I dodged a bullet, Matrix style, and I didn’t even realize it until the coronavirus hit. The coronavirus pandemic has caused mortgage rates to drop once more as investors seek the safety of bonds.
Had I not refinanced my primary residence mortgage before I bought a larger house, I wouldn’t have been able to get my low rate or maybe even refinance at all.
Nowadays, banks are extremely stringent when issuing new mortgages or refinancing old ones. LIAR NINJA loans are gone. 0% down payments and negative amortization loans are also no more.
This lending stringency is one of the main reasons why I don’t believe the next housing bust will be as bad as the last one. The combination of massive housing equity gains plus high credit-worthy buyers since 2009 means that any correction will be modest.
Getting The Best Mortgage Rate
Let me explain why refinancing before buying a new primary residence was a fortuitous event. I’ll also share with you two more life events where refinancing beforehand is a must if you want the best mortgage rate.
As a recap, I refinanced my primary residence to a 7/1 ARM at 2.625% with no fees plus a $220 credit. My primary residence will eventually turn into a rental and an office space because we’re planning to move to our larger house once some remodeling is done.
1) Refinance before you buy another primary residence.
When refinancing a mortgage, a lender will categorize your refinance either as a primary residence or as a rental property refinance. Refinancing a primary residence almost always has a lower mortgage rate when compared to refinancing a rental property. The average difference is anywhere from 0.75% – 1.25%.
The reason why a rental property mortgage has a higher interest rate than a primary residence mortgage is that the bank treats your rental property like a business. The bank assumes that you will have a tenant or multiple tenants who will pay you rent in order for you to pay your mortgage, taxes, insurance, and maintenance expenses.
Without a tenant, the bank assumes your business will have a difficult time surviving.
It doesn’t matter how high your income is or how much you have in assets, the bank will ring-fence your rental property and treat it as a stand-alone business that is dependent on rental income. Given there is more risk to the property, the bank will commensurately charge a higher interest rate to compensate for the higher risk.
Even if you show a history of rental income that more than covers all rental expenses, the bank will likely take a 30% discount to your historical rental income as well. This is the bank’s way of accounting for tenant vacancies, unknown maintenance expenses, and unknown risks.
Therefore, if you know you plan to buy another primary residence and you plan to keep your old residence as a rental, you must try and refinance your current primary residence before getting into contract if you want the best rate.
Please note that even if you buy another property with cash before you refinance your primary residence or while you are refinancing your primary residence, the lender will aggressively question the purpose of your purchase.
If the property is bigger, the lender will assume that you will eventually move into the new residence. Purchasing your new property with cash does not preclude you from scrutiny given you still have to pay the property tax and maintenance expenses.
What will help get the lender off your back if you did buy another property before or during your refinance is if you can show a signed rental lease agreement and proof of rent.
The lender is trying to avoid getting tricked into giving you a primary mortgage rate if the property is really a rental. However, the timing in which you can turn your primary residence into a rental is a gray area. After all, something can always come up. You have the right to rent out your property if you wish after the refinance is complete. You also have the right to buy a new primary residence whenever it is feasible to do so.
2) Refinance before you leave your job or retire.
Once you lose your W2 income you are dead to banks. It doesn’t matter how high your credit score is, how loyal you have been to the bank or the fact you have a coin collection worth more than the mortgage itself. If you no longer have a job, it is almost impossible to get a mortgage or refinance a mortgage.
The only way you can get a mortgage or refinance a mortgage without W2 income is if you have at least two years of 1099 freelance income. Not only do you need at least two years of freelance income, but your freelance income also has to be high enough to support the mortgage amount. Further, that freelance income amount has to consistently be at least 3X higher than the mortgage payment.
Although I strongly believe it’s easier to earn a lot more money as a freelancer since you can earn from multiple clients simultaneously, the initial years may be tough going. No bank wants to risk lending money at a prime rate to a person without a proven track record for making a steady income.
An exception to this rule is if you have significant amount of other assets as collateral and you have a large enough recurring stream of MISC-INT or passive income that has been established for many years prior. Even then, however, such income will be discounted by at least 20% when the lender does its analysis.
Even if you have a higher-paying new job to replace your old job, the bank may still decline your mortgage application if you have less than one year’s worth of employment history at the new shop. If the bank doesn’t outright reject you, it may charge you a higher interest rate to account for the uncertainty.
3) Refinance before you go back to school.
Going back to school is similar to quitting your job or retiring. The good thing about going back to school is that the process usually takes between 6-9 months i.e., apply to school, school acceptance, leave your job, start classes.
