Buying a home comes with huge financial implications, and many of them come into play well before you make an offer and close on your mortgage. You could spend months, years, or even decades saving up the down payment for your home — and that’s especially true if you plan to save 20% or more or if you live in an expensive area.
To make the most of your situation, you’ll need to focus on two main imperatives — figuring out where to save your down payment funds, and deciding on a mortgage that fits in with your budget and your goals.
Many people assume picking a mortgage is a piece of cake, but that couldn’t be further from the truth. While it’s easy to think you’ll just get a 30-year, fixed-rate mortgage because that’s what all your friends and colleagues have done, a home purchase provides the perfect opportunity to think differently about what you really want.
In this podcast, we’ll go over my thoughts on where you should save your down payment if your time horizon to buy is ten years or less. But we’ll also talk about the mortgages available today — and how the obvious mortgage choice isn’t always the best.
Ready to start saving for your dream home? Listen to today’s podcast episode by clicking on the links below:
How to Listen to Today’s Episode
Episode Links & Resources:
- 👉 Get Your One-Time Retirement Plan
- Ally Bank Online Savings Account
- CIT Bank Savings Builder Account
- All In One Mortgage Simulator
- Home Loan Gal – Sarah Lindsey
- Should I Invest if I’m Saving for My Next Home Purchase? [Blog]
- Don’t Buy a Home in San Diego — Rent Instead [Blog]
Episode Transcription
Saving for a Home? Don’t Make These Mistakes With Your Down Payment
Taylor Schulte: Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today we are talking about mortgages. I'm also going to be talking about how to invest the money you're saving for a down payment on a home, and maybe it's a primary home or another investment property.
But I want to put to rest a very common mistake that people make with their money when they're saving for these real estate down payments. And share with you what I think the best solution is and then be sure to stick around because I'm also going to have a special guest on the show today and her name is Sarah Lindsey.
She's a certified mortgage planning specialist, but she's better known as the home loan gal and she's a wealth of information and she has some really cool stuff to share with us today. Buying a home is really expensive and most people truly don't take costs into the consideration, and one of the biggest costs is the interest that you pay on the life of a mortgage.
So Sarah's going to be bringing to the surface a new type of loan that for the right person can help reduce the amount of interest you pay and also speed up the repayment of the loan. We typically only hear about 30-year mortgages or 15-year mortgages or maybe adjustable rate mortgages, which a lot of people got into trouble with.
But buying a home and securing a mortgage is a huge decision. And while the loan that Sarah's going to talk about today isn't for everyone by any means, I think we just kind of owe it to ourselves to explore all the available options out there and choose the one that's best for us and our financial plan and not just do what our friend or neighbor does or just because we've been doing this for the last hundred years.
For all the details links and show notes for this episode, you can go to youstaywealthy.com/42. All right, let's geek out on some real estate.
Sarah Lindsey: At the end of the day, you have to do what you're comfortable with. It's your financing, it's your future. The mortgage has been around for 90 years the same way all the time, so it's a different mindset to understand the way different products could work and could save you money. And then the next question like you said is are you comfortable to do it that way?
Taylor Schulte: Home prices are far from cheap today, and if you're making the smart money move to put at least 20% down on a home purchase, that down payment can be pretty large, like easily six figures in most major cities.
And when we see six figures in our bank account, uninvested and what most people would say, essentially doing nothing, it's easy to start to wonder if we should be investing that money to try and earn a higher rate of return. Maybe you're not going to buy this home or this investment property for three to five years, and most of us, you want that to earn as much of a return as possible.
We certainly don't want it to do nothing, and we also don't want an inflation to erode that bucket of money. And while it's important to make sure our money is working for us, we do have to kind of take a step back and really think about the goal that we're saving for and align our investment plan up with that specific goal.
In short, if you think that you're going to use the money that you're saving for a down payment on a home within the next 10 years, yes, 10 years, that money probably shouldn't be invested in stocks and bonds.
The best place for this money in my opinion, is a high-yield savings account that's FDIC protected. The good news is that these high-yield savings accounts, especially the online banks, are paying around two and a half percent these days. Some of them are paying even more. So we're finally starting to see some return on cash, which is a positive.
And as long as you're not with one of these big brick-and-mortar banks, you're going to get a little bit of a rate of return, which is nice. So our money really isn't doing nothing. Now two or 3% isn't anything to write home about, but it's certainly better than the 0% that a lot of us were getting for a long time.
Personally, I use an online bank for my cash savings called Ally ALLY. It's not a recommendation, it's not for everybody, but there are dozens and dozens of online banks out there, very similar to Ally that all pay a very competitive rate of return.
Now, I know what you're probably thinking right now, like 10 years. You want me to put this money in cash for the next 10 years. That sounds absolutely absurd. So let me break this down a little bit.
First, 10 years is my personal conservative rule of thumb. You might hear other people say five years, you might hear people say seven or eight years, but I say 10 years because there have been time periods historically where stock market returns have had a negative return over a 10 year time period. You might've heard the term the lost decade. We've had lost decades before and we certainly don't want our down payment.
