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Hi...Trying to decide whether or not to refinance
Old 10-10-2011, 11:49 PM   #1
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Hi...Trying to decide whether or not to refinance

Hi everyone,

I have so many different questions but I thought I would start by asking your opinion about the most immediate one. I am 43, married (wife is 41) with one 5 year old son. My wife and I make 200k combined per year in salary. We are both tenured college professors so that gives us (I hope) more job security than many, so that is the one good aspect of our situation.

Some facts to consider here: we both contribute 7.5% of our salary to the State's DB pension plan. We both will be vested within 6 months. In addition, we each are now contributing $1000 per month in our respective retirement plans with TIAA-CREF. However, prior to just recently, we were barely contributing at all. In total, combined, we have $160k in our plans. Neither of us right now really know much about how to allocate what we do contribute, but that question is for another day.

We own two homes, both significantly underwater. One is a beach house. We owe $589k (1st mortgage) and $77k (2nd) on it. The interest rate on the 1st is 3% and on the second is 5.25%--both are variable. This house is a rental and we (for the first time) made a profit on it last year due to the falling interest rates. We made $125 according to our accountant! This house would probably appraise for $500k today.

Our other house is our primary residence and it is the subject of my question. We owe $547k (1st) and 75k (2nd) on it. The first mortgage is at a rate of 6.375% 30 year fixed and the second is at 5.35% variable.

We also own an empty beach lot which we bought for 400k and is now worth 200k. The silver lining here is that we don't owe anything on that!

I would like to refinance something to take advantage of today's low rates. Our rental is so far under water that this is impossible, as far as I can tell. I had always thought; however, that our primary residence had not significantly declined in value. That was until I sought a refinancing. As it turns out, our home has declined in value significantly. The bottom line is that I was told that if I could pay down the first mortgage from $547k to 417K then I would have a conforming loan and that a 15 year fixed rate on that loan would be 3.5%. I think our payment would go up a just a little bit but not significantly. It would reduce the term left on our loan by almost 9 years, which is very attractive to us. The problem is that it would involve us paying $135k to make it happen! We only have $100k in savings--it is currently making .1% interest--but my father volunteered to open a CD at a local bank so that I could borrow the rest against it if I wanted to. Do I do this?? Something is telling me that hurling this much money to lower the rate on our primary residence is just not worth it. However, paying off the house in 15 years dovetails nicely with our plan to hopefully retire at that time. I would like to sell the house in 15 years, buy a condo on the beach and live off the proceeds of the house, our limited supplemental retirement accounts and our DB payments.

I would love to hear your thoughts about what we should do. As you can probably glean from my post, we are pretty clueless. Please be gentle!

I have enjoyed perusing the boards and I thank you in advance for any help!
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Old 10-11-2011, 06:47 AM   #2
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Hey Gator,

As nice as it would be to reduce your interest rates, I think using all of your savings (plus having to borrow more) might not be a good idea. While you have solid jobs, you never know when you may have some kind of financial emergency and you'd have nothing to fall back on. Maybe you could build that cushion back up again, but I get the sense that there isn't necessarily a lot left over each month based on all of your real estate... IMO, a comfortable amount of property for a $200,000 income is maybe $500,000, excluding rental property (assuming it cash flows). Although if you've got no kids and your retirement will largely be taken care of with DB plans, maybe more works okay. Am I wrong about the saving / spending? Anyway, not sure if there's a good answer for this but that's what first came to mind for me. There are lots of smart people here though that might have some other thoughts.
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Old 10-11-2011, 06:50 AM   #3
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Edit: Sorry about overlooking your 5-yr old in my last post!
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Old 10-11-2011, 06:58 AM   #4
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So, what about the beach property? Do you expect it to appreciate significantly? If not, why not sell it to generate capital for the refinance. Also, what about a 30 year mortgage. That will reduce your required payment in case problems come up demanding a little cash flow and you can still make voluntary payments against principle if you want to get out in 15 years. Better yet, invest the extra payment money in accounts earmarked for early mortgage buyout. That is what I did. I paid off my principle and weekend home mortgages just before I retired. In the meantime I took advantage of a longer larger tax break. And the payoff money is available for a crisis - like layoffs in academe.
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Old 10-11-2011, 07:19 AM   #5
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Sell the beach lot and use the proceeds to refinance the house and possibly get rid of the second on your beach house. You have virtually all of your assets tied up in real estate, which I am sure I don't need to tell you hasn't exactly been a stellar performer in Florida.

