This is Mortgage Secrets Episode 2

This is Mortgage Secrets Episode #2, and I’m John Downs. In this episode of Mortgage Secrets, we’re going to talk to you about what your mortgage really costs—all the juicy details of everything included in that payment.

First, we have to talk about “What is a mortgage payment?”

So, you buy a house, you’re financing money, and you know that you have to write a check on the first of every month to live in that house, so what’s included? You’re borrowing money at a rate, so you have to pay interest. You have to pay the loan down—principal and interest. Mostly, if you just go to any Google mortgage calculator, put in an amount of money and a rate, that’s your principal and interest. You’re paying it back at a certain rate over a period of time.

The other piece will be property taxes, home insurance, and things that are not included in the mortgage payment, but you still have to pay—home association dues, condo dues, things like water, sewer, front foot benefits. There are some other costs involved, but it’s important to know each of those so that you know exactly what your fixed costs are moving forward.

The reason this is so important… And I get this question all the time, “Really, you’re going to go podcast on what’s in a mortgage payment?” But I think it’s important because I get this phone call all the time. What usually happens is someone wants to buy a house. They’re now working with an agent. We give them a quote, and they usually call back or text or email and say, “John, your payment was $600 more than what I thought it was, so we really need to talk. Something is wrong with your quote.”

What I find is that so many people wind up using different online sources that end up excluding property taxes. I’ve seen somewhere they’ll use property taxes that are two and three years old. I’ve seen some that they don’t include the condo dues, even though that’s a real payment. I thought we would dive into all those pieces so that, if you’re out there getting ready to look for a property, you can start even doing this yourself. Just grab a calculator and follow this podcast, and you can map out exactly what your payment will be, so you can fact check all the resources that you’ll see online.

Let’s start with the mortgage payment itself.

When I say “mortgage payment,” I’m talking very specifically of the mortgage. You’re borrowing money to buy the house, and how are you borrowing that money? What is the rate for that money that you’re borrowing? When do you have to pay it back? How is it advertised? Is there a second mortgage involved or not? Is that second mortgage interest-only or not? You have to first use all those pieces, figure out what kind of loan you’re getting, and again, it’s very simple. You just grab a calculator, Google prevailing rates, and you can just plug it all in and figure it out, but the principal and interest is the largest line item on your billing statement for most people, unless you’re putting buckets of money down, and that’s what that is. You’re paying your loan down a little bit every month, and you’re paying interest for borrowing the money. That’s the fixed part of your payment that won’t change if you have a fixed-rate mortgage.

The way loans amortize, it’s pretty interesting. I’m not a mathematician, but I still find it kind of interesting. It’s easy to figure out. In a way, there’s this magical payment that starts with a certain amount of principal, and that payment is fixed over, let’s call it, a 30-year period of time, and it feels front-loaded of interest. But it’s just as easy to say, “I’m borrowing $400,000 at 4%.” $400,000 at 4% is $16,000 of annual interest that you’ll pay that year. Divide that by 12, and that’s your interest.

The way mortgage amortizes is you start with a little bit of principal, so the very next month, you owe less. It’s that same calculation again. What is that balance times that rate, divided by 12? That’s how much interest you pay. It feels like mortgages are front-loaded in interest, but that’s just because you haven’t paid down that much, but over time, you’ll see the payment shifts, and people start paying more and more money towards principal and less and less interest over time.

Now, if you have an adjustable rate, it’s not much different.

Most adjustable rates still amortize, and that’s the key when you’re trying to figure out your payment. “What is the lender using for a pay-off term?” Even those adjustable-rate mortgages of 3, 5, 7, 10 years or whatever you get, they’re typically based on 30-year amortization loans. In 30 years, it’s paid off; it’s $0. They take whatever the rate is that you have. You throw that into the calculator. Just know, though, that at the end of that period of time is when an adjustment can take place. There are just other questions to ask:

How does that adjust?
What are the factors?
What are the margins and indexes?

That’s probably a whole different conversation, but you should know as you’re getting into the process what loan you have and how long it’s fixed before things change.

The next big part of your mortgage payment is the escrow account.