This money that we saved so hard, we work so hard for and we save for this down payment on a home or an investment property. We don't want this money to happen negative rate of return when we could be safely getting one, two, 3%, maybe even more if interest rates creep up. If we can get a safe rate of return, we certainly don't want to expose ourselves to a potential negative return.
So that's the first thing. The other way I like to illustrate this is to play a little game with yourself. And I can't think of a better title, I just call it what's worse play this game called What's worse. So let's say my wife and I want to buy a home in the next five years and we have a savings account. We've worked really hard and we've saved up about $200,000 and we want to use this $200,000 for a down payment on our next home.
We have two options. We can keep that money in cash at our online bank that's paying us a little bit of interest, or we can invest this money into stocks and bonds and try and earn a little bit more of a return. Remember, there's no such thing as low-risk high return.
So if we're going to put our money in stocks and bonds, we're going to hope for a little higher rate of return. It's more risk, a little bit more return. So we have these two options available to us and let's look at the worst case scenario for each of these options and then play this game. What's worse?
So worst case scenario number one, we keep the money in cash. We keep our $200,000 in cash. Let's just say it earns 2% per year over the next five years. Okay, we earned a little bit of something, but let's say the stock market was just on fire and earned 8% per year over that time period.
So that's worst-case scenario number one, we leave the money in cash and we just watch the stock market just rip on bias and it earns 8% per year. And if that happened, my wife's probably looking at me right now and really angry with me and saying, I told you we should have invested this money. I thought you were a financial planner. What's wrong with you?
So that's worst-case scenario number one, and that doesn't feel good for anybody. Worst case scenario number two is we invest this $200,000 that we have earmarked for a home, we invest it into stocks and bonds, and the economy goes through a recession, which is completely normal. Recessions are part of normal economic cycles. So we don't have a crystal ball. We don't know when that's going to happen.
So let's just say tomorrow we invest this money in stocks and bonds and then in a year or two years, the economy goes through a recession and this $200,000 that we had saved for this down payment, let's just say is now worth $125,000 because the stock and the bond markets are just kind of falling apart.
I'm pretty sure that my wife would be even more angry at me in this scenario when I tell her that we no longer have that 20% down to buy that beautiful San Diego home that she had her heart set on, and now we have to sit around and we have to wait for the market to turn around and the economy to turn around.
So for me, for us, for my wife and I, scenario number two is far worse and I would choose number one every time, and maybe you're different. Maybe you're willing to take that risk and if you're willing to take that risk, that's fine. Just explore it and understand the risk that you're taking and be sure you talk to your spouse.
This is a really important conversation. Now, there are other scenarios you can around with too, such as maybe you don't plan to buy a home for five to seven years. And so again, you start thinking, well, if we're not going to buy a home for five to seven years, maybe we should put this money to work and invest it in stocks and bonds.
But what if you have a significant life change? What if you have a baby or you have a career change or a sudden change to your life and all of a sudden now you want to buy a home next year or you want to buy a home right now and that five to seven time year period just doesn't apply anymore?
These big changes can certainly occur, and if the cash that you had earmarked for a home is invested, and again, the market's in a tough place and maybe that 200,000 is worth 180 or one 50, you might not be able to buy the home that you are hoping for. So just because your goal is five to seven years now, remember, that can change.
And so I like that 10-year number because anything can happen in 10 years, that's a pretty long time period, but I like to use that 10-year number as a really conservative number. So again, things can change quickly and we can't plan for everything perfectly. It's just not possible.
If you've worked hard to save money for this home down payment, keep that money safe, keep that money close to you in case something changes or in case the economy goes through a difficult time. To me, it's just not worth the risk to try and squeeze out a little extra return on this bucket of money.
So in summary, stocks for the long run, 10 plus years cash for the short term less than 10 years. Be sure to check out the show notes for the links to where you can park your cash. I'll link to some of these online savings accounts that pay a decent rate of return.
Again, you can go to youstaywealthy.com/42 and stay with me because joining me right now is Sarah Lindsey, the home loan gal, and she's going to talk to us about mortgages, the history of mortgages, and a new type of loan that for the right person can be a way to mitigate interest and pay down the mortgage quicker. I hope you enjoy.
I wanted to kick things off with the stat that you shared with me, which I think might shock a lot of people, which is a $300,000 loan 30-year fix, which is like a really standard loan that everyone knows about a 30-year fixed loan at 4%, which is pretty low on historical standards. If you hold this loan to term and you pay it off at the end of 30-years, you shared with me that you're going to pay about $215,000 in interest on the term of this loan.
So that's $215,000 of interest on a $300,000 loan. And I love the way you put it, which is that's about $7 for every $10 you borrow. So how the heck does this? Even you think, again, you have this 4% loan, it's a great rate. How do you end up in this position at the end?
Sarah Lindsey: Banks know how to make money is basically what it boils down to. It's the mortgage product is from the depression era, getting people into homes, but also making money for banking institutions. And it works really well that way, and the traditional mortgage is set up to pay the majority of your interest first.
Taylor Schulte: And that's what I definitely want to talk about for sure, because you have something really neat to share with us today before we get to what that solution is. A mortgage is the single biggest personal expense any of us will commit to during our lifetime.
