Copyright © 2006 Ed Bagley
I told my son that normal closing costs for a re-fi of $148,638 at 6.5% for 30 years is $2,500. Total closing costs for his $134,999 proposed loan were $5,412, only $2,912 more. So I asked him “Could you be paying too much for closing costs?” Answer: Yes.
Then we looked at his original principal balance owing of $123,773 versus his new principal amount owing of $134,999 should he accept the loan. I pointed out that he is losing $11,226 before he even starts servicing the new loan. Yes, he is getting a home equity loan of $10,409, but what is he really gaining? Answer: Nothing. He is losing again.
Then we calculated the closing cost recovery rate of $5,412 using a financial planning program. He learned it would take 30 months of payments just to recover his closing costs. I pointed out that until you recover your closing costs you have not saved a cent in the transaction.
He had already made 12 payments on his existing $123,773 loan, reducing his principal amount owing to $122,623. He had earned $1,150 in equity by making 12 payments at $862 a month.
Then we looked at what his principal amount owing would be when he reached his 30th payment with the new loan. (Remember, it is going to take 30 payments to recover his closing costs.) Answer: $133,085 at a monthly payment of $1,233.
Then I asked him what his principal amount owing would be if he just kept paying another 30 months on his current loan plus the 12 months he had already paid. Answer: $119,342 at $898 a month.
The lights began to turn on in his mind. Now he recognized that he would be $13,743 ahead in principal owing if he just kept paying on the existing loan at the lower monthly payment ($335 less!).
This sudden revelation begged the question: How can this be? Answer: The interest on mortgage loans is front loaded. He learned that if he went for this nationally known lender’s great loan deal that he would be making loan payments for 30 months (2.5 years) and still owe $13,743 more in principal balance than if he kept his present loan and paid $335 less in his monthly payment.
Finally we looked at what it would cost to service both loans. His current loan had 348 months remaining (29 years) at $898 monthly. Total cost? $312,504. The proposed loan had 360 months remaining (30 years) at $1,233 monthly. Total cost? $443,880. The difference? $131,376.
Just how badly did he need that home equity loan? Answer: Not at all.
And how much would he save in actual dollars by not accepting the proposed re-fi from the lender who was supposedly helping him out? Answer: $157,495.
Here are the savings:
1) $11,226, the difference in the original amounts of the loans.
2) $1,150, the equity he already had earned from making 12 payments on his present loan.
3) $13,743, the difference in principal owing if he continued paying his present loan.
4) $131,376, the difference in the cost to service the proposed loan.
Never forget that finance is a dirty business like finding a cockroach on a cow pie.
The banker, mortgage broker or financial predator you are dealing with is not your friend trying to help you. He (or she) is your enemy trying to hurt you so his company can profit at your expense while he gets his big commission check and looks good to his employer.
If you want an excellent example of how your banker educates you about your finances, try swallowing his line about your first home purchase being probably the greatest and most rewarding investment you will ever make.
Remember that he talked about how your new home would be such a great asset for you. Anything to get you thinking you could not possibly afford your new home without his help, and that it would be your greatest investment.
Your banking friend never told you that your fantastic new asset is not even an asset but a liability. A liability, you say? Of course, silly, the bank holds the paper on your home until you pay it off, and your loan is really an asset on the bank’s balance sheet, not on yours.
By lending you the money to buy your home, your bank creates an asset on its balance sheet, and if it is an asset for the bank, it must, by straight accounting procedures and common sense, be a liability on your personal balance sheet.
Heck, if the banker told you this, you might think twice about becoming a 30-year employee of the bank while you are making your payments for the next 360 months.
Are all bankers and mortgage brokers bad people? Naw, only 95% of them. When you go to borrow money for your next mortgage, my best advice is Good Luck, and God Speed. I certainly hope you educate yourself enough to realize that dealing with the 5% will save you a ton of money and grief over the next 30 years.