Financing for a Second-Time Homebuyer
April 11th, 2008 | 6:14 am | Posted in Bargains, Finance, Mortgage | 3 Comments »
Not that I’m in the market to buy a house right now, but if the foreclosures come like their forecasted too (I’m not holding my breath), I may take a closer look.
Having already purchased a home once, in hindsight, I kinda wish I’d gone the 80/20 route (taking out two loans) so as to avoid paying PMI. Not sure how much of a benefit it would have resulted in, or even if I would have been able to make the payments that first year, but at the time, I didn’t even know it was an option.
But let’s say, for instance, the house next door to me went into foreclosure. I’ve always kinda wanted to “own the block”, you know, take over the neighborhood and eventually name the whole street after myself, so this scenario would be a good start.
What would I do differently now that I understand how loans and, specifically, amortization schedules work?
Well, I’ll tell you…
Let’s say the house next door goes on the market at $200k and my GFI says the bank will loan me up to $240k. I decide to close on the house. For simplicity sake, let’s just say there is no down payment — 100% financed. Interest rates are about 6% these days, no? Well, let’s go with that figure.
I could go with the tried and true method I did with my first home purchase and just borrow the $200k at 6%.
Or… I could go and borrow the full $240k the bank is willing to spot me…
This time, the older and wiser Brainy would borrow the full $240k and then, with my first monthly payment, I’d send the mortgage company the extra $40k right back, knocking the balance back down to $200k.
Wait… what? Why not just borrow the $200k? You’re still sitting on a $200k balance… What’s the difference?
There’s a *HUGE* difference…
With the larger $240k loan, the fixed monthly payment would be $1438.92 which is roughly $240 more per month than a smaller $200k loan would be. That is the only disadvantage. And given the assumption that you can afford a second home, another $240 per month shouldn’t be that great of an issue.
Working greatly in your favor are the interest payments…
With the smaller loan, it would take 30 years and over $430k going towards interest alone.
With the larger loan, and an immediate “extra” payment of the difference ($40k), you’d only pay a little over $143k in interest. As an added bonus, you’d also knock off over 10 years on the term of mortgage.
The end result? A savings of $287k and 10 years of not having to pay a mortgage.
Hardly identical $200k loans, huh?
Sure, some will disagree, “Why not just take the smaller $200k loan and pay the “extra” $240 difference each month…”
Yeah, the number from that method works out about the same, but for me, I’d prefer to have more equity from the start and to be guaranteed to have the mortgage paid off early rather than leaving it up to my own personal financial discretions…
It would also be a great way of eliminating PMI on a 100% financed loan… ;0)
April 11th, 2008 at 1:03 pm
Mortgage fraud alert! If the house is worth $200,000 and you get an appraisal for $240,000, something fishy is going on. Bad loans like what you’re describing are a big part of the current mortgage crisis.
Luckily, you can do this without defrauding the bank. If you want to pay your mortgage off faster, get a 15-year loan. A side benefit is that 15-year loans usually have a lower interest rate than 30-year loans.
April 11th, 2008 at 3:11 pm
Hi Anne!
I disagree that things like this are what has caused the apparent mortgage crisis. That is due entirely to people borrowing more than they could afford, many through cash-out refi’s, and then not paying their bills. I’m not advocating that.
It’s not a bad loan or a high risk to the bank if the recipient can afford it without any strain.
True about the 15-year loans having lower rates, but they also have higher payments. The real purpose of my example was to show how to maintain a high cash flow (through a lower minimum payment) but still pay off early.
April 11th, 2008 at 3:44 pm
The reason that the bank gives a good interest rate on mortgages is because the loan is secured. No matter how good a credit risk you are, a bank will always charge you a higher rate for an unsecured loan. In this case, you are essentially talking about a $200,000 secured loan and $40,000 unsecured loan, only you are telling the bank that the loan is fully secured.
Re: “higher payments” – you can get a 20-year loan if the 15-year is too high. In your example, the $240,000 mortgage is paid off in almost exactly 20 years if you make an immediate payment of $40,000 and then regular monthly mortgage payments of $1438. If you take out a 20-year loan for $200,000 at the same 6% interest rate, your monthly payment will be $1432. It’s the exact same thing because you always pay interest based on the current principal amount owed. If you can get a 5.75% interest rate on the shorter-term loan, your payment is only $1404.