And one of the other statistics you shared with me is that many households spend up to half of their disposable income on housing costs, which is crazy. And then as you know, our saving rates are really, really low. So we're spending 50% on our housing. And then I think you said something like less than 5% saving for retirement.
Sarah Lindsey: Right now according to trading economics, it's gone up a little bit, 7.6, but still overall really low.
Taylor Schulte: Yeah, that's crazy. So I mean, unless someone really plans ahead and they're really smart and diligent with their money and using their mortgage properly, I see two types of dilemmas most, and you tell me, I mean, I know there are others and we can get way down this rabbit hole, but the two that I see most are client has their mortgage paid off approaching retirement, mortgage is paid off.
They have this beautiful six seven figure home in San Diego or wherever, but they didn't save enough for retirement, right? They're so committed to paying this loan down that they own this beautiful home that they probably want to retire and live in forever, but they didn't save enough for retirement.
So there's that dilemma that people run into. And then there's the other one where people are making good money, they've done a really good job saving for retirement, but they haven't put a dent in their mortgage. So they've got a million dollars saved up for retirement, but this huge loan still on their home and they have this dilemma to how do I fix this?
And we will talk about some of the solutions today, but you made the comment, the traditional, the original mortgage was a product of the depression era. So we're using this product that was born out of the 1930s. So maybe you could just start off by talking about some of the fundamental problems with this and why are we still using this product today?
Sarah Lindsey: Well, it makes the banks a lot of money, so they're not going to want to get rid of it. And it's really a wonderful product for banks because they get all of their money upfront and with most people, they don't refinance.
Well, they'll either refinance or sell the house within the first seven years. And I think most people can relate to having a mortgage balance. Let's just say that's $500,000 and they're making a $2,500 a month payment and $500 of that payment goes towards actually reducing the principal balance on the loan. That other $2,000 is going towards interest, and it's not until years 12 and 13 where you actually see on a traditional 30-year fixed mortgage.
That's what most of us have is where you actually see the amount of interest that you're paying is then equal to the amount of principal per payment. And then it's not until years 22 and 23 that you've paid just as much principle on the loan down on the loan as you have in total interest costs up to that point.
So it's just a major money maker for the bank, and it's with, like you said, if we can find ways to save more money, increase our savings, save more money for retirement, we're all going to be in a better position. And paying less interest on a mortgage is definitely something that a lot of people are interested in, and that's what I specialize in is finding ways to help people do that.
Taylor Schulte: And I think it's interesting that when you talk about mortgages with people or just lending in general, people seem concerned about two things, the rate, the interest rate and term. That's generally what we hear people talking about.
Oh, I got a great rate on my 30-year fixed mortgage, but again, you actually crunch those numbers and do the math and yeah, 4% sounds like a good rate, but stretch out over a long period of time and compared to how much you borrowed, again, you could be paying $7 on every $10 that you're borrowing, which is crazy. So are you a fan of the 30-year fixed?
Sarah Lindsey: I'm not a big fan of the 30-year fix. There are so many ways to use mortgage products to save yourself money if you structure them correctly. So banks have been feeding us this information for a very long time, get a good interest rate, get a long-term mortgage, but obviously they're the ones that are benefiting from it.
I mean, we are too. We're getting to buy a home and have this investment, but we're also paying, like we said in that earlier example, $215,000 or 70% of what we're borrowing is going towards interest or what we're paying in payments is going towards interest. So there's got to be a better way, or we can be smarter in the way we structure our loan financing to help save us the most money.
Taylor Schulte: Can you just make extra payments to start to chip away at that principle? How does that work? If someone wants to accelerate maybe paying down that mortgage, they realize they're paying a lot of interest, is there a way to accelerate that and just make extra payments to combat some of those issues?
Sarah Lindsey: Absolutely. They're shorter term loans than 30-year fixed, so you can do that, but your payment is going to increase significantly because of the shorter timeframe to pay it off. You can make extra payments towards your mortgage if you want to help reduce some of those interest costs.
A lot of people will do an extra payment per year, maybe bimonthly payments, any ways to or any extra money they have. They'll throw out the mortgage balance to reduce it and reduce that interest. But the only problem with that is once you pay your balance down, you don't have access to those funds anymore. Your money's gone.
Taylor Schulte: Yeah, now you're looking into home equity lines of credit or reverse mortgages down the road to start to tap into some of that equity. And then the other thing too is you make those extra payments, but your mortgage payment stays the same. The only way to really change your mortgage payment is to refinance the whole loan to get that payment down lower.
Sarah Lindsey: Exactly. Exactly. There's interest only loans where you can have that payment adjust monthly based on what the balance is. So if you pay money towards principal, it will adjust, but in any amortized loan, you have the same payment regardless of how much money you've paid down in principal faster than the required payments.
Taylor Schulte: Right. Okay. And so we like to look at loans and mortgages as part of the whole financial plan. We don't want to just look at the term and the rate and then call it a day. There's a lot of other pieces involved when considering the mortgage.
So we've brought to the surface that the big issue with this traditional mortgage is that you're paying a lot of interest in the beginning. I mean, you're paying a lot of interest in general on this giant, giant loan. And so one of the solutions that you brought to my attention that I thought was kind of unique and different that people don't talk about is what we're going to talk about today is what you call the all-in-one loan.
