment would have been almost thirty percent lower, and he would have had sixty to seventy thousand dollars more equity in his property!

Issue the third: What happens in such a situation if you have a need for that money? It's gone. But aging people - particularly without heirs - develop needs for money. For instance, long term care expenses. I wrote a three part series on that quite some time ago, and here are the most recent updates one, two, three (The Republican congress later in 2006 repealed the so-called Waxman Amendment I reference in part two, but most states still do not have a partnership program). And it's not just long term care, either. You may have medical coverage and not need to worry about it, but I assure you that many seniors are not in such happy circumstances. You may be wishing at some point in the future that you had that equity available to you. I've met quite a few who did.

In short, there are a lot of traps lying in wait (or ready to be set) for the people who shop by payment. Whereas if you shop by the tradeoff between rate and cost, Ask the questions you need to, get a loan quote guarantee and/or a back up loan, doing what is necessary to have the lender take the pricing risk, the payment is the byproduct of these more important items. Payment is, after all, determined by simple mathematics.

None of this is to say it may not be a good idea to buy the rate down as much as you can. If you have a history of not refinancing for ten years or longer, and you swear a pact in blood not to refinance ever, no matter how good the deal, it is a good idea to buy the rate down with points. It also reduces your cost of money over time, if you keep the loan long enough that you recover the cost of those points. The drawback is that this puts a lot of money into what is effectively a bet that you're not going to sell or refinance for a long time. If something about your situation changes before you've recouped the money, that money you sank into the rate is basically gone.

For most folks, this bet is a very poor one to make. It makes the odds of successfully completing an inside straight look good. The outcome is under your control, but the vast majority of people who make this bet voluntarily let the house bank off the hook before they've recouped their wager investment. Nonetheless, it is a bet that can work out very well if you are a member of that tiny minority who does keep their loans long enough. In the example referenced above, the borrower who keeps the initial 6% loan the full term and pays it off will pay only $360,583 in interest, versus $389,042 for the 6.5% loan, a difference of $28,458, almost five times the difference in cost of procuring the loan. For your upfront bet investment of about $6200, you get your payment lowered by $61 per month and initial cost of interest by about $96 per month. If you keep the loan the full term of 360 months, you more than get your money back. But for the population in aggregate, that's a money losing investment, as the median time people keep their mortgages is about 28 months. Even if you double that, you're still on the losing end of the wager.

Caveat Emptor

PS I am intentionally not taking into account the time value of money, or the alternative uses for the money, but $6000 invested at 10% per year turns into roughly $105,000 in 30 years, and $34,500 at 6%, which would, by the numbers alone, be another reason not to do it.