Over the weekend, we signed the closing documents for our refinancing into a 15-year fixed rate loan. It’s hard to believe that less than four years ago we bought our first house with a 30-year loan at around 6%. Thanks to additional principal prepayments and lower interest rates, our new monthly payment is actually lower than the payment from our original loan. Our lender sounded swamped with loan applications, and we basically closed on the 45th day of our 45-day interest rate lock. Here are some thoughts about the process.

Mortgage Rates Still Dropping
Here’s a chart of the historical mortgage rates, courtesy of HSH.com. It includes the 30-year fixed, 15-year fixed, and the 5/1 30-year adjustable. I’ve stopped trying to predict future rates, and just try to take advantage of what happens. National averages since 2010:

Since 1986:

Appraisal
It may be hard to believe, but the new appraisal for our house actually came in at 6% above our purchase price in late 2007. We have made several improvements to the house, including adding a small amount of square footage. But the main reason is simply that the prices in our neighborhood have held up well during the national price declines. Real estate is definitely local. As a percentage of our original purchase price, we have 35% equity.

Closing Documents
The new final HUD-1 settlement forms seemed to be clearer than what I remember last time. Charges are broken down more clearly, and the form compares side-by-side what was presented on the Good Faith Estimate (GFE) and what you were finally charged at closing. You can view a copy of the form at HUD.gov.

Mortgage Offset Account
Some people prefer 30-year mortgages because borrowing at low rates for a long period can act as a hedge against higher inflation. I personally would rather minimize my interest costs now and worry about higher rates if and when they come along. When the day arrives where I can invest in safe bonds or bank CDs that pay higher rates than my mortgage rate, then I plan on creating a mortgage offset account where I buy those CDs instead of paying down my mortgage. But either way, I’m still not satisfied with a 15-year payoff, our goal is to pay it off in 5-10 years.

Compare rate quotes from and Quicken Loans.

After the interest rate drama last week, I managed to lock in a refinance of my current 30-year mortgage (with 26 years left) which had a 4.75% fixed rate into a new 15-year mortgage at a 3.875% fixed rate. You’ll probably see lower rates in ads and elsewhere, but it did come with negative points that offset my closing costs completely and then some. Anyhow, I wanted to run the numbers to see the potential financial benefit.

To simplify the numbers, I am just going to assume a new mortgage with a loan amount of $300,000. First, we have a 30-year fixed rate with a lower payment, but higher interest rate and longer period of paying interest. Now, we do have the option of making extra payments toward principal and making the loan end early. Alternatively, we have a 15-year fixed mortgage with lower interest rate but higher mandatory monthly payment. There are many calculators out there, but I still like the simple and familiar ones at Dinkytown.

The 30-year at 4.75% would have a monthly payment of $1,565, while the 15-year would have a monthly payment of $2,200. Now, what would happen if we simply paid the $2,200 towards the 30-year mortgage? Using the calculator, we would enter an additional monthly payment of $635. That tells us the 30-year plus extra mortgage would be paid off in 16 year and 5 months, requiring an additional 1.4 years and $36,000 in interest. However, the 30-year does allow me the flexibility to reduce my payment by $600 a month if needed.

A note on interest paid. Lots of people simply look at how much interest is paid on a 30-year and compare it to a 15-year. It’s a big difference! However, you have to remember that you could have done something the money saved each month from a lower monthly payment. Theoretically, if you went out and bought a bank certificate of deposit paying the same rate of interest as the mortgage, there would be no real difference. For example, currently Discover Bank has a 10-year CD yielding 2.25% APY (see CD Rates & Calculator tab). This makes the true interest gap less than what it may appear. Still, there isn’t anything available at anything higher than 4.75% or even 3.875%, so I’m still happy to pay off this house in 15 years.

As part of new reforms, the government is debating what downpayment size should be required for a “qualified” residential mortgage. If a mortgage doesn’t meet the new standards, the lending bank would have to retain 5% ownership even if selling the rest to investors. The initial proposal is for 20%, but of course the mortgage industry wants the required down payment to be as small as possible. They want to keep the good ole’ days from being able to offload the risk entirely onto others.