Now, if you're a listener of the show that I like to make these really complex topics really simple. So let's just start with the basics. Basics of what you mean by this all-in loan. Maybe the first question is what's the basic difference between this all-in loan and this traditional type of mortgage that we just bashed on for a few minutes?
Sarah Lindsey: Very, very simply, how it works is that the all-in-one loan combines home financing with personal banking in one account. This provides borrowers the opportunity to leverage their regular deposits into a lower daily principle prior to using their money, and as a result, offset monthly mortgage interest.
Taylor Schulte: And the benefit of doing this is by lowering your balance on your loan, you are accruing less interest as you have that lower balance. The easiest way to do that is to combine it with a checking account.
So as you have deposits go in there, they reduce it's applied directly towards the principal balance on the loan, so your loan balance automatically drops. So that's one way people save money is their loan balance is automatically lower.
Another way is that people don't pay their bills all on one day. The money stays in their account for days, sometimes even weeks. So while their money is sitting there not being utilized, it is keeping their loan balance lower. So the amount of interest that's accruing on a daily basis is less.
The third way is actually because there's a lower loan balance and less interest is accruing, the monthly payment for the mortgage is less. So any additional money that they had in their account that they would traditionally use towards their mortgage payment now is just sitting in there as well, helping keep that loan balance lower.
And then the last way is that lower monthly balance and the lower interest gets pushed to the next month and it has a compounding effect as it keeps going.
Taylor Schulte: Let's really try and simplify this. So we have this $300,000 loan and instead of going and getting this traditional 30-year fixed where we're going to pay a bunch of interest in the beginning, and it's hard to tap the equity in there like we talked about. Instead, I'm going to get this, let's call it this all in one loan.
So I go get this loan on month one. What does this look like? I know you briefly glossed over it, which is you're going to take your entire paycheck and the paycheck's going to funnel into paying the payment. And so if you get paid $10,000 a month, that $10,000 is going to go straight from your paycheck into the loan payment. So it disappears all of a sudden.
But this all-in-one loan has some features that then allows you to pay your bills and your normal day-to-day spending is kind of built into the mechanics. Am I explaining that correctly?
Sarah Lindsey: You are. So an easy way to talk about it's just like that. If people have $10,000 worth of deposits that go into their account, and first of all, the way this product's going to work is if you have residual income every month, you can't be paycheck to paycheck because it's that residual income that's just sitting in your account is what makes this product work.
Taylor Schulte: So maybe we can stop right there and say, yeah, who is this for? Who's the perfect person?
Sarah Lindsey: The perfect person was someone that has a little bit of equity, a minimum of 20% and has residual income per month would help them the most.
Taylor Schulte: Okay. Is there someone at a certain stage in their life that it works well for?
Sarah Lindsey: Not necessarily. As long as the money that they have coming in exceeds the amount they have going out is the key to the program.
Taylor Schulte: And then who wouldn't this be for? Just someone who's living paycheck to paycheck and doesn't have that extra buffer each month? That paycheck-to-paycheck person is using almost all of their funds per month that they have going in.
And this product would have no advantage because there's no leftover funds in the account to keep the interest accrual at a minimum, you can write checks, you have a debit card, it works just like anything else, but whatever money you don't spend that's left over goes towards the principal balance.
Sarah Lindsey: Correct. Every deposit into the account lowers the principal balance on the loan first. Once a month, there is an interest amount that's taken out by the bank for the amount of interest that's accrued, but remember it's dramatically less because you've had extra money in that account using every day to keep the interest that's accruing lower.
So in the example of the $300,000 loan and we put in a $10,000 worth of deposits in month one because of our regular pay stubs. Okay, regular monthly income, then our loan balance is immediately 290,000. So while that money sits in there, before we take out any money from the account for regular bills, the interest that's accruing on the loan is at 290,000 on a per diem until we actually make a payment on something.
So then you make your car payment, maybe the next week you go buy some groceries or however you use your normal account checking account, then the balance will go up slightly as you take the money out.
But if you only have let's say $7,000 in normal monthly expenses, then you have that $3,000 that's left over every month that just sits in that account and keeps that loan balance lower to help lower the amount of interest that's accruing and that gets passed onto the next month.
So within two months timeframe, you already have $6,000 lowered on your loan balance where that would take you years to do on a traditional 30-year fixed mortgage.
Taylor Schulte: And if you wanted that to tap into that $6,000, what does that look like? If someone says, well, yeah, it's great, I had some extra money and it went to pay down some of my principal balance in my loan, but now I need that $6,000 for X, Y, and Z. So can they tap into that at any time?
Sarah Lindsey: Yeah it's like having a checking account. It's used in conjunction with the checking account. It's a very foreign concept and it's hard to understand without we can talk about it. I'm a very visual person, so I like to see it. I'm trying to make my examples as visual as possible.
Taylor Schulte: One of my questions is, let's say again, your monthly paycheck is $10,000. Do you have to commit that full $10,000 to the loan? Can you say, oh, well I'd actually like $7,000 to go towards this all-in-one loan and then I'm going to keep $3,000 for myself separate. Can you do that or do they require you to funnel your entire paycheck into this all in one loan?
