Sunday, November 20, 2011

save money by refinancing with confirming loan + HELOC instead of a jumbo loan

There is a huge difference cost of the loan and the interesting rate for Jumbo vs Confirming. Here is one example for

Conforming Loan
Rates as of
Rate1 (%)
APR2 (%)Monthly Payment2
(Based on $250,000 loan amount)
30yr Fixed4.21
Jumbo Loan

Rates as of
Rate1 (%)
Monthly Payment2
(Based on $640,000 loan amount)
30yr Fixed4.75
Lender InstitutionInterest RatePrepay PenaltyAnnual Fee
Schwab Bank3.99%NoNo

Of course, if you have the cash to buy down to a conforming loan then the decision is pretty straight forward. However, there is another option. You can do "structured financing" and get two loans at the same time. Get conforming to the maximum amount, then get a second HELOC (home equity line of credit) for the remaining balance. Here is the break down to the pros and cons.

1) Save money on the interest based on the primary loan
2) Save money on the cost of loan (initial down payment)
3) Save money on the current interest for the HELOC (at this time and likely the next few years, the interest rate for HELOC is lower then 30 yrs fixed)
4) With Schwab - you have 10 years interesting only payment option so you can reduce your monthly payment in case of emergency.
5) With Schwab - you have 10 year for draw period so you can access the paid off principle in case of emergency

1) Extra paperwork. This is pretty minor, in case fact, with Schwab, they give you a discounted interesting rate if you applied for the 2 loans other.
2) Exposure to adjustable rate. This is a serious risk for long term, but most of HELOC has per annual interest increase limit, and life-time cap on the interest rate. If you very careful with your cash reserve, this is manageable risk. In fact, depending on how much risk is acceptable, you might want to reduce the fixed loan portion of the conforming loan and increase the HELOC portion to maximum your interest rate savings.

All in the all, the risk is manageable, and the saving is quite significant. My beef is that I haven't been told of this option. I refinanced many properties and many loans. I have used loan advisors with the bank, and 3rd party mortgage "experts". Not once, I been advised to take this option. When I saw the the difference between the jumbo and conforming, I racked my brain to think of ways to take advantage of this difference. I came up with this option on my own and asked around multiple banks to confirm this is indeed a viable option. I won't speculate if the sales agents were taking advantage of me, or if they were ignorant also. For this simple change in the application process, I would save tens of thousands of dollars over the life of the loan.

Either ways, this experience demonstrates one of my core belief. Nobody has your interest in mind except yourself. You must get educated on the key aspects any major decisions you made. You can't fully trust advisers, agents, Realtor, banker, CPA,  teachers, etc. You absolutely need to understand and expand your scope of knowledge. You might be able to depend on agents to do the legwork for you. However, you can't trust them to think and look out for your interests in a strategic way.

The 4 classes of knowledge

A concept made infamous by Donald Rumfeld, but he only identified 3 out of 4. I think of the classes of knowledge as a grid.

Reality: Known and Unknown
Perception: Known and Unknown

Reality vs Perception.
       K   U
 K  | A | B |

 U  | C | D |

Grid A: Known Known : things that you know that you know. e.g. Your name, your address, your mother's voice, 1 + 1 = 2, etc.

Grid B: Known Unknown : things that you know that you don't know. Unless you are a physics major, you know that you don't know Quantum Mechanics, why E=MC^2, or how to proof that 1 + 1= 2.

Grid C: Unknown Known : things that you didn't know that you know. We all have gut feelings that we intuitively know to be true or false but can't articulate. We make unconscious, unspoken assumption and biases. For example, behavioral economics is all about understanding people decision patterns. People would automatically place greater value and preference for things they own, even when they are randomly chosen.

Grid D:  Unknown Unknown : In this infinitely interrelated world, where the flutter of a butterfly can influence weather pattern, it's impossible for us to know all the possible dependencies or outcomes of our decisions. We are always faced with unknown unknown.

So.... why are these classifications of knowledge useful? I use these 4 classes of knowledge to execute a strategy of learning and better decision making. 

This is very useful pattern for serious decision making. It helps me to think strategically over time about how risky and confident I feel about a decision. I rephrase the 4 classification this way.

Grid A : the facts that I know and confirm to be true. Over time, the objective is to increase the scope of A. However, things changes, new research comes along, what we knew to be true once, changes. It's a constant effort to keep up. The main risk for knowledge in grid A is over-confidence and being obsolete. Take the time to challenge your knowledge and reconfirm.

