Rising Interest Rates and Capitalizing on Mortgage Shorting

Buying a primary home is one of the single biggest financial decisions that a person has to make in their life. The decision is further complicated by the fact that this is also one of the few moments where everyone has the ability to leverage 4 to 1 their purchasing potential. This financial situation, like many others, can be seen as an opportunity or risk. Depending on the property you’ve determined to purchase and the cost you’re willing to pay, you have the potential to make a decent return on your investment (or, at the very least, significantly reduce your inflation exposure).

About three years ago, I made the truly scary decision to purchase a property. I happen to live in California where the real estate boom and bust cycles are exaggerated compared to the rest of the country and buying real estate is not a sport for the faint of heart! I felt that I locked in a relatively nice property with development potential that was fairly affordable. At the time we were buying the property, I had a bunch of simple metric to determine whether we would purchase the place or not. Was the PITI (principle interest taxes and insurance) near neighborhood rental rates? If it was then the place was affordable and we could buy.

At the end of 2010 we ended up with our first property and started with an initial loan of 4.25%. To make a long story short over the next three years we did two no cost refinances to lock in a 30yr, 3.5% loan for the place.  These were fairly good deals and each helped me lock in a greater principal savings if mortgage rates rose in the future. Mortgages are like any other bond out there. They have a coupon payment associated with them (monthly PI payment), a term (typically 30 or 15 years), a face value (amount of the bond), and posted collateral (your house). The difference is that when you get a mortgage, you are issuing a bond to the bank against your house. If you invest in the bond market to any degree (by typically holding a bond fund) you are actually taking the role of the bank and acting as the lender/creditor and holding some other corporation/entity’s bond. It’s very difficult for an individual to issue bonds outside of a small business situation and this is one of the few times you get to do this. Locking in a low interest rate is advantageous for the issuer, because if the rate environment rises the lender takes the hit to the par value and you can consider the loss in par value as actual income. In fact, corporations can choose to report in their income statement gains or losses from fair value accounting of assets or liabilities and can record on their balance sheet assets or liabilities at fair value, as opposed to just at principal amount (FAS 157 covers these accounting rules).

What this means is that as interest rates rise, the face value of my mortgage declines and I have made money by locking in an interest rate below prevailing market conditions. Using a simple bond calculator and assuming a $500k loan, I can figure out the book value of my mortgage as mortgage rates rise. For a market rate of 4.5% (current) and a stated interest rate of 3.5% and 29 terms left, the bond calculator states that my $500k mortgage is only worth $420k. In one year and a 1% increase, I’ve made $80k if I was to buy this bond back. If interest rates rise to 5.5% by next year and assuming 28 terms left, the mortgage is only worth $361k. That means I have the chance of making another $79k by holding this mortgage. This is a significant earnings per $500k that a fair number of households will make over the next couple of years.

That’s all well and good, and I believe everyone understands that you will be making money off the bond as interest rates rise, but we might also be a bit more concerned in how much of a reduction in interest expense you gain by holding a lower than market rate mortgage as opposed to current rates. To figure this out I went to a mortgage calculator (http://www.mlcalc.com) and priced three $500k mortgages; one at 3.5%, another at 4.5%, and a third at 5.5%. I then calculated the total interest paid as a function of years for each loan and then calculated the interest expense saved by year. For the hypothetical $500k loan, you’re saving nearly $4k in the first year between the 3.5% and 4.5% loan and nearly $8k in the first year between the 3.5% and 5.5% loan. If you hold the loan to maturity you’ll save $83k on the 3.5% to 4.5% change and $170k on the 3.5% to 5.5% change. I also wanted to know how long it would take me to realize this savings and so calculated a rolling Interest Rate of Change for each rate change. The annual interest expense saved per year divided by the total potential interest saved is then plotted as a percentage over the life of the loan. After 30 years you’ve saved 100% of the potential interest expense and you can see (from the plot below) that they follow fairly similar rates of change. Also note you make 50% of your money back in the first ten years. So as rates rise, do your best to hold your mortgage for at least the next 9 years.