I am pretty sure that sale of lot will be treated as capital loss reducing your taxes for many years to come. There is no way you'll have the money to do anything with the beach lot for the foreseeable future, nor should expect it to appreciate for the next 5+ years. (Disclaimer I know zip about Florida real estate). As a couple you guys have too much debt reduce it.
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Old 10-11-2011, 07:32 AM   #6
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Sell the beach lot, pay off the highest interest loans, work on a fixed rate for your primary home, then decide what's most important; real estate, other than home, college fund for your little guy or retirement. Think about delaying retirement a couple of years, stay with your retirement investing and you'll be in better shape than most. Today, cash is king! Yesterday, leverage was the way to go. Everytime we have a recession, cash is king! You're young, I'm not. You want to make sure you take advantage of your youth to grow wealth, safely. Most would like to be in your overall shape with your overall income and investment choices. Enjoy life, your kid only grows up once........I truly think you're pretty lucky......enjoy it.
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Old 10-11-2011, 11:31 AM   #7
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Some facts to consider here: we both contribute 7.5% of our salary to the State's DB pension plan.
If your state's DB plan doesn't provide health insurance during retirement, you probably need to give some attention to that matter, since it is often a problem for retirees these days.
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Old 10-11-2011, 04:18 PM   #8
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Thanks for your replies everyone. It seems the consensus is to sell the beach lot. We actually have signed a listing agreement to do just that but we have not sent it back yet. It is sitting on my desk as I type this. When I get a chance later on tonight I would like to share with you the situation with that and hopefully get some opinions. Maybe you all would feel the situation is more cut and dried then I do. Honestly, I had mentioned that I have lots of questions but now that I think about it I only have 3. The first one is what I posed at the beginning of the thread. The second one (which seems directly related to the first one) is "what the heck would you do with this beach lot" and the third is "are my allocation decisions in my TIAA-Cref account reasonable? Other then that, now that I think about it, those are the only financial decisions that are causing me grief.

Well, I might as well go ahead and provide the details surrounding my thinking about the beach lot. Here is the deal: the exact same lot in almost every meaningful respect sold within the last 3 months for $205k. The market has been falling. It may continue to slide, but it may not. If you stick a modest beach house on these lots then recent sales have been in the 380-450k range. By "modest" I mean a 3/2 home that meets all codes which we are told now costs about $130-140k. So, given just this information, it seems like we could take that same $135k I was talking about earlier and build a beach house with it and then sell it for $380k+. I was told that beach HOUSES are much easier to sell than beach LOTS because of the ease of financing houses over raw land. This seems plausible. We are friends with the people that built our last house and they would build another one for us and they are very good and they take about 4 months to do it.

Now, the downside of this is that this lot could literally be GONE if and when a big hurricane strikes. Literally, it could become an inlet. It has survived just fine several recent major hurricanes so this may be an eventuality that I might choose to minimize but it really is there. Even worse then that would be building a house, not being able to sell it and a hurricane comes and the house sits there perfectly fine but in 2 or 3 feet of water and not able to be rented. In this case, insurance would not pay off (the house is fine) and there I would sit...waiting on a condemnation notice from the town!

Alternatively, the house could sell rapidly as planned. Also, it could be built, not sell because of the market, but there are no catastrophic hurricanes. In that instance, the house would net, after expenses (including a full-time property manager), 20k per year if it is totally paid for. I would be perfectly comfortable with this as we have owned rental property like this for about 10 years with no real problems. I am also fairly certain that this 20k net would be a conservative estimate (factoring out the cost cost of the "land" portion of the property taxes, which would be paid either way).

Finally, this BP oil spill is looking increasingly like it will result in a major renourishment / coastal restoration project to be paid for through the fines imposed on BP and others. If this happens, and it is still an IF, then I honestly and truly believe that the value of that lot will rise very significantly, mainly because once an "engineered beach" is built it becomes part of the infrastructure of the town. This means that it would be continually rebuilt when it erodes away. This is a HUGE deal in terms of property values. Thus, I am constantly struggling with a) the fear that during any given hurricane season the property will be worth zero, b) trying to assure myself that by far the most likely outcome is that this doomsday scenario will not happen, c) property values are so low right now and it isn't hurting us at all to just hang on to it--so let's hang on to it and wait for better days (which might be right around the corner), and d) let's just cut our losses and move on. To actually think about owning that lot is getting to be painful and we can use the money for other things (see the refinance question).

I just want to make the best decision. I apologize for the length of my posts; I am just trying to add as much relevant information so that you can, if you are so inclined, help me in making the smartest move.

Thanks again.

Oh and yes, currently our State DB plan includes health care (at least last I heard)!