Grid B : the questions that I know enough to ask. Again, take the time to make a list of questions and people that might be able to help. Longer the list the better. Don't be scared of novice questions and be sure to cross check anything you learned with another source. It's a deliberate process to increase the scope of A by eliminating questions from grid B.

Grid C : Never fully ignore your gut instinct and never fully listen to your gut either. Things are most interesting when there is disconnect. Either way, your rational mind hesitates but your gut says just do it, or vice verse, There is no such thing like a brain in the gut. It's our right hemisphere brain sending strong signals of caution or excitement. The right brain doesn't have capacity for language, but it has the big picture, it understands the inter-dependencies. The right brain communicates through the gut and the heart. It's the feeling when your heart races at 100 beats per minute, It's the twisted feeling in your gut. Either way, until the two parts of the brain are fully harmonized, you must revisit everything in grid A and B. To better understand the disconnect, I try to make a list of biases and assumptions. Try to put your feelings into written words. Biases and feelings are neither bad nor good. It's an important part of the decision process to acknowledge that you have strong feelings and biases and if possible revisit the biases and challenge yourself to change or reconfirm them.

Grid D : Like dark matters in the universe, we can't see them, but we can indirectly measure them if we have enough tools and smarts at our disposal. When we are faced with a new decision, there is a vast amount of unknown. At first new knowledge trickles in slowly then it becomes a rush, especially if you have good mentors and friends and access to professional help. I can't know the scope and size of things in grid D. However, there will come a point when the rate of the new knowledge gained slows down, and there has been multiple confirmation of the same data. Do you know everything you need, probably not. However, you probably know enough to made a good decision and have a backup plan in case your assumption are wrong.

All elements of good decisions are here..
1) see multiple options in non black / white terms
2) harmony between gut, heart, and mind
3) understanding of the risks
4) backup plans for the unexpected

By categorizing knowledge and acknowledging the unknown, you can execute a strategic plan to increase knowledge, eliminate unknown, and achieve the end result of a better decision.

My first ETF purchase

My emergency cash reserve is too conservative. Given the inflation rate vs interest rate, the indirect loss of purchase power is unacceptable.

I split the cash reserve into 2 parts. The first part remains in an easy to access checking account with ACH transfer setup to quick access. The second part will go to my investment account. I plan to purchase SCHP. The ETF based on U.S. TIPS (Treasury Inflation Protected Securities).

Here are some interesting articles:
1) ETF vs actual bonds:
2) perspective on last 3 month of bond activity:

Why from Schwab? They have the lowest expense ratio:
IPE       SPDR Barclays Capital TIPS                    0.18%
LTPZ PIMCO 15+ Year US TIPS Index ETF 0.20%
SCHP Schwab U.S. TIPS ETF                            0.14%
STIP iShares Barclays 0-5 Year TIPS Bond 0.20%
STPZ PIMCO 1-5 Year US TIPS Index ETF 0.20%
TDTF FlexShares iBoxx 5Yr Target Dur TIPS ETF 0.23%
TDTT FlexShares iBoxx 3Yr Target Dur TIPS ETF 0.23%
TIP    iShares Barclays TIPS Bond                       0.20%
TIPZ PIMCO Broad U.S. TIPS Index ETF 0.20%

Why this might be a good decision...
1) Split emergency cash into 2 parts offers a better compromise between accessibility and protection
2) ETFs are easy to trade so I still have good access to the fund in case of emergency. 
3) TIPS offers a better protection against inflation and still conservative
4) Good diversification strategy. I don't have anything like this in my portfolio. This move would increase the diversity of my assets.  

Why this might be a bad decision...
1) This is an unexplored area for me. My first ETF purchase and first TIPS purchase. I don't have any sense on the tax implication or what kind of risk i'm taking on. This is the risk of the unknown rather than any specific or actual risk. 
2) Why not other ETF or bond? Why not gold or any other the investment options? My decision to investigate ETF and TIPS is predicated on my fear of inflation. In a sense my decision was already pre-made based on my fears. So am I really making the best possible decision? This is risk of sub-optimal decision.
3) Is this a part of herd thinking? Recent ramp up in the bond and treasury market seems to indicate that everyone is thinking along the same lines. Am I running of risk of entering the market at a particularly bad time and destined see the value crash right after purchase?

These questions always goes to the core of the blog...
I am the sum of my decisions and the intended and unintended consequence of the decisions