For example, you might decide in July 2020 that you want to get your MBA starting in August 2021. Therefore, given the average refinance takes roughly three months, you have plenty of time to refinance your primary residence. Get the refinance going once you’ve submitted your school application.
Even if you plan to rent out your primary residence after going to graduate school, you have every right to refinance your mortgage as a primary residence loan while it is still your primary residence. Again, life changes. Lenders can’t force you to live in your house forever.
The Best Mortgage Rate Comes When You Have A Job
Please don’t take your W2 income for granted. The longer you have the same job, the more attractive you will be to banks. Banks love stability.
By refinancing before these three events, your mortgage rate will be 0.75% – 1.25% lower than if you try to refinance after these events.
Unless you have mega millions, strangely, it doesn’t seem to matter how big your net worth is or how much you generate in passive income. As soon as you lose your W2 income, you might as well kiss your financial credit-worthiness goodbye.
Not only should you refinance your mortgage before giving up your W2 income, but you should also try to refinance any student loans and outstanding credit card debt if you have any.
Looking to refinance or getting a new mortgage? Check out Credible, my favorite mortgage marketplace where qualified lenders compete for your business. You will get real quotes to compare in under three minutes. Interest rates are back down to all-time lows thanks to the coronavirus pandemic and a bear market in stocks.
Readers, anybody make the mistake of trying to refinance after buying another property or after losing your W2 income? If so, how did that go?
Can Samurai explain???
How do banks justify giving 30 year home loans to 70 year olds? Even if they are working? I see it happening all around me, but they’ll more than likely be dead before 30 years? Are loans ever calibrated with life span? Or do they assume a 70 year old can keep earning at current rate for 30 more years? Is it illegal for them to discriminate on age?
We just had a business partner buy a 700k house with less than 20% down. We know he has very little because his marriage imploded because of an affair. His new wife is a broke bludger who had nothing and hadn’t worked- she had been living off of welfare, her mom and child support and doesn’t work now. Still he got a loan for a five bedroom house for his new family and he is about 70.
Another bullet point to add, refi or buy Before you change your job status from full – time to part – time. I learned this the hard way during a rental home purchase and lost my loan qualification. Your 95% dead to a bank with a part time employment status.
Hey. Really great gouge there, but I would recommend staying away from debt all together. I paid for my 1st house outright when I was 24. It’s actually very doable with determination. We made a small income back in those days but we saved enough to purchase an inexpensive condo from a foreclosure. They were selling off a bunch of them bc the property management group was going bust. I’m so thankful we bought and lived in that cheap place. It allowed us to bank a couple of years before trading it in on a starter home which easily doubled our initial investment. Then, after banking another couple years, I enrolled in a contractor class at the local collage to learn how to contract the construction of our large dream home. 4,800sf with a 3-4 car garage on a large lot. I’m not a builder, it was just something that I had always wanted to do and it actually saved us a ton. We were in and paid for at age of 28. After another few years of banking we changed our dreams again and transferred out of state for a new job followed by a complete career change. We ultimately purchased/lived/sold a few more houses which essentially doubled up assets again while still remaining completely debt free. It was kinda fun and the process became super easy. It quickly got to the point that I dreaded dealing with realtors. I preferred clean cash sales. Of course it saved a ton that way, but it also allowed me to be in charge of the deal. I was able to avoid the back and forth middle man crap all together. It’s much easier that way and less stressful in my opinion.
I know the arguments about low rate mortgages allowing wright-offs and investment capital, etc. but it’s tough going down that road when income is limited, especially with kids in to provide for.
I’m turning 53 in a few weeks and in yet another home as of 2.5 years ago. This one is my all time favorite. it’s actually the smallest too! Crazy, but I love it. Super nice little place on a large lot with great privacy. It even has a huge detached garage/man cave, automatic gates and so forth. I’m so thankful for my decision to remain debt free. I make a respectable salary in a stable pos these days but no one knows what the future will bring. I don’t ever want to to worry about a mortgage if something were to happen to my job, health, economy, or whatever. Any of those things can be snatched away in a blink of an eye. My current situation allows me to maximize my income toward saving for retirement. I’m able to max out the 401k, catch-up contributions, ROTHs, and sink the rest in individual investment accounts.
Congrats for paying cash for a home 30 years ago and believing it is easily doable today. If you have kids, is that what they did too?