 

Mario.

Interest Save RoC

Legoland

Our family has been searching for great weekend family activities for a while. We have had a couple of staple choices such as the Aquarium, the Los Angeles Zoo, and the Natural History Museum, but none of these really truly capture our boys’ hearts. Flo would complain that when we went to the Aquarium the boys would spend more time running around and playing in the outdoor water area than actually looking at the fish.

Not that this is a big issue, but we needed to have a change of venue/change of activity so that we were engaging the boys in what they wanted to do as opposed to something we thought they’d be ready for. Unfortunately when we thought of theme parks we ran into two issues. Firstly, admission is expensive to theme parks. Even if you do an annual pass so that you can go multiple times, it still ends up being fairly expensive when compared to other attractions. Due to the cost we decided that we’d only really consider one theme park per year and get an annual pass for the one we liked. Secondly, most theme parks are actually geared to older kids. I think the perfect age for theme parks is the 6-13 year range. At this age kids have the durability to hang out for more than a couple of hours, they can probably walk a mile or two within the day, and they can actually start to go on rides by themselves. Unfortunately for us, Ravi and Max are still only 4 and 2 years old. That means we still have to deal with diapers and naps and the kids aren’t really interested in walking long distances. It also means that we really wanted an activity that was geared for about a half day (5 – 7 hours) at the most. And whatever we chose should not have an incredibly long drive as that tends to upset Max and he can end up crying on the trip. He’s good for about an hour if he’s well rested, but nearly every trip past two hours he has cried.

We did some research on theme parks and thought about giving Legoland a try. It’s a fairly inexpensive theme park compared to others and it’s geared to younger kids. They have a very handy height restriction map that helps you decide if your kids will enjoy the park. Ravi is about 37 inches and Max is barely 34 inches.

Map of Legoland Park with Height Restrictions for Rides included.

Map of Legoland Park with Height Restrictions for Rides included.

As you can see on the map above by 40 inches or taller you can do nearly the whole theme park and by 34 inches you can do at least half of the park. This means that both Ravi and Max can participate.

We went to Legoland for the first time about 2 months ago and the boys have been having a blast. They love a number of the rides (especially Captain Cranky’s Challenge and the Coastersaurus) and Ravi loves getting a Lego toy at the end of the day. Since we have annual passes, it has become one of the ‘de facto’ top weekend choices for our family. In fact, we’ve had so much fun going to Legoland as a family that we’ve invited some of our close friends (and their young boys) to go with us this weekend. We’ll see how well we do when there are 5 young boys running around all at once!

 

 

Mario.

 

Posing with the Lego X-wing Fighter and Maxie doing his 'action' pose

Posing with the Lego X-wing Pilot and Maxie doing his ‘action’ pose

 

While Mommy and Daddy wait in line little kids can play with Legos at multiple Lego stands. Win-win for everyone.

While Mommy and Daddy wait in line the little ones can play with legos at multiple Lego stands. Win-win for everyone.

 

 

Daddy and Ravi on 'Sky Patrol!' Having fun and making the world a safer place for everyone.

Daddy and Ravi on ‘Sky Patrol!’ Having fun and making the world a safer place for everyone.

 

Legoland is partnered with Star Wars and includes a bunch of Star Wars themed Lego dioramas. Here's one of the arena on Geonosis from Episode 2.

Legoland is partnered with Star Wars and includes a bunch of Star Wars themed Lego dioramas. Here’s one of the arena on Geonosis from Episode 2.

 

First step to a new backyard — landscape design

One of the major reasons we bought our beloved yellow house was because of the rare large backyard in the area its in.  When we moved in, we completely renovated the interior of the house but left the backyard mostly untouched.  Maxie was just borne then, so neither Mario nor I had the bandwidth to do much about it.  Thus it remained a blank and ugly canvas for two years.  I often day dreamed of what it could be, envisioned the boys running around in it, playing games, picking fruits, and riding bikes.  It would be full of fruits and flowers, butterfly and honey birds, and the most gorgeous plants on earth.  Last year we finally decided it was time to give the backyard a make over.