What the heck--my allocations are split equally between Cref Stock, Growth, Equity Index and Global equities. This is for all contributions going forward. I happen to have some money sitting in the "Money Market" portion, which I know should be allocated to something else. I am thinking about just putting all of it in the TIAA traditional portion. The only reason for that is because it is "safe."

Finally, whomever assumed that we are heavily in debt and that we probably spend too much and/or do not have a lot left over to spend--it does feel that way. I guess I would add this: what I have listed is our debts. We don't have any car payments, credit card payments, student loans, etc. We can comfortably pay our bills and contribute to our retirement accounts as mentioned earlier. It just seems like we can't quite "get ahead." I am struggling to break something loose to give us that extra ability to save more aggressively into our retirement accounts.
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Old 10-11-2011, 05:32 PM   #9
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gator, I think that what is often missed when considering financial decisions is appropriate consideration of the downside risk you are faced with by making a significant financial decision. So apply this to your consideration of the land:

- If the "big one" comes along and washes out the lot, a large portion of your net worth (possibly most of it) is gone for good. You have also permanently lost the possibility of selling and rejiggering your primary residence mortgage.

- If you build a house which then does not sell or plunges in value, you are out a large chunk of net worth.

- If the area revitalizes, you make money.

There are lots of other potential outcomes, like the value of the lot dropping with the market. So what is the likelihood and potential magnitude of your upside? If you sell and use the proceeds to refi, you get a fairly clear return on the money (lower rates on your mortgage), clean up your balance sheet via debt reduction, and reduce the risk of holding the land. If you build the house and sell it, perhaps you make a modest profit. If you hold the land long term, you get some appreciation, especially if the area revitalizes.

I personally think you have too much debt and not enough net worth to take the risks you are taking, so I would sell the land and refi. You have to decide for yourself of course, but pay lots of attention to the downside inherent in any option you consider.
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Old 10-11-2011, 05:35 PM   #10
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Oh and yes, currently our State DB plan includes health care (at least last I heard)!
That's great. For a point of reference, in case you want to go into more detail on this point, my Hawaii state DB pension provides (from full retirement age) payment of Medicare part B premiums (which for me and my wife are $221/month) and supplemental insurance (medical, drug, vision, dental).

I don't know how to estimate the likelihood that a hurricane might destroy any house you built on your beach lot. Unless the house is actually destroyed, I doubt that the possibility of a hurricane would affect the selling price that much. When I bought my house in 1994, I knew that it had been slightly damaged by a hurricane two years previous (that was Iniki, in 1992), but that didn't seem to matter to anyone. And here we are, 17 years later, with no serious further hurricane threats.
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Old 10-11-2011, 05:43 PM   #11
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I personally think you have too much debt and not enough net worth to take the risks you are taking, so I would sell the land and refi. You have to decide for yourself of course, but pay lots of attention to the downside inherent in any option you consider.

I concur with Brewer. These types of lots can be speculative...a large sum of money can be gained, or a large sum of money can lost. I believe these "bets" are more appropriately suited for people that have a large networth. The large networth won't be critically impacted if things go awry with the lot.

Sell the lot, refi the house is how I would vote. Take the sure thing.

UD
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Old 10-11-2011, 06:13 PM   #12
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I concur with Brewer. These types of lots can be speculative...a large sum of money can be gained, or a large sum of money can lost. I believe these "bets" are more appropriately suited for people that have a large networth. The large networth won't be critically impacted if things go awry with the lot.

Sell the lot, refi the house is how I would vote. Take the sure thing.

UD
+1
If you feel things are tight now, adding more debt and risk is not a good strategy. Get rid of the lot and start to get your financial house in order.

As far as your asset allocation, this can be viewed a few different ways. My initial reaction is that you are being too aggressive with virtually 100% of your investments in stock. You are in for a wild ride! I would suggest something a little more moderate with perhaps 30%-35% of your portfolio in fixed income (such as the TIAA Traditional). This would also allow you to rebalance periodically to take adantage of market volatility. Buy low, sell high, right? Some CREF Real Estate would also add to the diversification in your portfolio. Asset allocation is a pretty personal decision so, of course, this is just my opinion. Clearly you are ok with a little risk with your personal finances. Another way to view your portfolio is that your pensions are a fixed income equivalent and therefore you could be much more aggressive with your other investments. If you ask me, that doesn't really make much of a difference when you look at a 403(b) statement that has dropped in value by 40%!
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Old 10-11-2011, 06:37 PM   #13
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+1
If you feel things are tight now, adding more debt and risk is not a good strategy. Get rid of the lot and start to get your financial house in order.