You’ll hear a lot of lenders quote, “It’s $1600 plus escrow.” So, what is escrow? Escrow is an account set up at the financial institution that’s used to pay all of the annual recurring bills, typically, for property taxes and home insurance. It’s like some crazy, ridiculous percentage of people that have escrow accounts compared to people who don’t. Mostly, it’s a budgeting tool. If your tax bill is $5,000 a year, divided by 12 is $400-something a month, it’s nice to know that that $400 is included in your payment and that you’re just not hit with this $5,000 bill out of the blue.

Escrow accounts are constantly going up and down. Every time you make a payment (1/12th of the annual tax and insurance bill is included in your payment. Then, of course, that escrow account is getting bigger with each month that you pay. But then, eventually, those bills are due, so the account winds up being paid down. They use that money to pay those bills.

Routinely, lenders will have what they call an “escrow analysis,” where they take current tax bill and current insurance, and they kind of rebalance your payments. Even if you have a 30-year fixed mortgage, you’ll notice that, over time, your payment can still increase very gradually, always tied directly to the property taxes and the home insurance that they change.

I always say that escrow accounts include taxes and insurance, but many times, I’ll see someone pay their own insurance. Some people get discounts. “If you have an auto-debit for your home insurance paid monthly, we’ll give you 20% off.” It’s not always taxes and insurance. I’d say most that I see usually is, but that is flexibility that you have where you can pay your home insurance.

Now, for those of you out there who do not want an escrow account, most lenders and more regulatory standard is that if you do not have 20% equity in the property, the lender has to have the escrow account in most cases.

But let’s say you didn’t want an escrow account.

Escrow accounts are non-interest-bearing accounts that is actually a profit center for all lenders. When you choose to waive an escrow account, there’s actually a fee associated with it. Be careful if you’re shopping for a mortgage, and you want control of your escrow account. When you get that price, say, “I don’t want escrows included,” so you can get an accurate quote. It’s always an uncomfortable conversation later on when someone says, “I want to pay my own,” and the lender says, “It’s going to cost you,” but there is a financial reason. If 90% of the people out there have escrow accounts, banks are going to build in their pricing model assuming that escrow account is there, and they’re actually going to penalize you if it’s not.

Now, when would I say makes sense to waive escrow? Think of a $100,000 loan, and your tax bill is $8,000 a year. Obviously, keep your $8,000, pay the small charge to waive the escrow. But the other reason I’m usually against waiving escrows or paying those escrow charges is it’s only for that loan. If you refinance in a year from now, and you want to waive that escrow again, well that fee is there again. Just know that that escrow fee isn’t transferrable when you do refinances unless you build it into the price.

Talking about property taxes is always interesting because, again, I’ll hear people call back and say, “Hey, John, your tax estimate is wrong,” or, “I’ve got this other quote, and the other lender’s payment is $200 less a month.” You get that quote, and you realize that their tax bill is $200 a month less.

There are a couple of things that go into this. Again, if you’re a consumer, and you’re a little bit of a control freak (which I am!), you don’t really trust what you see online from the online marketing sites, like Zillow. A lot of times, their data mining tools can be outdated. Here we are in 2017. They could use a 2015 tax bill. Taxes change, right? As properties become more and more expensive, tax bills naturally go up in tandem with those increased prices.

What many lenders do (and what many online calculators do) is whatever is in that marketing portal, they’re going to pull that in there, divide it by 12, and call that your tax bill. If you just Google, whatever county you’re purchasing in, “property tax inquiry.” You’ll pop up immediately to the site. You input the address. You can see exactly what the annual taxes are. You can see what they were. You can typically see phased-in assessments to get a snapshot of what next year’s bill is going to be.

The reason that’s important is, oftentimes, if you think of a scenario where you’re buying a property that was recently flipped and renovated… They bought it for $400,000, they put some work into it, and you’re buying it for $650,000. Well, that house might actually have a current assessment of $300,000 and a really low tax bill, but if you’re on a tight budget, wouldn’t you want to know that next year that tax bill is going to be $5,000? I think it’s important to use those government sites—those actual government sites and not the online marketing portals that you typically see—so you can make sure you have an accurate quote.

