Do you want to move but have a mortgage rate that is too low? Here’s what my friend does

I spoke with a friend the other day who was selling his house and moving to a larger home.

Crazy I know! And what about home prices, where mortgage rates are more than double their levels in early 2022?

However, they needed more space (and wanted a new place) and were ready to move out of their old house.

Sure, it may not be the best time to buy a home, but it’s not always about the finances.

Even so, they have a plan to offset the big jump in interest expenses.

They currently have a 30-year fixed mortgage at 2.75%.

First some basic information about the deal. They purchased their current home around 2012, which was essentially the lowest point of the housing market after the global financial crisis.

This was one of the best times to buy a home in recent memory. Aside from seeing the value of their home nearly triple, they were also stuck with an insanely low mortgage rate.

30 years fixed at 2.75%. It is very difficult to overcome. The purchase price of the house was about $400,000, and it is expected to be sold for about $1 million today. It’s also hard to beat!

The problem is that mortgage rates are now closer to 7% and replacement home prices are relatively high as well.

In short, if you sell today you get a much higher mortgage rate and sales price. This means a much higher payout.

They can actually accommodate the higher payment, but they know that swapping a 2.75% mortgage for a 7.25% mortgage isn’t a great trade-off.

So, this is the plan to offset the much higher interest expense.

Use the sales proceeds to prepay the new mortgage

This may not be for everyone, but many home sellers today enjoy home equity.

They either bought their homes decades ago and don’t have a mortgage, or they bought them in the early 2010s and saw their property values ​​skyrocket.

If we consider my friend’s purchase of a $400,000 house in 2012 with a 20% down payment and a 2.75% mortgage rate, the loan balance would be about $222,000 today.

Assuming a sale price of $1 million, they could get $650,000 or more. They chose to use some of these proceeds to make a dent in their new mortgage.

Not all of this matters to you, to save for an emergency fund. But a good piece of it.

Once they sell their old home, they will apply a large lump sum to the new loan. Let’s say the price of the new home was $1.2 million and they made a 20% down payment again.

The loan amount is $960,000 and the monthly payment of 7.25% is about $6,550. Obviously, this is a big jump from their old payment of about $1,300.

But they are able to pay a higher monthly amount, perhaps due to higher wages. Or maybe because they can always afford more.

Regardless, they don’t need a lower push to get it done. Their plan is to drop this loan balance in a short time.

They can pay off the new loan in less than 15 years

Compare lump sum payment
The loan amount is $960,000
There is no additional payment
Lump sum payment of $300,000
interest rate 7.25% 7.25%
Monthly payment $6,548.89 $6,548.89
Loan period 30 years 13 years
Interest savings unavailable $1,018,498

Now let’s imagine that once they sell their old home, they apply $300,000 of the sales proceeds to the new mortgage.

This brings the balance down to about $657,000 after just a few months into the new loan term.

Most importantly, this extra mortgage payment does not reduce future mortgage payments, because that’s not how mortgages work.

They still have to continue making that payment of about $6,550 unless they ask the lender to recast the loan.

However, and this is a big deal, they will save about $1 million in interest if they hold the loan to maturity.

Speaking of the maturity date, their loan will be paid off in about 13 years instead of 30 years.

This would effectively convert your 7.25% mortgage interest rate into something similar to your original interest rate. All thanks to the sales proceeds being sent toward the new mortgage.

Refinancing your mortgage is still an option

In the meantime, they can also monitor mortgage rates, and if they drop low enough, the refinance rate and refinance term may also be an option.

So they are not necessarily committed to the new 7.25% rate. If interest rates fall, they will have a much smaller outstanding loan balance.

This means your loan-to-value (LTV) ratio will be much lower, which equates to fewer rate adjustments.

For example, their LTV may be closer to 50% instead of 80% when it comes time to refinance. Generally, this means a lower mortgage rate as well.

Aside from refinancing, recasting the loan is usually also an option, assuming they want a lower payment.

This won’t save them a lot of money, nor will the mortgage be paid off early, but it lowers the monthly payments by re-amortizing the loan based on the smaller balance.

But if you’re more interested in paying less in interest, perhaps because you’re used to keeping a 2-3% mortgage, this is one way to do it. Assuming you can afford the higher monthly payment.

It is one way that an existing homeowner with a mortgage interest rate can free themselves without feeling bad about losing their old, cheap home loan.

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