As far as your asset allocation, this can be viewed a few different ways. My initial reaction is that you are being too aggressive with virtually 100% of your investments in stock. You are in for a wild ride! I would suggest something a little more moderate with perhaps 30%-35% of your portfolio in fixed income (such as the TIAA Traditional). This would also allow you to rebalance periodically to take adantage of market volatility. Buy low, sell high, right? Some CREF Real Estate would also add to the diversification in your portfolio. Asset allocation is a pretty personal decision so, of course, this is just my opinion. Clearly you are ok with a little risk with your personal finances. Another way to view your portfolio is that your pensions are a fixed income equivalent and therefore you could be much more aggressive with your other investments. If you ask me, that doesn't really make much of a difference when you look at a 403(b) statement that has dropped in value by 40%!
Edit #2... You already have too much real estate in your portfolio. CREF Real Estate is unnecessary at this time!
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Old 10-11-2011, 09:11 PM   #14
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I wouldn't be so amazed by this situation if you weren't both tenured professors, (please tell me you aren't business or economics professors) which I assume means PHd, and IQ in the top couple % of the country.

So lets do a balance sheet
Liabilities total $1,288,000 now admittedly you only have "good" not bad debt, like credit card or car loan. On the other hand I don't consider 2nd mortgages good debt to me it is a sign of overleveraging.
Assets
Beach Lot 200k
Primary residents $520K?
Beach house $500k
Total Real Estate $1,220,000
Now I am going to decrease the value of your real estate by 10% to account for brokerages commissions and it being buyers market out there.
Liquidation value of real estate $1,098,000
Savings 100,000
Retirement savings 160,000
Total Asset $1,358,000
Less Liabilities $1,288,000
Net worth $70K

So the good news is that unlike many people in Florida that invest in real estate you have a positive net worth. The bad news is you are leveraged almost 20-1, this similar to companies like Lehman Brothers and we all know how that turned out.


Right now it looks like you are paying $60K in interest a year that is 30% of your income, once you include principal payments it is well above any guidelines. The good news is the Feds have told us that interest rates aren't going up before the election. The bad news is if the economy picks up, which would be good for the Florida real estate market, it also means the interest on your loans is going up. A 2% rise in interest rates, back to a historical leves, means another $14K or so in interest expense for you guys.

So your idea is to borrow more money to build a house?? Is this because there is a shortage of houses in Florida and people are waiting in line to put offers in as soon as beach front properties go on sale? Last I looked Florida had a huge surplus of houses.

Best case adding a house to the lot nets you 30K after paying commissions with lots of risk, hurricanes, builder etc. The refi on your primary residence saves you $20K/year in interest expense and it is guaranteed.

The first rule of the hole is to stop digging. You are in debt hole.
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Old 10-11-2011, 10:28 PM   #15
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Thanks for the replies everyone. I really appreciate that you took the time to consider our situation and let me know what you think. What is most helpful to me is it seems that selling the beach lot seems to be a sort of obvious solution. I can appreciate the fact that if 200k were "play money" to us then it might be worth holding on and hoping for a big payoff; however, given our situation there is simply too much risk. That was our initial inclination (thus the signed but not yet delivered listing agreement) but it was nice getting some confirmation on that point. I will point out that my 200k figure is in line with recent "fire sale" prices and is significantly below current listings. All the figures that I have presented to you reflect that attitude. At least I am realistic.

As for our balance sheet posted above, this looks about right, though I have not run into any problems with our debt-to-income ratio being high, at least as far as bankers considering us for refinancing is concerned. That is not to say that we don't have too much debt--just that we do not seem to set off "alarm bells" on that issue when we talk to banks about refinancing. On a related note, (and I seem to remember a discussion about this on this forum) wouldn't the money we have contributed to our DB plan count for something in viewing a balance sheet? I don't really obsess about that, just that the pension is a pretty big part of our ultimate retirement plan...you would think that would count for something!

Overall, in my mind I have just looked at our situation as, "the beach house basically pays for itself (at least for now) and after we contribute to our retirement funds we can pay all the expenses for our primary residence and still squirrel away a bit in savings for a rainy day...meanwhile, we do own this darn lot that we could sell if it all falls down." That's how we've been operating in a nutshell. I just want to significantly increase our retirement contributions. If we could do that, I'd be happy. We are getting serious about getting our affairs in order to actually try to retire once we both put in our 25 years. Thus, I found this forum and asked my questions. Anyway, just a bit of background. Again, thank you very much for spending your time considering our situation and weighing in. I am definitely going to strongly consider what you are telling me.
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Old 10-12-2011, 12:13 AM   #16
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The first rule of the hole is to stop digging. You are in debt hole.
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I am definitely going to strongly consider what you are telling me.
"... but first I need to find a bigger shovel."
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Old 10-12-2011, 01:07 AM   #17
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"... but first I need to find a bigger shovel."
I take it that you think I mean, "but I plan to do what I want anyway." Ok. You are entitled to your opinion, but you are wrong. I meant exactly what I said. I hope the "boys on the board" got a good chuckle out of your hilarious dig at the newbie who hasn't lived the frugal, disciplined life that you have.

