Not Rich Yet | Managing higher incomes

May/10

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How I saved $5,600/yr on my mortgage

Our story

In spring of 2009 my wife and I fulfilled a long-time dream of ours and bought a house. We decided to live close to down-town in one of the larger metro areas, so we had to pay a steep price of around $600,000, but since we both hold good jobs we were able to comfortably afford the house.

Through some persistence and stubbornness we were able to lower our annual mortgage payment by a whopping $5,600. How? We avoided the so-called jumbo spread.

Fannie, Freddie and the Jumbo Spread

When you get a mortgage in the US, the issuing bank will often sell you mortgage to Fannie Mae / Freddie Mac. Those companies are pseudo-owned by the US government, and their principal role is to lower mortgage rates by buying up mortgages from banks for decent prices.

The government however has regulated what kind of mortgages Fannie and Freddie may buy. Mortgages they may buy are called “conforming”. Currently in most locations, including our city the limit for such conforming loans is $417,000 – i.e. your mortgage may not exceed $417,000. If you mortgage is larger than that magic number it is called a “jumbo” loan. Jumbo loans cannot be bought by Fannie and Freddie, and are therefore not subsidized. This leads to jumbo loan interest rates being higher than interest rates for conforming loans, an effect often called the jumbo spread. In the past year, the jumbo spread has been around 1.8% to 0.6%, impacted heavily by the real estate crisis.

What this means is that just by getting a mortgage north of $417,000 you automatically pay a higher interest rate e.g. 6.6% instead of 6%.

The hack

In order to buy our house for $600,000 with 20% down, we had to get a total mortgage of $480,000 – clearly above the conforming limit. When I started calling mortgage brokers, they all insisted that I needed to get a jumbo loan for 1.5% above the conforming rate – so instead of paying 5%, they wanted to charge me 6.5%.

If found this very frustrating, and was sure there was a better way. So I did my research and came up with the idea of a 2nd mortgage and found a good mortgage broker that allowed me to get 2 mortgages. The 1st mortgage was for $417,000 – a nice 30-year fixed rate conforming loan for a low 5% interest rate. The 2nd mortgage was just to cover the remaining $63,000. In the end my mortgage broker was able to offer me several options including a HELOC for 4.75% and a 5/2 ARM for a similar rate. By accepting the small risk of the variable rate for the HELOC or ARM, I was able to fix the vast majority of my mortgage a very low rate – over 1.5% lower than the jumbo rate. In fact, simple math shows that I would make out better with the 2nd mortgage vs. the jumbo-loan as long as the HELOC or ARM rate stayed below ~15%, a rather unlikely situation.

The impact

By implementing this jumbo-avoidance “hack”, I was able to reduce my effective interest rate from 6.5% to a bit under 5%, saving over $5,600 on my mortgage payments annually. While the jumbo-spread has come down a bit in recent months, it is still quite substantial and could also peak again if the much-talked about second wave of foreclosures rocks the real estate market.

How to do this yourself

When to use:

  • If you are even just even a little comfortable putting in some extra effort and dealing with some financial math
  • Either for new purchase or refinance
  • If your total mortgage would exceed your local conforming loan limit,. Please look up you local conforming limit here.
  • If your jumbo-spread is substantial, e.g. >25%: ask your mortgage broker for side-by-side quotes of a full (jumbo) mortgage and a conforming mortgage (both with same points, fees etc) – to see what the difference is. National rates are tracked here.

What to do:

Call up your mortgage broker and say you don’t want a single jumbo loan but instead 2 loans, one conforming loan and a 2nd mortgage for the remainder

  • If your broker doesn’t know what you are talking about, or pretends that this doesn’t make sense, fire him/her  and find a new broker
    • Brokers are not created equally
    • Going to 2 loan approach is more work for them, but of huge value to you, so you should insist on this
    • There are knowledgeable and hard-working mortgage brokers out there who will go the extra mile to win your business
  • Choose which 2nd mortgage option you are comfortable with and go and save a lot of money!

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1 comment

  • Christine Yokley · October 11, 2010 at 22:56

    Can I fire my mortgage broker we have signed some paper work but are still not yet finalized.

    Reply

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