Good news! After almost four months, my latest mortgage refinance to 2.375% from 2.625% for a 5/1 jumbo ARM is now done! What used to take 30 – 60 days to refinance a mortgage pre-crisis now regularly takes three months or more due to increased scrutiny by lenders. Higher lending standards is one of the main reasons why I don’t think there will be a housing correction as painful as we had in 2007-2010.
New readers may not know, but in 2015 I failed at my initial attempt to refinance my 5/1 jumbo ARM in its fourth year. The main reason for failure was I didn’t have two full years of consulting income under my belt. For any of you who are freelancers, even if you make $1,000,000 in 1.9 years, the banks will not count any of it during their underwriting calculations until you get past year two.
For those of you thinking about leaving your day job and becoming a rockstar freelancer, please refinance before leaving your job. Once you no longer have W2 income, you become dead to banks. Thank goodness rates came down again in 2016 and I did not give up! In this post, I’d like to share the factors that allowed for a successful refinance. Maybe it will encourage you to refinance or never give up if you’re in the process too.
The Deciding Mortgage Refinance Factor
After about the second month, my mortgage officer gave me the bad news that I wasn’t eligible to refinance the full ~$981,000 amount because my debt-to-income ratio was still too high. I needed to get it down to 42% or less. The most I could borrow was $800,000 if my income stayed the same.
Paying down $181,000 was possible because I had about $190,000 in cash at the time. But it didn’t feel good to lose so much liquidity at once. Instead, I asked her what if I just earned a higher income? After all, I was purposefully earning a lower monthly income to save on taxes and give myself the optionality for a bigger bonus at year end. She said that would work if I could give myself a raise without being an officer / owner of my company. I told her no problem since the owner and I are tight.
As proposed, my paycheck increased from $9,000 a month to $20,000 a month in the third month of the refinance. I got the company to write a letter to my bank stating I received a promotion to “VP Of Marketing” at the firm. Whoo hoo! The bank now said I could refinance up to $936,000 from just $800,000 previously, but still not $981,000.
Given I was willing to pay down $181,000 of principal to refinance $800,000 if the bank rejected my higher income and company letter explanation, I decided to split the difference and pay down ~$130,000 and refinance $850,000. It felt good paying down principal while still having ~$60,000 left in the bank instead of just $9,000.
Below is a snapshot of my final new loan. The total closing cost was actually around $2,800. The $4,779.25 in the document includes almost two months of pre-paid interest before my first regular payment is due.
Key Takeaways From My Latest Refinance
Takeaway #1: In any negotiation, there’s always a compromise. I refused to believe that having to pay down $181,000 in principal was the only way so I worked with my mortgage officer to find alternative solutions. Ask your officer what they are. Also, when in doubt, choose a middle path. A part of me wanted to refinance to the maximum allowable $936,000 and pay down just $45,000 in principal because my new interest rate of 2.375% was so low. Splitting the middle by paying down ~$130,000 instead of $181,000 allowed me to finally make up my mind and feel good about the decision.
Takeaway #2: Most people won’t be so lucky to have a boss who will give them a raise and a promotion any time they want. But most people don’t ask to take voluntary pay cuts as well, as I did at the beginning of 2016 to save on self-employment tax. Nor do most people have enough trust to give 100% ownership of a company to someone else given I started Financial Samurai while I was working in 2009, and didn’t want to have any conflicts of interest. Having a lower monthly income in 2016 than in 2015 looked off to the underwriter because they feared I was trending the wrong way. Therefore, if you plan to refinance or get a mortgage, always earn the same or an increasing amount of income.
My original plan was to earn a small paycheck and then receive a bigger bonus come year end to give myself and the business the most optionality possible. A business owner would love it if all employees were OK with earning a tiny salary until year end. As an entrepreneur, you never know exactly what your full income will be, therefore, it’s better to stay conservative until the chickens come home. I do not live off my online business income due to my passive income streams. For those interested, I can write a new post on how I structured my business to create better tax efficiencies if interested.
Takeaway #3: A long mortgage refinance is a blessing. Embrace it! Refinancing a mortgage is stressful because you’re up against a deadline. The longer the deadline, the less stress you’ll feel and the more time you’ll be able to improve your finances. To prove I was getting a raise, I needed another 15 – 30 days so I could show my new pay stub. As long as you aren’t paying extra fees for a longer mortgage refinance, encourage them to take their time. Drag your feet if they drag their feet. You want to maximize the fixed rate of your existing ARM until the adjustment period so you can get a longer fixed rate on the back end. Given this mortgage took almost 4 months, I gained two more months of “free time” because my next interest rate change is in August 2021 instead of June 2021. In other words, I was able to utilize my previous 5/1 ARM at 2.625% for 4 years and 2 months.
Takeaway #4: Be diligent. Not only do you need to get the timing of the refinance lock right, you’ve also got to get approved. I got my timing right in 2015 when the 10-year bond yield collapsed, but failed to get approved because I didn’t have two years of freelance income yet. I kept watching the bond market until rates collapsed again in early February 2016 when the stock market sold off by 10%. Banks want your business. So they will do everything possible to win it. It’s the regulators and underwriters who make things difficult. Check out the latest mortgage rates online to get multiple competitive quotes for free. Then use those written competitive quotes and forward the on to your existing bank to make them match or beat the rates. That’s exactly what I did in order to get 0.125% lower than the lowest quote possible.
Takeaway #5: If it so happens there’s a refinance opportunity between January 1 – April 15, wonderful! Refinancing during tax season makes the process easier because you’ve got to gather all your documents for the IRS anyway. There’s only about 20% more documents you need to gather for your mortgage application e.g. monthly pay stubs, proof of homeowner’s insurance, proof of consulting employment, etc. You may or may not have to get your taxes done for the previous year to get your mortgage approved either. I didn’t because I filed an extension due to a delayed K-1 statement. They just had me send in proof of the extension.
No More Refinancing This Property!
I’m tired. I’ve owned this refinanced property since 2005 and I never plan to refinance it again. Given I was able to pay off one of my rental properties in 12 years, I definitely want to pay off this property in 20 years or less (2025). Yes, $850,000 is a boat load of debt to pay down within nine years, but I’m going to try!
My strategy will be to wait until year four or five to see what rates and the economy are like before paying down multiple lump sums. 2.375% is just too cheap of a rate for me to aggressively pay down sooner.
I have yet to regret paying off my $464,000 rental property mortgage early in 2015. I doubt I’ll have any regrets paying this larger one off early either when the time finally comes.
Update: I also paid off $815,000 of mortgage in 2017 by selling my single family rental. It feels so good to deleverage as the bull market starts showing signs of cracks in stocks and real estate. 2018 was a down year for the S&P 500, while the median home price in SF fell by 11.5% from its peak i n2018.
In 2019, interest rates are now back down to two-year lows amazingly. See the chart below how treasury rates from different durations have all declined. It looks like the Fed will likely have to cut rates by 2020 instead.
Refinance Your Mortgage: Check out LendingTree for some of the lowest free mortgage rate quotes online for purchase or refinance. They’ve got one of the largest banking networks today. Rates have come down post election, and even after the Fed started hiking interest rates. When banks compete, you win.
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Updated for 2020 and beyond.