My New Blog

I’ve worked in the mortgage industry for years and I’ve seen this market hit many highs and survive some tough lows. While the national media outlets are reporting the facts, they often miss the underlying story. Here are some of the questions I know many people are considering, and I would like to share my response:

1. What’s really happening with major lenders – have we seen the last of the 100% financing options?

•      “100% financing is likely to be available only to those borrowers with the most pristine credit, which will impact affordability in our area as potential borrowers diminish. That means credit remediation is more important than ever for those who want to become borrowers. But in my experience consumers don’t really understand what impacts their credit scores. They don’t know there are some straightforward ways that their mortgage advisor can help to increase those all-important credit scores.”

2. What is considered a risky loan by today’s lending standards?

•      “Borrowers with credit scores below 620 have proven to bring more risk to the table than those with higher scores. That doesn’t mean they can’t get a loan – but the days of the easy subprime loan are over. Here’s what consumers with less than perfect credit in our area may want to consider: Expanded approval loans. Backed by Fannie Mae, these loans reward borrowers by lowering the interest rate after 24 consecutive months of timely payments. Tougher documentation standards. Borrowers will be asked to at least state their income and in many cases they will also be required to provide the documentation to support it.”

3.  Are home values going to be affected by rising defaults?

•     “Depending on the severity of the rate of loan defaults, it may have a significant impact on our local housing valuations. Consider this: Banks don’t want to hold on to properties – they want to get them off their books. That means they will sell at a discount. We saw this in the early 1990s when there was a rise in foreclosures and a subsequent decline in property values.”

There is a great debate within the inner-mortgage circles these days. Should we, as loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if we helped them to understand the advantages of 15-year amortization schedules and pre-paying principal? Let's examine the pros and cons of both strategies.

Leveraging Your Property. In order to understand why you'd want to borrow as much as possible for your home purchase, you must first grasp the concept that equity has a zero rate of return. Here's an example:

If Consumer "A" buys a home for $300,000, and puts 20% down, then they have $60,000 in equity. Over the next 5 years, the property appreciates $100,000 in value. Consumer "A" now has $160,000 in equity.

Consumer "B" buys a home for $300,000, and puts no money down. At the end of 5 years, that same home is now worth $400,000. Consumer "B" has $100,000 in equity, which is the same appreciation as Consumer "A", a net $100,000.

As you can see, your down payment has nothing to do with your rate of return. What becomes important is how you choose to manage the $60,000 you didn't use as a down payment. If you use it for frivolous activities, such as buying toys or going to Las Vegas, it would be more prudent for you to use that money as a down payment. Especially since this will enable you to obtain a lower interest rate.

However, if you were to invest the $60,000 in a vehicle that can out-earn the cost of that debt, then this could be a formula for success. This is why some lending professionals suggest putting as little down as you possibly can, maximizing your tax write-off, and investing the rest. This principle has been applied for many years in the life insurance game. The old saying goes, "Buy term and invest the rest." The key component is taking the money you would have used as a down payment and creating an asset accumulation account. This account should earn a significant enough rate of return to enable you to pay your mortgage off entirely and achieve the ultimate goal of being debt-free.

Paying Your Home Down Rapidly. There are very few times over the course of my career that I have seen a client with zero debt and no financial difficulties. Choosing to pay off all of your debt can reduce stress and help you to gain freedom of cash flow for investment opportunities. A 15-year mortgage or a bi-weekly payment strategy provides structure. It can also put you on track to have your mortgage paid off within a set timeframe. Simply put, it contains built-in discipline.

It's important, however, to understand that regardless of how rapidly you pay your home off, you're not getting any greater rate of return on your investment than if you paid it off slowly.

Conclusion. So how does one determine which scenario is best? The choice depends entirely upon the individual. Savvy consumers who are disciplined, and are comfortable taking chances from an investment perspective, would do well with the first scenario. Over the course of time, it's been proven that your rate of return over the long-haul will be far greater than the rate you'd pay for a mortgage in today's rate environment. It's important to seek the advice of a skilled investment advisor to ensure success with this strategy.

The second scenario is best for those who have a difficult time managing their money or who'll sleep easier at night knowing they have a plan in place to pay their loan off more rapidly. Be sure that your budget can handle accelerated payments. When consumers "bite off more than they can chew" with a 15-year mortgage, they frequently end up having to refinance back into a 30-year schedule.

If you find this subject intriguing and would like to know more, I recommend that you read a book titled, Missed Fortune 101, by Douglas Andrew. It's an outstanding read that is very simplistic and goes into far greater detail than I can cover in this column. Douglas is a financial planner who advises safe-structured investments such as whole life policies and tax-free fixed income instruments.