Financial Peace University #8: Real Estate and Mortgages

“Pay off the house early….???? Whaaaaaaaat!”

That’s what most people in our FPU class were saying as we begun our lesson this past Wednesday night. For most people, having a mortgage payment for 30 (or more) years seems completely norm, as it’s this huge balance that we could never actually chip away enough at to make a dent in it, right? Yet Dave Ramsey’s first big point to get across during this lesson was to indeed, payoff the dang house early and be rid of the payment.

Thus introduces Baby Step 6, which is to payoff the house, your last debt, the biggest one. By then, if you’ve followed Dave’s teachings, you’ll have paid off all of your other debts in Baby Step 2, and built yourself a healthy emergency fund in Baby Step 3. You’re consistently saving for retirement as outlined in Baby Step 4, and consistently saving for your kid’s college funds in Baby Step 5. What other financial goals are there? The only thing left is to payoff the house, and then continue to build wealth, and be generous in your giving to other causes. After all…

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Hey, he’s got a point…

So in this lesson, Dave and his friends talk about how to set yourself up for successful home-ownership to begin with – by not taking out more than a 15 year fixed rate mortgage, and not having the mortgage payment be more than a quarter of your monthly take home pay. The idea behind these guidelines is so that one doesn’t become “house-poor”, which is a very real thing — people buying a more expensive house than they can truly afford. And Dave’s guidelines of the 15 year fixed rate mortgage with the payment being 1/4th of your take-home pay are super conservative guidelines. VERY conservative. I work in mortgage lending, you guys. I see what banks will qualify people for and most everyone takes out a 30 year loan. When I do see a 15 or a 20 year loan application come in, I have to do a double take, they are that rare. And banks will approve a person to qualify for a payment that is up to around – get this – 43% of their GROSS income, that’s before-tax — which, let’s face it, is not what we pay our bills off of. We pay our bills off of what actually reaches our checking account on payday. So the amount that banks will qualify a person to repay and what a comfortable payment is for some people can be two really different figures.

If we had followed Dave’s teachings before we bought our house, my husband and I would have been buying a house that did not fit his guidelines. While we now know that our mortgage payment is a comfortable percentage of our take home pay, we have a 30 year fixed, so we are in a loan that Dave wouldn’t recommend.

In this lesson, Dave goes into types of mortgages to avoid, tips for both purchasing and selling a home, and then there are case studies that we discussed when we broke out into small groups. The case studies have examples of people in situations that we all face, and asks us participants to advise if those people are ready to buy a home or not based on the information given.

The homework was actually really insightful. Having worked in mortgage lending for many years now, I do understand the amount of interest paid over the life of the loan and how much extra a homeowner will pay above the principal of the original loan amount, just for the sake of borrowing money. But on the FPU website that we have access to during the class, there is a handy mortgage calculator on there that shows you how much extra in interest you’ll pay over the life of your loan. Then the calculator has some variables you can enter, such as if you make extra payments, how much sooner you’d payoff your mortgage and how much money you’d save. What if you cut out eating lunch out, or a latte habit? The calculator allows you to play with these figures to see how your own diligence at paying down your mortgage can affect the payoff.

So, in the end it makes sense that Baby Step 6 involves chipping away at your home mortgage. You should have a lot of residual income by that time, since you’ve paid off your debts, and besides food, utilities and the normal life stuff, shouldn’t really have any other large payments. So setting up some extra payments on your mortgage is a great way to spend those dollars, since you’ll save thousands in interest by paying off your loan early.

Oh, another note: for those of us currently in a 30 year loan but have a good interest rate (such as we do), it’s not necessary to refinance simply to get a 15 year loan. Simply use a mortgage calculator online to determine what your 15 year mortgage payment would be, and pay extra on your house payment. You’ll payoff the loan early and still get to keep your great rate. But, if you’re paying an interest rate in the 4, 5, or even 6% range, it’s probably worth it to refinance anyway and save on interest too. Hopefully you’re not paying a rate that high, but if you are, get with a mortgage professional about a 15 year fixed interest rate in the low 3% range, stat!