Thank you much:) Just to be clear, I do not believe it’s easy to pay off a house these days! I said it is very doable with determination. Not easy. No sir! The part that I believe is easy is the process of buying and selling a home (without a realtor). Not saying realtors aren’t useful. I usually prefer to lead the deal myself for simplicity. Of course it saves money as an added benefit. I’ve found it to be even easier with cash. Cash can be a huge bargaining tool. It is ultimately what landed my current home at a price well below asking. This home is in a hot area that’s hard to purchase anyway as they commonly bid up above the asking price. Cash and flexibility are huge tools when entering a bid!
The kids: No, haha. They are both in college. My daughter is a 1998 model who’s 1/2 through college with a full academic ride. My son is a 2000 model. This is his 1st year at college. He got 75% covered. I’m very thankful for that because I didn’t put near enough in their college funds. They are both working to pay for expenses that scholarships do not. They have student loans in place but they haven’t had to dip into that yet. They did something recently that impressed me. After bouncing about low paying part-time jobs the oldest decided that if she’s going to work she’s going to shoot for the best job available. She landing a part time job at the most expensive restaurant in town. Two layers of interview with video submissions. Intense for someone that age. They spend 2 months training before ever cutting them loose to wait tables. Tip are insane and she can adjust her schedule to accommodate college. She recently helped my youngest get an interview at the same place. Now he’s hired also. Hopefully they are own their way to doing something great with school but neither of them have a cue what that might be at this point.
1) Why pay cash when you can borrow sub 3% and make 6-10% in the equity market (more if tax adjusted 401k or IRA)? Just make sure your monthly payment is less than 25% of your income, ideally closer to 10%.
2) Median house US is over $200k, and in larger cities way over that. Very few people will have that kind of liquid cash to pay 100% cash.
3) Unfortunately the foreclosure market isn’t as easy to win cheaply these day swith so many flippers
Solid advice. There are so many things that are easy to overlook when it comes to mortgages and real estate and you nailed this one on the head. Long term W2 income is huge when it comes to refinancing. I remember hearing about a self employed freelancer who wanted to get a new loan and couldn’t because she didn’t have any W2 income and the banks didn’t want to take the risks with her.
Any advice for someone purchasing their first home under a current rate lock? Looks like rates have dropped 20 bps since I locked, is there a protocol for people in my situation to renegotiate with the bank that’s done the work and approved the loan? Closing date is in 45 days, got approved early.
Simply ask if you can re-lock since rates have collapsed recently.
It is one of the mortgage refinance fees.
I was able to lower my mortgage rate after I locked, with no additional cost. You never know unless you ask.
Ah this is gold. My wife and I are in the process of purchasing for the first time and we are looking for a mortgage that will give us 0% down, and the lowest possible rate. Seems impossible but I am almost certain I have found something that meets that criteria.
Great pointers on what to do/what not to do before refinancing, although im sure the same rules apply for buying too.
Thanks for the great post
Regards,
Dr. Dividend
One addition to the “new job” situation. Many corporate relocation packages include a preferred loan vendor that will work with initial financing of a new home purchase. In my experience, they frown on financing a new mortgage if you have one on the previous home. After the new home purchase they are often willing to work on a refinance even though you have been in your new job < 1 year. YMMV, of course, but they tend to like to stay in the good graces of the corporate relo people to keep that income stream coming.
Sam, can I ask your advice for how my wife and I might find the best rate for a new home purchase? I am willing to do a 7/1 ARM like what you did in your recent refi, but not sure if I should approach a mortgage broker, or seek out special “relationship pricing” at a big bank, or all of the above?
Incidentally, we just moved to SF and are hoping to find a 2/2 condo for under $1.5m.
I’d check online first since it’s the easiest route. Then I’d compare what you found online with your main banking relationship and see if they can beat it. Then ask about relationship pricing.
I’ve noticed each bank generally has 3 or 4 tiers of relationship pricing, depending on the amount of assets you bring over. $250K/$500K/$750K/$1M+ are levels I’ve seen.
I will be shocked if you can’t get a nice 2/2 condo in a good area for $1.5M or less. There is a lot more inventory for condos. GL!
Where are you getting those refi rates? I don’t see anything like 2.6 out there even with perfect credit and relationship discounts.
I assume you are paying points? If not, please list the bank. I’m sure they would appreciate the plug.
No points. I listed WF before in my post: All The Costs In A No-Cost Refinance.
I also talk about relationship pricing here: The Difficulties Of Relationship Pricing
Are you bringing over $1 million+ in assets? What rates are you seeing for a 7/1 and 5/1 ARM? I did refinance back with the 10-year bond yield was at this level too: 1.6%.
Sam-New refi rates are at 2.375% for 7/1 with $1M relationship pricing at Chase. I am the one who directed u to WF
Amazing! Time to refinance again! :)
Hmm, but I’ve already got assets at Chase. But it’s a business account, not personal. You think I can still qualify?