Sarah Lindsey: No, you can handle it any way you want. I would never recommend putting all of your money into any one account, and I'm sure you'd agree with me on that, but you can decide how much money you want to go into the account per month and how much money you want to take out. Okay.
And in the example before, if you, within the first two months, I said you've lowered your loan balance and our example by $6,000, if for any reason you need to access, because it works like a checking account, you have access to the equity that you've created. So you can go in with a check or debit card or ATM card and access that money if you want to.
Taylor Schulte: Those checks or that debit card is through any bank or the actual bank that's underwriting this loan.
Sarah Lindsey: It's the bank that does the servicing on this particular loan. It's going to be a specialized banking institutions that offer it, and it's going to be specific on where you live on what banking institution that is. But it's works just like any traditional checking account. You get all the bells and whistles that go along with it.
Taylor Schulte: Yeah. So the more I talk about this more, what I like about it is the flexibility of it. So again, let's say that your monthly mortgage payment is $500 and you're like, well, I've got extra money. I have more money that I want to throw at this thing and I want to pay it down and I want to pay off principal and I want to pay as less interest as possible.
So you can say, well, instead of $2,500 a month at my mortgage, I'm going to send $5,000 a month at my mortgage, and so you're going to pay down more principal with this type of loan. But if something in your life changes in three years or four years or 10 years, you can access that equity that you've built up, right? Correct. Pretty easily. Whereas reverse mortgages have their own set of challenges.
Refinancing loans have their own set of challenges, especially when people are in retirement and they don't have income, it's hard to qualify, it's hard to refinance. So going back to my previous examples of these dilemmas that people face, one of the biggest issues is the equity in the home and actually using that equity properly.
So I like the flexibility of it. I guess what I was thinking is I didn't realize you could maybe break apart some of your paycheck and not have to commit the whole thing. You can still keep your own little buffer for your purposes.
And then also I would say that everyone should have their emergency savings account already funded and established, so you should already have an account like that set aside, giving you some of the flexibility to use something like this to properly plan.
Sarah Lindsey: Exactly. And you brought up a good point how this loan is structured. Are you familiar with a home equity line of credit?
Taylor Schulte: Yeah. Yep. They work. I have one. Yeah.
Sarah Lindsey: Most people do, or if they own a home have had one at one point in their lives, this loan is set up like a first lien home equity line of credit. Think of that home equity line of credit being in conjunction with your checking account now.
So as you pay down the balance on the loan, you have access to your total line of credit that you can tap into at any time with checks, ATM cards, debit cards, however it is that you handle your funds or pay your bills, you always have access to it, which eliminates the need to access your equity at a later time by opening a home equity line or a fixed line second or refinancing to pull cash out because you need to do something or you need money for something, it eliminates the need to refinance because you have access to that credit line.
Taylor Schulte: And do you have access to it forever?
Sarah Lindsey: It is a 30-year loan. So on that $300,000 example, keep going back to that. Since we have it going for the first 10 years, you have access to all $300,000 no matter if you've paid the loan completely off. If you've paid down 50,000, doesn't matter.
You have access to a full $300,000 after that 10-year marker, your available credit or the amount of money or credit line that you have, I guess would be an easy way to put it goes down by 1/240th every single month because there's now 240 months left in the loan. 20 years total term. Yeah.
So it'll go down a little bit every single month after that. So at the end of 30-years, you have a zero balance and you don't have access to your credit line anymore. It has to be paid off.
Taylor Schulte: But you can tap into the 300,000 or no?
Sarah Lindsey: No, that credit line of 300,000, that original stays for 10 years, and then after that, that balance or that credit limit will drop a little bit every month until there's no credit line left at the end of 30-years.
Taylor Schulte: Okay. So in the 31st year, can you tap into any of your equity? No, no, no. It's done. It's done.
Sarah Lindsey: Alright. But for 30 years you have access to equity in your home.
Taylor Schulte: Got it. Okay. So it could work well for someone in the later stage of life entering into retirement, who does want to use their home equity in a smart way, and if they're 60 and this 30-year loan puts them out into 90, which is probably their life expectancy or exceeds, then this could be a tool.
Sarah Lindsey: Yeah, absolutely.
Taylor Schulte: I think one, again, as I'm learning more about, I think one of the things that comes to mind for me that could be a challenge, and I'm not sure if you've talked about it or thought about it, but the behavior issue behind this, which is there's something to be said for real estate in that it's illiquid, it's hard to touch.
And so people do well investing in real estate, they invest it forever and they don't touch it. They don't buy and sell their stocks because they can't, but this kind of flexibility allows them to start to play with and easily access some of their equity. Is that something you've explored at all and making sure people don't mess too much with the plan they've put in place?
Sarah Lindsey: So there's a simulator that we use to help people decide, first of all, is this the program for them? Because they have to have enough residual income per month to make a difference, and based on each individual situation, we can give them an idea of if they keep their spending habits exactly the same when they'll pay off their mortgage.
Typically, all the examples that I've looked at, people that have 30-year fixed mortgages that look at this product as an option and they have the positive income per month, they're looking at payoff anywhere between 10 and 16 years.
Taylor Schulte: Oh, wow. Okay.
