Mortgage Rate Mirage – Podcast Episode #467
– People often brag on social media about their low mortgage rate. But there’s a thread on Twitter about someone who might lose their house for taking a lower mortgage rate.
– The mortgage payment for these folks every month is $4,572.00 for a 10-year mortgage at 1.875%, which is now difficult to maintain due to their slowing business, and refinancing now would increase their payment due to a much higher mortgage rate.
– The thread suggests that taking a longer-term loan allows for more flexibility, as you can make extra payments when possible but revert to the minimum if finances get tight, which can be a safer strategy to manage cash flow and unexpected changes in income. Rather than reach for the lowest possible mortgage rate.
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Transcript for Mortgage Rate Mirage – Podcast Episode #467
Mortgage Rate Mirage
Welcome back to the podcast. This is episode number 467. I am Tom Mullooly, and let’s get into it.
I found a very interesting thread on Twitter recently that I wanted to share with you. It’s a little unusual.
People often brag on social media about their low mortgage rate. This is a thread that I’m going to share with you, where someone might actually lose their house for taking a lower mortgage rate.
I’m going to link to this in the show notes so you can read it for yourself, because it’s pretty amazing.
But it starts out by saying “I have a friend who might lose their home for taking a lower interest mortgage rate.”
I’m just going to say that again because it’s a real head-scratcher. Someone might lose their home because they took a lower mortgage rate.
Back in 2021, these people took out a 10-year mortgage. Ten! A 10-year mortgage rate at 1.875%, so one and seven-eighths percent. So two years ago, they took out a 10-year mortgage at one and seven-eighths instead of taking a 30-year mortgage rate at 2.75%.
Now, 2.75% mortgage rate for 30 years is about as close to “free money” as you can get. And we’re often asked by folks, “Should we consider paying off our mortgage?”
And the question usually comes down to, “Well, what are you earning on your excess cash versus what rate are you paying on your mortgage?”
Anyway, back to the story. The mortgage payment for these folks every month—this is just principal and interest, does not include taxes or insurance—is $4,572.00.
Instead, if they took a 30-year loan, their principal and interest payment would be $2,041. Their mortgage payment would be half.
They own a business. And now that their business is slowing down, they’re having a tough time making the monthly payment of $4,572. Even if they refinanced today to a 30-year mortgage, their payment would increase because rates have gone up. They would be looking at a monthly payment of $3,327 and would be paying hundreds of thousands in extra interest over the remaining 28 years of their loan.
If they took it all the way to maturity, they got into this loan in 2021. They’re two years into it. They’re in their third year. If they were to refinance today to a 30-year, they’re looking at 27 years of payments. Of course, you can always pay off your mortgage faster than that.
The original poster of this thread said, “I always advise clients to take the longer-term loan, even if the interest rate is slightly higher.” Then that’s where folks started chiming in… “Sure, always take the longer-term loan. You have the option to pay it off early.”
Plenty of other folks were coming in saying these people are stupid. “They played themselves.” “They just weren’t thinking of the downside.” One poster wrote a 30-year loan below 3% is only one step removed from a rich uncle giving you an interest-free loan.
This is a painful lesson to learn. Someone suggested, “Why don’t you ask for a loan modification? Banks will do anything to keep a house.” I don’t necessarily agree with that because the late payment and delinquency rates right now on mortgages—at the end of 2023—are at historic lows.
People are paying their mortgages, and plenty of people have mortgages that are below 4% interest, so people are in their homes. They’re not going anywhere. This is another reason why there is no inventory for sale in the marketplace.
This person chimed in with, “Ask for a loan modification. Banks will do anything to keep a house.” Again, I’m not so sure. It’s pretty early in the delinquency game. “Or allow someone to take it over subject to… and in return take a 20-year remaining term, or… it’s just complicated. I don’t know if that would work.
Someone came in with a question: What would be the payoff time if they took the 30-year and made the actual $4,572 payment for as long as they could? Meaning, what this person is asking is, I know that they’re struggling right now to make the $4,500 a month payment. What if they were to refinance into a 30-year loan at $3,300 but continue to make the $4,500 payment?
How much faster would they be paying down the principal owed on their balance? A person who’s in the mortgage business came back and said they would probably be paying off somewhere in the 15 to 16-year range—instead of the original 10 years, which still had over seven years to go, or a 30-year loan.
The person who posed that question came back and said, “I would take the 30-year mortgage and make extra payments. I did something similar with a 15-year versus a 30-year. I think I figured I was finished around 22 years. I made the 15-year payment for a while, but things changed, and that’s okay. Move to more regular payments instead.”
It hedges the risk, and that’s actually a really good idea. When you’re locking in a mortgage, look at what it would take to finish paying off the mortgage. If you’re taking a 30-year, ask:
– What would it take to pay off the loan in 20 years?
– What would it take to pay it off in 15 years?
Figure out the cash flow to make this work. And if you run into a tight spot, you can always revert back to the minimum payment.
We take the same concept when we’re talking with folks when they want to eliminate credit card debt, student loans, or any kind of debt.
When you have a debt and you get that invoice in the mail or sent to you online, understand that the finance company or loan originator is asking for the minimum payment for that month. That is the minimum.
If you can do more, you really ought to think about it.
Folks are in this thread saying, “Hey, they should have made extra payments along the way and get ahead on this mortgage.”