I was so happy to take on the backyard renovation project!  I had already subscribed to gardening magazines and owned several books on landscaping.  For 10 months, I gathered information and drafted landscape plans.  But dozens of revisions later, I still wasn’t happy with my designs.  Even though I challenged myself to think differently for each plan, I couldn’t break out of my boxy designs.  I knew it could be so much more than my limited knowledge and skill could fathom.  What I needed was a fresh perspective.  So I investigated into employing a landscape design company but the cost was too high for my budget.  By chance I found out about this independent landscape designer with a reasonable price tag.  She had recently designed a friend’s front yard and I was eager to give her a try.

I contacted her in March of this year and provided her my wishlist:

Backyard –a lush garden full of flowers and fruits in every season, and an interesting place for little kids to explore and play.

Must have:

– Safe and fun place for young children
– Space to accommodate a play set
– Need to determine what ground covering works best for the play set
– Accommodate existing shed

Like to have:

– 4-8 dwarf fruit trees (Chinese pomelo, miniature tangerines, peaches, ruby grapefruit, …etc)
– Outdoor seating area
– Raised beds (more than 2 at 6x3ft2)
– Curved path way
– Raspberry and blueberry garden
– David Austin’s English rose and/or climbing rose garden
– Water feature
– Dwarf Japanese maple

Two weeks later, she same back with a landscape plan.

Our Back Yard Landscape Design

Our Back Yard Landscape Design

I was over the moon!  She gave me almost everything I asked for.  I loved that her fluid and casual design made total sense for the rigid rectangular space, and her use of plants’ textures, heights, and color combination really wow’ed me.  I won’t bore you with detail of every plant, but here’s a condensed version of her plant list (numbers corresponding to the call out of the landscape plan):

1. Black Satin Blackberry

4. Burgundy plum

5. Camelia, “Taylor’s Perfection”

7. Cercis canadensis “Forest Pansy”

8. More Blood Orange

9. Rose, “Generous Gardener” (David Austin roses)

12.  Japanese Maple (I forgot the variety name)

14. Rose, “Lady Emma” (David Austin roses)

17. Rose, “Teasing Georgia” (David Austin roses)

19. Ficus carica, “Black Jack” fig

20. Bearded Iris, “Total Recall”

21.  Apple, Malus domestica, “Anna”, espaliered

23. Rose, “Abraham Darby” (David Austin roses)

32. Rose, “Harlow Carr” (David Austin roses)

33. Chinese Grapefruit (pummelo)

34. Rose, “Tess of the d’Urbervilles”  (David Austin roses)

& 3 varieties of dwarf tangerines (including Kishu mini) and 2 varieties of blueberries (including Sunshine and Bountiful)

 

I was so excited that I couldn’t wait to get started.  Just imagine being able to collect 10 different varieties of fruits, cut roses from 6 different varieties and colors, and an assortment of herbs for cooking.  This landscape design has surpassed all my expectations.  That garden of Eden was so near I could smell it!  Though little did I know then, I was far from making the garden of my dreams a reality.

-Flo.

Ravi’s Half Circus Experience

A month ago my sister and nieces came to LA for a visit.  To celebrate their arrival grandpa and grandma bought tickets to take everyone out to the Ringling Brother’s Circus show at Nokia Theater.  There was much anticipation for this event since Ravi and Max have never been to a circus show before, and going there for the first time with their cousins was definitely going to be more exciting than anything else.

On the day of the show Ravi was so excited.  The show took place in mid afternoon and, as planned, Maxie napped on the drive over to the show.  Despite our warming, Ravi never even tried to rest.  He kept talking and singing during the drive, then half way through the show he fell asleep in my arms and didn’t wake up till the show ended.

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We were so sad that he missed these wonderful moments.  At least we have pictures to show him.

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-Flo.