Now, I’ll tell you there is a big frustration with escrow accounts, and that is the constant up-and-down that winds up happening over time.

In a perfect-world scenario, values never change: your tax bill is fixed forever, and your insurance is fixed forever. It’s pretty easy; nothing ever changes. But the way it works with escrow accounts is lenders typically will only do the analysis once a year, and that’s usually after they’ve paid all the bills.

If you think about it, your payment is calculated and fixed at a certain amount. You pay that payment to the lender all year long, and then, all of a sudden, the lender pays the tax bill, and the tax bill is $1,000 more a month. Then they come back to you, and they say, “Hey, look, your payment actually needs to be $80 more a month because taxes went up.” It’s kind of easy to swallow. You can kind of see it. But then they say, “We weren’t budgeted properly for that, so you also have a $1,000 deficiency, so now we’re going to add another $80 per month for the next year in order to make the escrow account whole.”

Just know that, when you get those tax statements, and when you get your insurance renewal, you should kind of look at it right then and there. How much did it go up? You can even reach out to your lender proactively and say, “Hey, I’d like to change my payment right now because I see it’s going to up in the future,” and most lenders will. And if they won’t, at least you can be budgeted for it for when that happens.

There’s one last thing about escrow accounts.

Let’s say your mortgage gets sold, and then let’s say the mortgage gets sold when tax bills are due. I’ve seen countless examples of this over time with horror stories that happen where, all of a sudden, a tax payment didn’t get made. Then the new lender does an escrow analysis and says, “Hey, you’ve got all this extra money leftover in your escrow account. Here’s a check.” Everyone sort of thinks that the tax bill was paid. 6 months later, you get notices from the tax office that your house is going to tax sale because the bill was not paid. Your payment has already been readjusted with the new lender, and now you’ve got a huge escrow deficiency. Key point here: If your loan gets sold, look into it further. When are the tax and insurance bills due? Just triple check that those payments were actually made by either the old lender or the new.

Another part of your payment is insurance.

I know a lot of people would say, “Eh, that’s a pretty easy topic—you need insurance.” If you’re renting right now, you probably remember signing a lease and your landlord saying, “I want proof of renter’s coverage.” If you think about your house burning down, let’s say, or the dishwasher flooding, it’s your fault. You need some insurance to cover the inside of the place. Or maybe it burns down, and you have clothes, jewelry, and TVs.

When you own a house, you need insurance for vandalism, theft, fire. Just think of all the normal disasters that can happen out there, and you need some insurance to protect it. Now, for the most part, insurance is kind of cut-and-dry. Most companies seem to be within this general area, although I will say that, in my office, I actually have these thresholds. I look at the sale price in the area, and we kind of just peg the amounts. I tell everyone, “Hey, when the insurance comes in, if it’s over by, say, 15% or 20% or so, please bring it to my attention, so we can double look at that policy.”

Things that we found? Over-insured dwelling coverage.

You call and say, “Hey, I’m buying a $500,000 house,” and you get $500,000 worth of dwelling coverage. Well, that house sits on a piece of land that’s worth something. If the house burns down, you’re not replacing the land, so dwelling coverage is the key. How much will it cost to rebuild? That’s really what lenders care about. We could have a somewhat expensive house with really small dwelling coverage, but if there’s a rider called “full-replacement cost,” that’s all lenders care about. “If it burns down, it can be rebuilt—our collateral is protected.”

Now, as a consumer, you might want to dig a little deeper. When I see some bills that are a little out of whack, it’s usually a wedding ring—just expensive stuff that, personally, you are insuring. Cameras and whatever. I think that’s one area.

A couple of weird little pitfalls…

One thing I’ve noticed is that every few years, insurance is probably one of the easiest things to shop and save. Just like everything, it seems like you get a policy, and a year later, it went up a little bit, and a year later, it went up a little bit… And what you find with insurance companies is they’re all concentrated around the country, but some are heavier in some parts over others.

Let’s say there’s a natural disaster, like a flood or a massive wildfire or something. If someone got clobbered in that area of the country, they typically defray some of the cost in increased coverage or policy premiums around the country. You just might not know that, so it’s really easy to shop around, so if you know that you bought your house in July, and maybe every couple of years, you re-shop your insurance.