Sarah Lindsey: So after that, worst case, 16-year timeframe, they still have access to that equity if they want to use it for the next 15. Correct. We can also calculate in if they have any expenses that they see coming up in the future, maybe college for a child or they have to buy a new car or whatever the case may be, we can input those numbers if they plan to access the equity line basically that they have now because they've paid their mortgage down and give them an idea of what that will do to their monthly payments.
It's definitely something that people have to people who are good at managing their money to use, because you do have the temptation of having access to all your equity, so you have to be able to be smart with it and use it the right way so you can see the tens of thousands of dollars of interest savings you would compared to a traditional loan.
Taylor Schulte: Right. Well, I think going back to what you said, this product works really well for people who aren't living paycheck to paycheck. So if you're not living paycheck to paycheck and you do have that ability, you probably are smart with your money. Probably people that live paycheck to paycheck have not made the best decision sometimes or they've been put in tough situations.
So if you're not living paycheck to paycheck and you have extra funds left over each month and you're trying to be smart with those funds, it's something to explore. And I think you hit on something important too, which is this isn't the solution for everybody. If you're out there exploring loans, you should know that there are other options out there.
You can go ahead and look at that 30-year fixed or a 15-year fixed and compare that to something like this and see how it might play out and how much interest you're going to pay between the different scenarios.
And I know you mentioned the simulator that you guys have, and I'll link to that in the show notes so people can go and enter their own information and play around there. A lot of what we've already talked about probably sounds like a really foreign concept to people and people's eyes are probably glazing over right now. What is this thing? I just want my 30-year fix. I don't care how much interest I pay, but this isn't a completely foreign concept. There are other countries that have used this for a long time, is that right?
Sarah Lindsey: Yeah, that's correct. They have names like the Offset Mortgage or Money Merge Accounts, Canada, the UK, Australia, New Zealand, they all have products like this. It's newer to the US. It was originally brought over here in 2005 and then was rebranded into a new name and got different banking systems in place in 2010. So it's been around.
Taylor Schulte: Okay. So yeah, it's not a foreign concept. Other people have used it, other countries have used it. Do you think that it will become more widely used as people start to learn about this as a solution?
Sarah Lindsey: If we can get the education out there for people, the amount of interest savings that you can have by just doing your normal spending habits if you fall into that group that this would work for is absolutely amazing. And you can use it for your home. You can use it for a second home. You can even use this for rental properties.
So it's a really great way to lower your total interest costs on a mortgage, which is what I do all the time, is try to make sure that we're saving people the most money in total interest costs over the term that they want to keep the loan for.
Taylor Schulte: No, which I appreciate you could look at everything in a vacuum and just look at this year. Again, 4%, it sounds like a great rate. So if we just look at this year, it looks good on paper, but let's spread this out over the next 10, 20, 30 years and actually see how much interest you're paying. It's pretty crazy.
So I do like that we're looking at the big picture here and we're not just getting focused on the rate and the term and calling it a day. What are some of maybe the downsides to a loan like this?
Sarah Lindsey: The downside to a loan like this is that it's going to be an adjustable rate mortgage, just like a home equity line of credit. You don't have access to your funds and the flexibility of your equity without the adjustable portion of it.
And it's the same with this, but unlike the home equity line of credit, this is based off the one month L-I-B-O-R plus a margin on top. And in the simulations that we do, we actually look at increasing rate over the term that they plan on and over the 30-year term to see worst case scenario if it will still help them save money compared to a 30-year fixed mortgage.
Taylor Schulte: Okay. It's adjustable. The rate's adjustable, but there is a cap, correct?
Sarah Lindsey: Yes. Okay.
Taylor Schulte: Can you talk a little bit about how that works?
Sarah Lindsey: Yeah. So there's a floor rate on the loan, so it'll never be below 3.75%, and the cap rate is 6% over whatever interest rate you start at. So if you start at 4%, then your interest rate can never go above 10%. And in most of the simulations I do, compared to a 30-year fixed mortgage, that interest rate would have to be a lot higher than that for them not to have any kind of savings on this particular product.
Taylor Schulte: So again, I'm going to remind people, don't look at this stuff in a vacuum. Don't look at just 2019 and pick the lowest rate because if you're aggressively paying down your loan, if you're throwing extra principal payments at this thing and you want to pay it down as quick as possible and pay as little amount of interest as possible. Crunch the numbers because 10% might sound high, but if you're following your plan, you might actually pay a lot less interest, even if the rate is at 10%, 100%.
Sarah Lindsey: And those simulations will give us those numbers so they can say, oh, I would have to have an interest rate at this amount for this product not to work for me. And most of the time, this actually, I've never seen a scenario where this product didn't beat a 30-year fixed product every day.
Taylor Schulte: Sure. Yeah. And I think the biggest challenge here is that can people commit and stick to their long-term plan? And I think that's really hard for most people. Maybe they are really good and diligent and smart with their money and they can wrap their head around something like this and be even smarter.
Maybe they have somebody in their life that's guiding them and making sure that they stay committed to this plan, but the plan can certainly fall apart when humans get involved and we start making irrational decisions with stuff like this.