I suppose any helpful advice will now stop now that "nords" has weighed in and ridiculed me. That is the kiss of death. Cast me off into the vast know-nothings who fail to LBYM. Look, I've got 15 years to go before I hope to retire and I am trying to get things on the right track. I am a reasonably intelligent guy hoping to join the club. Why jump on me right away? Aren't you a moderator on this board? Is this the message you want to send to new posters?
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Old 10-12-2011, 05:51 AM   #18
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Lostgator, Nords isn't a moderator. Like me, he's a former mod who is now retired - from both the working world and mod duties.

Having been around this board for a while, my advice to you would be to chill out. If you hang around for a while you'll find it helps to have a sense of humor here - even if the joke is occasionally on you. So put down that shovel, slap on some skin toughener and sort through the advice given. It appears to me that most of it is dead on.
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Old 10-12-2011, 06:29 AM   #19
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As for our balance sheet posted above, this looks about right, though I have not run into any problems with our debt-to-income ratio being high, at least as far as bankers considering us for refinancing is concerned. That is not to say that we don't have too much debt--just that we do not seem to set off "alarm bells" on that issue when we talk to banks about refinancing. On a related note, (and I seem to remember a discussion about this on this forum) wouldn't the money we have contributed to our DB plan count for something in viewing a balance sheet? I don't really obsess about that, just that the pension is a pretty big part of our ultimate retirement plan...you would think that would count for something!

Overall, in my mind I have just looked at our situation as, "the beach house basically pays for itself (at least for now) and after we contribute to our retirement funds we can pay all the expenses for our primary residence and still squirrel away a bit in savings for a rainy day...meanwhile, we do own this darn lot that we could sell if it all falls down." That's how we've been operating in a nutshell. I just want to significantly increase our retirement contributions. If we could do that, I'd be happy. We are getting serious about getting our affairs in order to actually try to retire once we both put in our 25 years. Thus, I found this forum and asked my questions. Anyway, just a bit of background. Again, thank you very much for spending your time considering our situation and weighing in. I am definitely going to strongly consider what you are telling me.
Gator-
The thing about banks is they don't care at all about your overall financial circumstances, only that you can scrape together enough money to make the mortgage payment. Even if you can't send your kids to college or afford to retire until your 80, they're good with that. They also don't consider a number of cash flow issues in their debt to income calculation that really are important... like the amount you pay for daycare or a nanny. Are you setting aside money every month for your next car? If not you'll have a nice car payment that wasn't included in the original calculation. Also, what if you are disabled and can't pay all your bills? Maybe you get 60% of your salary in a LT disability benefit but that won't cover much after taxes, especially if you're stretching right now. You'll probably let most financial obligations slide except the mortgage payment. And in the worst case, the bank gets the house back anyway. In short, don't let the bank determine you much you can afford, because it'll only get you in trouble.

As far as counting the DB plan on your balance sheet, it's not really considered until you have it and then it's more of an addition to cash flows (like Social Security). It would be interesting to put a present value to it at some point though. If you are currently vested and can take the pension as a lump sum, then I would put it on your net worth statement now.

Keep that shovel handy, but only to fill in that hole.
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Old 10-12-2011, 07:12 AM   #20
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Ah so you thought that the be gentle plea would save you. I think Nords ask for that once at the Naval Academy and they sentenced him to 90 days hard labor at the bottom of the sea.

Yes your pension is definitely an a valuable asset. Lots of debate about how to value it but since like college education you can not sell or transfer it, probably not worthwhile to stick on a balance sheet until you can take as a lump sum.

How banks treat rental properties is a somewhat a mystery to me. I will point out that they offered you a 3.5% interest rate only for a conforming loan. A conforming loan has strict limits on both a loan to value ratio (80% max) and total payments to income. By paying down your mortgage you both reduce the LTV and with lower debt and lower interest rates, you reduce interest payments by 20K this makes it easier to make the debt to income ratio.

The secondary market for non conforming loans isn't good right now so bank really prefer to make conforming loans, since they can foist sell them to Fannie or Freddie, collect their fees and get them off their balance sheets.
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