Pirate Brothers

There was a dress up day at the kids’ school last month where all the boys supposed to dress up as pirates and girls as princesses.  Upon hearing this, my first thought was why force the words pirates and princesses into the same sentence?  Second thought was, where the heck am I going to find costumes off season!?  Luckily it turned out alright and the boys loved the costumes I put together.  When we showed up at their classes the next morning, I felt like I deserve at least a B+ for my effort, which made me feel really good about myself.

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Maxie and Ravi dressed up as pirates

Maxie and Ravi dressed up as pirates

-Flo.

Ravi, You Are 53 Months Old Today!

My Dear Ravi,

You have turned 53 months old today!  In this past month, you have settled nicely into your new pre-K class and had to meet growing expectations from your new teacher.

You are now a fantastic sleeper.  Mommy would never have believed it when you were an infant, crying all night unless you were walked and rocked.  Today, you and your dad compete for the top sleeper spot in our family.  Even though you refuse to nap, once we get you down you could sleep for hours!  In the morning you are always the last to wake.  My oh my, you have come a long way.

Your new teacher at school has requested that we let you grow up!  You loved having mommy drop you off to class every morning, because mommy always carry you to your class.  That’s when mommy gets a few private moments to kiss you a few dozen times as we chat along the way.  One day, your teacher cornered me and told me that I need to help you grow up.  She outlined several areas for “improvements.”  One, you need to walk to class instead of being carried; two, you need to carry in your own lunch bag; three, you need to eat your own meals instead of getting fed by mommy.  Apparently you have asked your teacher to feed you during lunch and she was aghast to find out that your mommy (and grandma) are still feeding you everyday.  So now we have to play by her rule… but mommy still carries you when we are at home, and grandma still feeds you your favorite Chinese noodles because you can’t use chopsticks yet 🙂  Daddy has promised to keep mum so no one at school will find out.  Problem solved!

Mommy is also being forced to grow up with you.  Mommy now has “homework” from your teacher everyday.  A few weeks ago mommy found out that she didn’t bring your swim trunks for your beach day, then a few days later white shirt for your tied dye day.  When mommy show up empty handed at you class, your new teacher always asked “did you read the calendar?”  What?  What is this mystical piece of document?  … Oh, that’s the sheet that mommy always discards without a glance at its contents.  Oops, bad mommy!  Apparently your new teacher has taken this calendar concept very seriously and lists daily activities and required materials on it and expects parents to bring them in on cue.  Mommy struggled with this for several weeks and missed bringing things in.  Finally at beginning of August, mommy officially taped up your new calendar on the wall of the entrance hall so it gets reviewed every morning.  Let’s hope mommy will not drop the ball anymore.

You had a pirate day at school.  This is before mommy paid any attention to your calendar and found out about it only two days before it took place.  By then, it was already too late to order anything from Amazon.  So the night before, mommy took off of work early and hit the stores.  When I got home, you and your brother were so excited so I had dressed both of you up.  Oh boy you were so adorable wearing an eye patch and a skull sash on your waist, waving foam swords and muttering fake pirate non-sense.  You had on your pirate costume on all night and couldn’t wait to get it back on the next morning.  When we got to school, you were the center of everyone’s attention, all the other kids were so excited to see your costume and curious to touch your sash and sword.

My darling Ravi, you told mommy that you are no longer her baby, because you are a big boy now.  That made mommy both proud and sad.  Sad, because mommy wants so much to hold on to that little boy in you.  Over time, the distance between us will grow, but I will remember the days when mommy was your everything.

 

Love,

-Mommy

Maxie at 25 Month [Picture]

I blinked for a second, suddenly Maxie is 25 months old.  I am so thankful that he still has some cute chubby cheeks left, so kissable!

Just woke up in the morning.  Maxie at 25 months old.

Just woke up in the morning. Maxie at 25 months old.

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Happy to be up after a bottle of chocolate milk. Maxie at 25 months.

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Happy baby smiling at me. Maxie at 25 months.

Maxie at 25 Months Old

That’s one funny Mickey Mouse!  Maxie at 25 months old

-Flo.