So that's definitely probably one of the big downsides for me, and just knowing how humans behave and work, it probably requires, again, either some real diligence on their part or somebody that's guiding them and making sure they're not making mistakes with this thing.
Sarah Lindsey: Exactly. It's definitely a very unique product, but for the right people, it can save them a lot of money.
Taylor Schulte: Sure. Alright. Where could people learn more about this? I know you've got some articles and stuff that I'll link to in the show notes. Are there other resources that you might point them toward?
Sarah Lindsey: If you're interested in just seeing what your situation is with this product before talking to anybody, test out the simulator. You can go to my website at homeloangal.com/aio, which stands for all in one, and they can get information on the loan product and link to the simulator.
And then they can go in and type in their numbers of what they have coming in every month and what their monthly expenses are, and it'll do a full analysis for them to show them what that product will look like, how fast they'll pay off the mortgage, how much interest savings that they'll have, and compare it to a traditional 30-year fixed mortgage.
Taylor Schulte: And you mentioned that you're not a huge fan of the 30-year fix. Are you a bigger fan of the 15 year fixed?
Sarah Lindsey: 15 year fixes are great. If people have the income to pay the higher monthly payment to shorten their payoff term in half, it's great. See, the whole thing is that most people don't stay in the house or keep a loan for 30 years. So the longer your fixed term on your loan, the higher the interest rate offering. That's why a 30-year fixed mortgage is going to be higher than a 15 year fixed mortgage, for example.
So really, I like to bring up the question of adjustable rate mortgages. I know they've had a bad wrap in the past, but if you look at the longer term ones, like the 10-year adjustable rate mortgage, the 10-year arms, you're spending less money in interest. If the all-in-one doesn't work for you, you're spending less money in interest because of the lower interest rate because it only has a fixed term of 10 years, although it is a traditional 30-year mortgage, I keep saying fixed after that.
So it is a 30-year product, but that first 10 years is the fixed portion gives you a lower interest rate, which gives you a tremendous amount of interest savings compared to a 15-year or 30-year fixed mortgage. So that's definitely something to look at because it will still hold within most people's terms of refinancing or selling the property.
Traditionally, when people do that is within about a year timeframe. So getting a 30-year fixed, you're paying more money in case you might not sell or refinance that house after 10 years. The arm gives you that savings now to be able to access a less interest cost and put your money elsewhere.
So it's just an option to look at. It doesn't fit for everybody, but if you know that your goals or you have a kid leaving college and you're going to have to refinance or you're going to have upcoming expenses or you're not going to be in the property for that long or whatever the case may be, definitely like to look at it and bring it to people's attention.
Taylor Schulte: Yeah you bring up a good point. I think the average holding period for a primary home is like four and a half years or five years or something, right?
Sarah Lindsey: Yeah. Since the 2008 financial crisis that got pushed up to about seven or eight just because no one had equity in their home, so they couldn't do anything. But on average, yeah, you're right.
So why pay for a 30-year product, which is a higher interest rate and more interest cost to you if you're not going to hold onto that product for 30 years? It's just something to talk about and to bring into the conversation and look at the differences.
Taylor Schulte: Right? Well, and in that 30-year fix, you're going to be paying a lot of interest in the first 10 years anyway. Right? Exactly. It's a challenge. It really is. I can understand the math behind it and appreciate how a variable rate or an all-in-one type loan mathematically might make more sense, but there's that certain level of comfort that a 30-year fixed gives you, right?
What if we do stay in this home forever? Now we have this great loan at a really low rate. So I always say sometimes the textbook answer doesn't always make sense for everybody. If you just feel more comfortable with that 30-year fixed, that might be the answer for you. But it's a challenge.
Sarah Lindsey: At the end of the day, you have to do what you're comfortable with. It's your financing, it's your future. The mortgage has been around for 90 years the same way all the time. So it's a different mindset to understand the way different products could work and could save you money. And then the next question, like you said is, are you comfortable to do it that way?
Taylor Schulte: Well, I really appreciate all this. Again, this may not be for everybody, but hopefully people learn just something new, something different. Know that there are other options out there. You don't have to just walk into your local brick and mortar bank and go get a 30-year fix.
Sarah Lindsey: No don’t do that. Yeah.
Taylor Schulte: You can get a little creative and use this as a financial planning tool rather than just this monthly payment that you didn't put much thought into. Use it as a tool to think ahead and plan for your future and plan for retirement.
So again, may not be for everybody, but I've learned a ton. I think it's really, really interesting. I'm excited to watch and see how this develops. And hopefully with your education, it becomes more widely used for the right person.
Sarah Lindsey: At east more people should know about it. Right. Play on the simulator. It's fun.
Taylor Schulte: There you go. So homeloangal.com/aio. We'll definitely link to that. You've got some other resources and stuff there. If people want to learn more about you, anywhere else people can find you or everybody, go to the website.
Sarah Lindsey: Go to the website. That's perfect. If you Google my name or you'll find all kinds of information about me because all over the place.
Taylor Schulte: Okay cool. Well, thanks so much.
Sarah Lindsey: Yeah, thank you.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.
How to Save for a Home
Buying a home can be expensive regardless, but the price tag can hit the roof if you live in an expensive area like San Diego. And you have to remember, it’s not just the cost of the house itself that can drain your finances. The ongoing costs of mortgage interest, property taxes, upkeep, maintenance, and repairs make owning a home an expensive endeavor.