Some real food for thought here. We do intend to sell our home, one that has no mortgage and is just a few miles from from NYC, before moving someplace warmer, cheaper, and considerably less urban.
I had thought of keeping the house as a rental, but I don’t want the headache, especially as we will be a long ways away most of the year. On the other hand, this would certainly be the way to go if we did, using the freed cash to build/buy the new home.
Before, I had always assumed we would sell first, then live in a RV, or rent, until the new place was ready, or else sell some non-retirement fund equities and pay cash if we were going to wind up holding both at once for any length of time.
Depends on your cash flow and other assets.
Managing a NYC home while in Florida may be a PITA, even with a property manager. Depends what you want to do with that house too e.g. give it to your kids.
I plan to rent out my house b/c it is where my son was born. It is also only 1 month away and I know everything needed to fix and maintain the house there is. There are synergies when a handyman comes over to just fix something at the other house.
The house I sold in 2017 was across down. Only 20 minutes, but much more a PITA. And the tenants were terrible.
Yep. I was doing it the other way around when I first moved up here. Kept my newly purchased home in Florida as a rental.
But even with superb tenants and a property manager, I found it a nuisance (especially minor repairs) and I was only making about 9% on the investment as far as I could figure.
So I sold it to the tenants just a few years ago and put the money into ANNGs (FAANGs without the F) and Rockwell Automation (just because I’m a big believer in automation). Quickly tripled the return and have since doubled the money (knock on wood).
And you’re right, remotely managing this house would be an even bigger PITA, even though I’ve constantly been doing some fairly major renovations (bathrooms) and having things replaced, roof, appliances, AC, etc.) nothing will make it a new home and it needs an owner that’s a handyman (or knows how to call in favors from one).
Just echoing your thoughts. All very true. Most odd to me is the complete disregard for the owner’s balance sheet even if its many multiples of the mortgage requested.
Another minor point is to get a refi before a major remodel . . . or after it’s fully done.
Whenever we’ve done a refi the bank makes us sign that we will use the residence as our primary residence for at least 12 months. The closing documents include a form that says if we change the property from a Primary Residence to an Investment/Rental within 12 months we have to notify the bank.
We turned our most recent primary residence into a rental when we moved in 2019.
Good to know. I’ve always just had verbal inquiries. I’ve never had to sign a document. But maybe I have in the past and I just don’t remember. I didn’t have to sign such a document this time around.
The thing is, even if you move into a new house before 12 months and notify the bank, what is your lender going to do? Completely change the terms? I’ve never heard that happen. Life happens though. What if you just need a bigger house or got another job opportunity and had to buy a new house in a new location?
If there are stories about lenders changing the terms after one moves into a new house within 12 months I’d love to hear it. It feels like the stuff is just a formality. A lender cannot control your life after the loan closes.
I agree, tough to see the lender taking action even if you move. Maybe if rates had increased significantly, but then housing prices would be under pressure and don’t see the lender wanting to take action as long as payments are being made.
The occupancy agreement on my most recent loan (which seems in line with prior mortgages) indicates that it has to do with the assignment of the loan. So it’s possible you didn’t have to sign anything if the lender was planning to keep the mortgage in their portfolio.
“The Lender has advised me and I understand that this loan which I have applied for has been made available with the understanding that it will be assigned by the Lender to another mortgage investor, and that a requirement of
such assignment is that I will occupy the property as certified in Paragraph 1 above.”
Paragraph 1 just states that I have to move in within 60 days, and have to maintain the property as my year round address for 12 months.
I think I’ve had two loans get sold to another bank. One was the loan I just refinanced. It was resetting to 4.5% and I’m sure the acquiring bank was hoping I’d pay the new higher rate.
Enforcing action after a loan is closed reminds me of investing as a non-accredited investor for a deal that requires accreditation but without verification. What is the gov’t going to do if they find out? By the time they do, you could be accredited.
Samurai, what would you say about the VA-backed home mortgage program? Veterans that have served honorably for as little as one term of enlistment or commissioning can qualify for up to $510,400 with NO DOWN PAYMENT for a total cost of a 1% funding fee (initial loan), or 3.5% on all subsequent mortgages! Another benefit of military service!
Sounds great to me! I think our veterans need all the support from the government and from us. I fully support any programs that can help people who served in our military.
Into the veterans who can take advantage of these loans, just make sure you’re not buying more than you can really afford. You can get an easy loan, but you might not be able to get bailed out if things go awry.