You have just been pre-approved by your lender for a purchase price of $500,000. Both you and your wife have worked hard through education and your career to prepare for the future. So now it is time to make a real estate investment. Many of your colleagues have purchased properties so you have been seeking advice from your friends as to what financing you should select. Your Realtor® has been working closely with your lender to make sure you have a solid credit approval. All of your documents that your lender has asked for have been submitted. Since you have enough money to make a 20% down payment, you are debating whether to make a $100,000 down payment or not. You have been pre-approved at 100% financing to purchase your home.
Both you and your wife make enough to be pre-approved at 100% financing. However, you know if you put 20% down your monthly payments on your mortgage will be lower. According to your lender, your payments at 100% financing will be roughly $3,956 which includes both taxes and insurance. With 20% down payment your monthly payments will be roughly $3,097 with taxes and insurance included. When both you and wife calculated your household budget, you concluded that a $4,500 mortgage payment would be a comfortable payment for you to make. However, the lowest payment sounds more appealing because you want cash flow incase an emergency arises you have the difference of $859 monthly saved. Besides your parents gave you a gift of $50,000 so you have that additional monies saved along with the $859 monthly contributions. So you are really considering a 20% down payment.
Before you actually started looking into buying your home, you asked your parents for advice. They advised you to look for a good home that you can live in for at least 7 years. However, they advised you to select a 30 yr. fixed so your payment is secured and never changes. When you consulted with your lender they had recommended a 5/1 LIBOR Interest Only ARM, Pay Option ARM, and a 30 Yr. Fixed as financing options. After reviewing the loan options provided to you, you become confuse because you don't know which loan would be the best for your needs. The excitement you and your wife had at the very beginning has now become sort of a nightmare. Your lender has been courteous yet has only provided options, and no solutions for your financial and investment plans. This is a common scenario that many first time home buyers are challenged with when purchasing their first home.
There are over 600,000 loan originators in the United States. It is sad, but about, roughly, 89% of these loan originators don't know how to offer solutions to this type of buyer. Most loan originators forget to ask very important financial questions that may impact first time home buyers payment and equity objectives. A real estate transaction is one of the biggest investment people will make in their lives. Making sure selecting the right mortgage is important, because you want to be able to integrate your mortgage with your overall short and long term financial, investment, and payment and equity objectives. "Most people spend more time researching the VCR or DVD players they plan to buy then the mortgage they select for their specific financial needs. A DVD player will cost anywhere from $100 to $200. Home owners will pay anywhere from $10,000 to $50,000 yearly on mortgage payments. Make sure you work with a Mortgage Planner that will take the time to create a Mortgage Plane that can be integrated with your finance strategy[1]."
Let's take a look at the same scenario from a Mortgage Planning perspective. This couple is qualified for a purchase price of $500,000 at 100% financing. However, they have a 20% down payment. Assuming they have $800 in consumer credit we can conclude that this couple makes approximately $13,000 gross monthly income. They are at a 38% debt to income ratio so they can actually afford this purchase price and possibly even more. However, for sake of conversation we will keep this purchase price. Since this couple plans to stay in their home at least 7 years you want to make sure you recommend a loan product that will meet those objectives. Since they are also in a 35% tax bracket you want to make sure you can help them maximize their tax deductions. They are concerned about cash flow, but, like every family, they also want to increase their total net worth. Let's also assume that the young couple is 29 years old and plans retiring at the age of 55. Also, they know that their income will increase in the next 2 to 5 years at about $15,000 and $30,000 respectively. What would be the best mortgage for their financial plan? As a Mortgage Planner, my primary role is to help my clients integrate the loan they select into their overall short- and long term financial, investment, and payment and equity objectives when purchasing a home.
In this case, I would recommend 10/1 LIBOR Interest Only Adjustable Rate Mortgage and 30/15 Balloon Fixed each with a 3 yr. soft prepayment penalty. I am acknowledging the fact that the couple wants to stay in their new home at least 7 years. I am also empathizing with their concern with cash flow. Furthermore, this will help them maximize tax deductions since they are paying interest only for the next 10 years. Assuming the couple qualified for an interest rate of 5.75% on the first mortgage and an interest rate of 9.75% on the second mortgage. Their total monthly mortgage payments with taxes and insurance will be $3,439. Also, they will see tax benefits of approximately $1,073 per month and $12,876 per year. Since they also want to increase their net worth, I recommended 100% financing.
If they would have invested the $150,000 into a down payment for their home, they would have made that money not liquid anymore. I am a firm believer of leverage. Instead of investing their monies in their new home, I would recommend for them to invest their monies in an asset accumulation account. After speaking to my Financial Advisor, he said a good interest rate on their monies on a moderate risk investment would be 8%. If we invest the difference between the payment at 100% financing from earlier and the one in the previous paragraph, we have a monthly savings of $517. In California real estate appreciates on an average of 4%. In seven years their real estate value will be $703,550 and their asset accumulation value will be at $318,170. By subtracting their loan balance in 7 years of $494,411 from the total of $1,021,720 their net worth will be $527,309. In contrast to this scenario, if the couple would have put 20% down payment and have invested $50,000 on an asset accumulation account with $1,000 monthly contributions; the couple would have a net worth of $503,035. By keeping their monies liquid their net worth is $24,274 more than investing $100,000 into real estate. In fact, in 9.42 years the couple will have more in assets then debts with a total net worth of $1,803,007.
As their Mortgage Planner, I have just created a mortgage plan that will help them integrate their loan with their short- and long term financial and investment plan to help them minimize taxes, improve cash flow, and minimize interest expense. This young couple fresh out of college have now found a vehicle that will allow them to have financial freedom in approximately 9.42 years. Is that achieving the "American Dream" or what?
Mortgage Planning is different from traditional loan originating. Mortgage Planners don't just do loans they provide advice and help their clients successfully manage their Home Equity. As your Mortgage Planner Specialist and trusted advisor, I will provide you with expert advice you can depend on. We believe and go by these Core Values, which are Knowledge, Integrity, Experience, Service, and Trust. If you are interested in Mortgage Planning, please call me at 805-207-5114.
Sincerely,
Eliseo Cisneros, MPS
3 Years of Home Equity Management Expertise
[1] Barry Habib with CNN
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