Still, the main factor that impacts your monthly housing costs is probably the home loan you end up with. Will you get a 30-year home loan? A 15-year loan? A mortgage with an adjustable rate that changes after five or seven years? The decisions you make now can impact not only your monthly payment but also how much interest you pay over the life of your loan.
Beyond just the way you choose a home loan, another factor to consider is where to keep your down payment as it grows. If you are buying in a pricey area and plan to save 20% to avoid private mortgage insurance, or PMI, your down payment could easily reach six figures or more. How and where you invest that money can hurt or help you as you save, but there’s a lot of conflicting advice on the best way to get the job done.
Where Should You Keep Your Down Payment Money?
Well, here’s what I think: If you believe you’ll be using your cash reserves to buy a home within the next ten years, you shouldn’t be investing your down payment money in stocks and bonds.
There, I said it!
That advice may go against the grain depending on who you ask, but I still give it to anyone who will listen.
The thing is, you don’t want to keep your down payment money in a regular savings account earning .01%. My advice is saving your down payment funds in a high-yield savings account from an online bank. Many banks are offering up to 2.5% APY online without any banking fees, so you don’t want your money lingering with a brick and mortar bank that hardly pays anything. Earning 2% or 3% on your money isn’t anything to write home about, but it’s way better than nothing.
You may think ten years is a lot of time, and it is! The thing is, the stock market is entirely too volatile to invest your down payment funds over such a short timeline. You may not get rich with a high-yield savings account, but at least you won’t lose the down payment money you worked so hard to earn.
Think Long and Hard About Your New Mortgage
Next up, let’s talk about the type of mortgage you should plan for. While 30-year, fixed-rate home loans have long been the norm, few people ever think about how much these mortgages cost. But if you dive deep on the details, you may be shocked at how much interest you can pay over three decades of mortgage payments.
Mortgage expert Sarah Lindsey, who is known as the “Home Loan Gal,” offers this statistic to put things into perspective:
If you borrow $300,000 with a 30-year, fixed-rate mortgage at 4%, you’ll pay $215,000 in interest over the life of the loan. That’s $7 for every $10 of your mortgage amount, which is insane. With a traditional mortgage, the bank also sets up your loan so you pay the bulk of your interest toward the beginning.
This is a huge problem. Lindsey says that, on a traditional 30-year loan, you won’t see the amount of interest equal the principal you’re paying in until year 12 or 13. After that, it’s not until years 22 and 23 where you finally reach a point where you’ve paid as much of your principal down as you’ve paid in interest!
Of course, you don’t have to get a 30-year home loan. Lindsey smartly points out that there are shorter term mortgages available, including the popular 15-year, fixed-rate mortgage. Of course, you can also just make extra payments on your longer-term loan, which is a popular strategy for people who want to pay extra when they can.
Making extra payments can absolutely reduce the principal balance you owe, but you also need to remember that any money you pay toward your principal is now locked up in your home’s equity. If you need to access that cash down the line, you would have to refinance your home loan or consider a home equity product like a home equity loan or HELOC.
Consider an “All In One” Home Loan
For that reason, Lindsey suggests taking a closer look at what is called an “all in one” home loan. With an all in one loan, the borrower can combine their mortgage loan and their banking services in a single account.
This strategy allows them to leverage their regular deposits in conjunction with their home mortgage, ultimately saving money on monthly mortgage interest. At the same time, this loan allows borrowers to have easy access to their money if they need it.
But, how does an all in one mortgage work?
“By lowering your balance on your loan, you are accruing less interest as you have that lower balance,” said Lindsey. The easiest way to do this involves combining your loan with a checking account so that money deposited into your account is applied directly toward the principal balance of your loan.
Remember that people don’t pay their bills all in a day. While excess funds are in their bank account and not being utilized, putting that money to work can help them save money on interest.
Another benefit to consider is the fact that, because there’s a lower loan balance while you have excess money in your account, the monthly payment on your mortgage drops. This means that excess funds can do double duty by paying even more money toward keeping the principal of your loan balance low.
Finally, the lower balance on your loan can get pushed into the next month when you have excess funds in your account, meaning the interest savings can roll over and save you even more.
In the end, this lets you save money on interest and access your cash when you need it. On the flip side, the fact that this loan comes with an adjustable rate means you could wind up with a higher rate than you initially signed up for over time.
This may not be the right loan for every buyer, but there are real benefits to consider if you want to save on interest and need some flexibility. At the end of the day, you should consider multiple home loans and spend some time figuring out how each of them might work in your favor.
Final Thoughts
Saving up for a home is no joke, but there are plenty of ways you can set yourself up for success. Make sure you’re earning plenty of interest on your down payment so it will grow faster, but also remember to keep your mind open when it comes time to choose a mortgage. A 30-year-, fixed-rate mortgage may be exactly what you need and want, but a short-term loan or a new mortgage product may fit better with your lifestyle and goals.
The bottom line: Don’t fall into the trap of doing what other people are doing without thinking it through. Think for yourself and think of what you want, and you’ll always be better off in the end.