But people would have laughed at them. “Why are you paying down a 2.75% mortgage early? You should let that last as long as you can.”
It really depends on your situation, so you can’t take what you read online as the answer for your situation.
Maybe you’re self-employed.
Maybe you’re in a job where you work on commission.
Maybe you work in a situation where your income is going to fluctuate because there’s no more overtime.
When you do get overtime, or you get that extra bonus check, or you do get a commission that’s very large, you can do things like this.
Or if you have cash that is not earning the rate that you’re paying on your mortgage, of course, you should consider doing something like that.
Even if the rate is two and three-quarters percent, it makes sense to look at this.
But this is situation-specific; it’s anecdotal.
You can’t as a rule say, “Hey, you know if you’ve got this 2.75 percent mortgage, you should play it out for 30 years.”
Everyone is going to be in a different situation.
The thread goes on where they talk, and people are just amazed that someone who’s got a mortgage at under 2%, at 1.875%, is in danger of possibly losing their house. Because now they’re in a jam. They took this as a 10-year loan. And now they just don’t have the cash flow to make it.
Principal and interest alone is $4,572, almost $4,600.
Yes, they do have equity.
Yes, the price of the home went up, as it has across the United States.
So they could simply sell their house and just move into a different situation. But they could also do a lot of things like they’ve got equity in the home.
They could do a home equity loan. They could do a home equity line of credit. But this may only be a band-aid solution.
Because if their income is down, it’s going to be harder for them to qualify for a home equity line. And the payment is going to be a lot higher because it’s a second mortgage.
When you’re doing a home equity, remember there’s going to be two mortgages on the property. There are lots of people who chimed in on this thread saying, “Hey, they could have done this, they could have done that, they could have done an adjustable-rate mortgage, they could have taken out a 7/1 ARM.” They could have done all of these things.
The tragedy of all of this is, if they refinance to a 30-year loan, their payment is going from $4,572 to $2,041, and the interest saved per month is about $350 bucks. It’s not really even going to move the needle for them.
There were lots of people who were talking about “Oh, you should take in roommates, you should think about putting renters in there.” That’s going to be very difficult on a cash flow basis.
So, yes, they do have equity. They are in a situation where there’s not a lot of inventory, or they could probably put the house on the market and do something with this.
Friends, this comes down to managing cash flow, understanding budgets, understanding what could go wrong.
When you’re looking at these different scenarios, it’s very hard to predict the future. It’s very hard to say that your income is going to stay the same or go higher. It’s very difficult to say what the stock market is going to do, what interest rates are going to do.
It’s very hard to do these things. And so you’re taking a leap of faith.
When you’re building a budget and you’re managing your cash flow, you have to allow for the worst possible scenario.
In this person’s situation, ask “What if our business slows down and we then have trouble making a mortgage payment month to month? What next? What are we going to do?”
– Well, we have equity.
– We could sell the house.
– We could try and refinance and change our cash flow.
It depends on their situation. It’s going to be tough for someone, say, in their 60s, to refinance into a 30-year loan. Certainly, you could do it, but you’ll have, technically, mortgage payments until your late 80s or maybe even 90 years old.
There are a lot of folks that say, “Hey, I just want to refinance this down to a 15-year loan or down to (in this case) a 10-year loan. They want to be finished as soon as possible. The problem is they have really boxed themselves into a hole.
They are just two and a half, maybe three years, into these mortgage payments. And they’re finding out that they’re really drowning on this. And they’re in a situation now where they’re probably going to have to sell the house. It just seems like a head-scratcher. Maybe a year ago these people were probably bragging that they have a mortgage for under 2%, at 1.875%.
And now they’re in a situation where their payments are so high that they’re really struggling with this. Honestly, it’s a sad situation. Even if they were to take a 30-year mortgage at the time, back then at 2.75%, it’s so, so low compared to what’s out there right now.
I don’t think anybody expected that interest rates and mortgages would be going as high as they did. I mean, this summer, people were looking at 8% mortgages.
It was very possible he could have taken on a 30-year mortgage and just made extra payments. People would have probably laughed at him and said, “You have a mortgage at under 3%, why are you making extra payments? You could probably put the money into something else! Possibly earn a greater return, or earn extra interest—just sitting in treasuries.”
At the time no one knew where interest rates were going to go. Not only on mortgages but on investments in fixed investments like treasuries and CDs, bank accounts, and things like that.
Again, we’ll link to this thread in the show notes so you can see it for yourselves. There are a lot of people that chimed in, basically bashing these people for making a bad decision.
We all make bad decisions! But when it comes to things like understanding cash flow and understanding budgets, if you are in a situation with debt—whether it’s paying Visa or your mortgage, or student loan. Or any other kind of debt that’s out there—when you get the invoice, that is the minimum payment that you can make.
You can always send in more. Apply it to the principal and get your loan completed faster.
The problem is, you walk into a car dealership. The first thing they ask you is, “What kind of monthly payment can you afford?” You’re going to be locked into making payments for the rest of your life. Don’t do that. Think about what you can afford, what’s going to work for you.
Are you in a situation where you can pay down a loan balance a little faster? This is really a story about budgeting, about cash flow, about understanding your own situation because everyone’s situation is going to be different.
That’s going to wrap up episode 467.
Thanks, as always, for tuning in.
Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions in securities discussed in this podcast.