Honestly, if banks can’t handle keeping even 5% ownership of the loans they originate, why would I trust their underwriting at all? Their track record for determining creditworthiness hasn’t exactly been stellar. Of course, their public argument is that a low downpayment keep homes “affordable” for everyone. From the Washington Post:

“Why, in a law intended to fix the mistakes that caused the credit crisis, would you mandate a certain down payment when low down payments were not the problem?” said Kathleen Day, spokeswoman for the Center for Responsible Lending.

Actually, they are a problem. Felix Salmon points out how the mortgage industry is trying to influence people with misleading statistics, saying that “boosting down payments in 5 percent increments has only a negligible impact on default rates.” After some wrangling, Salmon got this clearer chart showing delinquency rates as a function of downpayment size for the period 2002-2008:

When the mortgage industry starts complaining about the 14 million people who would be denied the chance to buy a qualified mortgage if they don’t have a 5% downpayment, it’s worth remembering that qualified mortgages for people who don’t have a 5% downpayment have a delinquency rate of 16% over the course of the whole housing cycle. (You can be sure the numbers were much higher still in 2006 and 2007, which is why Guarino didn’t give them to me.)

And you can see too why the 20% downpayment limit was put in place: it’s the point at which delinquencies fall to less than 5%. If you take one group of loans with a 20-25% downpayment, and a second group of loans with a 15-20% downpayment, then the second group, on these numbers will have a delinquency rate 56% higher than the first.

The fact is, downpayment size does matter. Imagine what the chart above would look like with data from 2006 to 2009. It should serve as a reminder that giving anyone with a pulse a mortgage loan because it’s the American Dream was a bad idea.

A 20% downpayment was the standard when banks actually kept 100% of mortgage on their books. I’m not saying every single person should need 20% today; A bank should be able to create a mortgage that requires less, but in exchange it should have to have some skin in the game. If a lender won’t even keep a mere 5% on their books, doesn’t that just show the mortgage is too risky in the first place?

More reading: NY Times, ChicagoMag

The S&P Case Shiller Home Price index was updated yesterday with data through March 2011, or 2011 Q1. Here is the press release [PDF]. Here is the chart:

Click to enlarge. Sources: S&P Indices

Nationally, home prices are back to their mid-2002 levels. This means that any run-up in home prices between 2002 and the 2006 peak has been erased. On average home prices are selling at the same value they were nine years ago and are 34% below their 2006Q2 peak.

I feel like this whole thing is still going to take a while to fully unwind.

Catherine over at Visualizing Economics has another nice graphic on Housing Quality and its effect on Home Values. In the top chart, she shows how inflation-adjusted median home values have increased due to the fact that the median home has changed (bigger, better plumbing). This is in contrast with the popular Case-Shiller home price chart, which tracks the inflation-adjusted resale value of a fixed-size house in large metro areas.

Click to view full image

It’s a different view of things, but the Shiller chart still shows that my house’s value probably won’t increase much faster than inflation over time (my house isn’t going to magically grow in size). That doesn’t necessarily mean someone shouldn’t buy a house though, because I can pay off my house, while rent also increases with inflation.

What I also found interesting was something I’ve noticed before – how the average household has gotten so much smaller, even as houses keep getting larger and larger. From 1940 to 2010, the amount of square feet per person has tripled in size.

25% of the houses were already built in 1940, so today’s new houses being built are bigger than the median 2,135 sf. Oops, misread that, 2,135 is for new houses. I did find that the median size of new houses actually dropped from over 2,300 sf recently. Do we really need all that space? Or perhaps going a bit smaller might be another area that people can be frugal and maximize value?

Buy vs. rent? It’s still a tough question for a lot of folks. According to real estate website Trulia.com, one rule of thumb is to divide the median list price compared with the median rent of similar properties. If the price/rent ratio is over 20, you should rent because buying is too expensive. From 16-20, it can be a grey zone, depending on a variety of factors. If it is under 15, you should consider buying. Very rough, but it’s a place to start.

Trulia has calculated this ratio for the two-bedroom apartments, condos and townhomes listed in their database for the largest 50 cities in the US, and illustrated them on an interactive chart. There are a few options to play around with. (Click to visit and enlarge.)

It looks like big red New York City is still more affordable to rent, with more cities being pockets of green. Supposedly, in 72% of major cities it is now more affordable to be a homeowner. I guess we’ll see if they’re right. I just added some nice vinyl fencing to my money pit home sweet home. Specific cities are highlighted in this related CNN Money article.