Isn’t winning awesome? I remember vividly the intensity and the sheer excitement of even my most trivial successes throughout my mediocre D-3 baseball career.
One year, in the finals of the semi-regional against Illinois Wesleyan, I drove in the tying run in the top of the 6th inning, and then in the bottom of the 7th I threw a runner out at third base from right field—a laser one-hopper right at the glove. For those few moments, I was on top of the world.
Moments like that are hard to describe, but I remember the adrenaline pumping and the pure excitement inside me and exuding from my teammates.
Now, we ended up losing the game on a swinging bunt, but hey, there is still a point to be made here and believe it or not, it does actually relate to finance! I can honestly say this description of being “in the zone” is how I felt after a thank you phone call from a client I was able to recently help. Dramatic? Maybe. But this wasn’t just a normal client in a typical home-buying scenario. I was able to help him pocket $14,500 in pure NEW cash through a succession of events over a 12 month period that cost him NOTHING.
‘Ok, great (sarcastically)’….one might say. Take a large enough loan at a high rate, reduce it to a low rate, and you can save that kind of money. But that’s not what this was. This was more like letting a stranger into your home, him asking you to trust him, and then he hands you over fourteen grand in cash.
(PS. Don’t actually do that…meaning literally let a stranger in your house because he has money…ever.)
This was stretching, twisting and pulling cash out of thin air where no one else would have envisioned.
This was winning, for him and for me, and it felt good to hear his gratitude.
It all started in January of 2012. I received a phone call from client Mr. Smart (pseudonym, obviously) who was responding to a flyer I had sent out for a Streamline VA refinance. He had a VA loan that had a rate of 4.00%. He said he received a dozen flyers a month on VA streamline refinances from so many different companies, but for some reason he decided to respond to mine because the flyer seemed like it represented a simple process, and he just wanted to see where rates were. I explained that our zero point option was at 3.625%, but he would incur fees of about $6,670 (VA Funding fee, title fees, tax stamps), and reduce his payment by $123 per month. We both intrinsically knew this did not make a lot of sense. That’s a huge cost for a relatively small gain. For most lenders and for most borrowers, that would have been the end of the conversation.
I seek to educate my clients, so we took this a step further. We discussed a critical mathematic tool—and what I believe is typically the MOST important factor when considering a refinance. This tool is Breakeven Analysis. This is one of the most vital concepts that anyone, especially military who know they will be relocating in short period of time, needs to utilize. It’s not earth shattering or any type of brain surgery. It’s just simple arithmetic. In Mr. Smart’s case: $6670 in closing costs / $123 per month savings = 54.22 months; meaning it would take him 4.5 years to recoup his closing costs, or to “break-even”. He knew he was not going to be in the home more than 3-4 years, so that obviously didn’t make sense.
Now here is what makes what I do special…I knew I could still make him money!
Instead of walking away, we discussed our 3.75% option. Yes, you’re reading that right…I offered him a HIGHER rate! This was the sweet spot on the rate sheet, and provided a huge amount of lender credits (indicating the secondary markets that were bundling and selling loans had a lot of interest in selling this specific rate at that specific time, but you don’t really need ot know all that). That structure intrinsically had 1.75 points in lender credit, meaning I could pay him quite a bit to take a higher rate and he could use that credit to offset his fees.
Based on our 631,000 loan amount, this generated $11,042 in lender credits. We used this to eliminate the $6,670 in total fees, and had $4,372 in credits left over. Typically lenders won’t price something with more credits than fees, because that means they go to waste. On a streamline loan, you can’t take cash out, and a lender cannot convert credits into cash and let you walk away from the table with it, unfortunately. So, what to do with those credits you might ask?
When a loan closes, we are required to place enough money in the new tax and insurance escrow account so that it is fully funded. After the existing loan is paid off, the previous lender sends a check back to the client with the old escrow balance. In this specific example, we needed to place $4,600 into the new escrow account. So instead of rolling the $4,600 back into the loan and adding onto the loan amount, we used those remaining credits toward setting up the escrow account. Because the client would be receiving the old escrow balance back, it is should net out to wash in theory. However, in this case, if you are not rolling this money into the loan or it isn’t coming out of your pocket, and you are getting this cash back in your pocket from your prior lender, this is newly created money out of the transaction! Obviously, one is taking a higher rate relative to the option that includes cost. But, if one’s horizon is short term, it’s a no brainer. Take the lower payment, incur no costs out of pocket or added to the loan, and also receive new cash in because of the additional credits that helped set up the escrow account. And after all that, we still saved $109/month due to his payment going down. See…winning!
It gets better. In this example, we hit lightning in a bottle because rates continued to drop. We did this exercise two more times, going from 3.75% to 3.5% with eliminating all the costs and having credits to help cover the majority of the new escrow account, and again from 3.5% to 3.25%. In fact, when you add up the monthly savings over a year ($109 * 12 months = $2,376) and the 3 sets of escrows checks received back ($12,375), they netted $14,751 in pure cash out of thin air. All that they paid was the limited time and energy they put into the processes.
This all derived from a client who had the patience to hear me out. He knew that I was well versed in the process as I explained all the moving parts in great detail. While having a low payment is important, it is not everything. We were able to work together to see the big picture. We didn’t roll a large amount of funds back in the loan, which was so important to this type of deal. In several years when they are ready to sell this property, they can look back and know they didn’t roll any fees or even escrows back into the loan. They will net out as much money as they would have if they would have not done anything. Mr. Smart saw the value in something that many might not have, and for that (mixed with a little luck) I helped him make over $14,000 in cash during the course of one year!
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