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?