Another thing that actually just popped up a couple of weeks ago…

A personal friend of mine was buying a place. It was a modest house, but the premium came in at $1900 a year, which was just crazy for what he was buying. We took that policy and brought it to three other providers that we knew, and then one of my best guys called me and said, “Man, I hate to say this, John. This has never happened before, but I can’t insure that house.”

It turns out that the prior owner had three large claims on that house, and all of the insurance carriers were basically looking at that house like it was plagued, like that might just be a bad house. It was expensive, and we heard a few different things of 3 to 5 years from the final claim of the prior seller.

Again, insurance is a component. For the most part, it’s pretty simple, but there are some things to look a little bit deeper into.

Now, another part of the mortgage payment that kind of gets lost…

It’s not really part of the mortgage payment, but it’s kind of part of the mortgage payment. It’s the fee for owning that property that you have to pay in some way, shape, or form, monthly or quarterly—that’s HOA dues or condo dues. Many of the listings out there will have them.

I’ll give you my personal story. We bought a house, and it had an HOA fee of $75, paid quarterly. We move in, and maybe 6 months later, we get this rogue bill for $275, and I said, “That doesn’t make sense.” Well, it turns out that we lived… This was 13 years ago in my first house. We didn’t know any better. I actually live in a big planned community. You pull in, and it’s beautifully landscaped. It’s this mile-long, awesome, double-lane road on both sides, beautiful trees. I guess my $75 a month that I was paying was to maybe cover all that stuff, right? Tot lots, insurances, and all the community amenities. Well, it turns out that that entrance of that master community had an HOA fee, and then my little subsection of the community had a separate HOA feel.

When you’re looking at listings, a planned-unit development is a single-family home or a townhouse. If you see parks and pools and trails and beautiful landscaping and flowers that change every quarter, typically, there’s an HOA involved. Any condominium has them, and there are just wide ranges of condo fees. You’ll find that sometimes you’ll see a condo fee with the “special assessments,” which is… Think of a scenario where the condominium is going through some renovations, and they need to raise some money. The way they raise money is they charge their unit owners more money. They call those “special assessments.”

So, the HOA is something that should definitely be considered in your budget. It gets lost a lot, and I will routinely have people call at least once a week and say, “John, your payment is way higher than the other people—what’s the difference?” and it goes down to that HOA fee.

The last thing that you need to think about when you buy this house and have your mortgage payment are the other little, fixed costs that are not necessarily included in your payment but are required to pay. Those are things like utility bills, landscaping, and the like.

On the utility side, because I think that is a big piece, with many of the utility companies, you can simply input the address and actually get a really good snapshot of how that person is living, what their bills are. Now, again, my house… If you have two small kids, you’re washing clothes 15 times a day, and you’re keeping super heat and lots of cooling, so your bills are going to be crazy, so just be mindful of that, too. Who are the people living in that house? Who are you, and how are you different?

That pretty much covers everything you need to know about what’s included in this mortgage payment when you buy your house. I think if there’s one thing to take away here, it’s to really take a look at the payment that any lender gives you.

You can go right to that payment breakdown and just ask a very simple question with each one of those line items:

Where did that come from?
How did you get that?
Why did you use this number?
Where did that number come from?

By doing that, you can figure out where the inconsistencies might lie. If they said, “Oh, I got it from Zillow,” you can follow up. “Did you check the local jurisdiction site?” or you can do it yourself, and you can add all those things up. That will give you a lot of insight into what that payment is.

Again, I hope you enjoyed this podcast, a deep dive into the mortgage payment. We have a lot more good stuff coming your way. How do you figure out what you should buy? What type of down payment should you prepare for? Lots of juicy details coming down.

If you have any questions between now and then, feel free, again, to email us at DownsGroup@VellumMortgage.com, or check out our website www.DownsMortgageGroup.com.

If you want to learn more about shopping for mortgage, be sure to download my companion e-book to this podcast at DownsMortgageGroup.com/shop. Or, as always, you can email me at DownsGroup@VellumMortgage.com. Thanks so much for joining us!