I get the question quite often, what is mortgage planning? The simple answer is that mortgage planning is looking at a mortgage from a different perspective; a hybrid of a typical loan officer and a financial planner. We use a clients mortgage as a tool to achieve the client's long and short term goals. If you've viewed my profile on Active Rain, or visited my website, you've undoubtedly seen a version of this explanation.
Sometimes, though, I think what people hear is "blah blah blah, mortgage, blah blah blah blah." A better way to explain the difference between mortgage planning and a "mortgage-in-a-box" business models is through case studies. The following is an example of a real-life situation where mortgage planning came into play, and what the results were.
Client A: How Much To Put Down?
Client A was referred to me by a Realtor Partner in Portland, Oregon last month. He was looking to buy a home, with a price of $300,000, and could afford a 20% down payment. He was referred to me because various sources were giving him conflicting advice, and they had a genuinely intelligent man thoroughly confused. His financial planner told him to put the minimum amount of cash down and invest the difference, his banker told him to put the full 20% down to avoid mortgage insurance, and his wife told him to just hurry up and make a decision; she was ready for a new house!
After Client A and I had a couple of conversations, I put together an analysis for him of his different options. His plan was to stay in the home for 10 years, at which point his goal was to sell and move to a smaller home on the coast for retirement. One of his major goals was to replenish his liquid cash or add to it.
The first thing we look at is the total cost of each loan, usually over the first 5 years; this is what his options looked like:
Over the first 5 years, the 30-year FHA loan is the most expensive and the 30-year fixed conventional loan is the least expensive. Of course, in order to qualify for the conventional loan, Client A had to spend $60,000 of his liquid cash, while the FHA loan only required a down payment of $10,500. Based on this information, it appears that the financial planner was correct; putting down the least amount was the more prudent choice, and it was spelled out for him clearly and concisely.
But we need to go deeper for Client A. Remember he isn't planning to keep the home for only 5 years, he's actually planning to be in the home 10 years. So our next plan is to put together an asset accumulation strategy for him, which looks like this:
What we did here was create a safe, separate side account for Client A. How the account was structured depends on which loan we use. For the conventional 30-yr loan, we don't have any liquid cash left to begin with; but the monthly payment is $394 less than the FHA 30-year loan, so we have that to work with each month. Starting from zero, we apply $394 to the account each month, calculating a rate of return of 6%; and in 10 years our account balance is $64,568. Not bad, mission accomplished.
For the Split MI loan, we were able to start the account with $30,000 since we only had to put 10% cash down. The monthly payment is $146 less than the FHA plan, so we are able to add that in as well each month; and at the 10 year point we have $78,508 in liquid cash. Goal exceeded.
By using the FHA loan and only putting down the minimum 3.5%, we are able to put a full $49,500 in the side account. Since this is the most expensive loan we have available, from a monthly payment standpoint, there is no additional cash flow each month to add to the account. But as you can see, in 10 years at 6% ROR the side account now has a value of $90,060. A clear and easy winner, right? The least expensive loan at 5 years, and $30,000 more in our side account than we had hoped for.
Not so fast. Remember, Client A is planning on selling at this point and moving into a smaller home. So while the FHA plan has the highest side account accumulation value, if you switch focus to net worth the conventional loan is superior by nearly $16,000. Client A already had it in his mind that the financial planner was right, and was surprised to see with his own eyes what the long-term effects of his decision were.
So What Did We Do?
Obviously, the 30-year conventional loan provided the best return for Client A in the long-term, right?
Nope. Consider Option 4.
We used the 10% down with split MI, but had the client use a portion of the leftover cash to buy his rate down from 5.5% to 4.5%. Our cash account starts at $24,000 after the 2% buy-down, but our monthly payment is $311 less than the FHA loan so we can add that each month. At the 10-year mark, we have increased Client A's net worth $10,000 over and above the conventional loan; and based on 3% yearly appreciation Client A should be able to petition at the 3-year point to have the mortgage insurance removed. If he is successful, he will save an additional $3300.
So, in essence, that is mortgage planning. Everyone doesn't fit into the same box, and what appears to be a good idea on the surface can pale in comparison over time. Mortgage planning is thinking outside of a box that is already outside of the box.
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