Leverage or Pay Down

Should You Leverage Your Home or Pay It Down Rapidly?

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 would want to borrow as much money as possible for your home purchase, you must first understand 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 he has $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. Rather than spend it on the frivolous, such as buying toys or going to Las Vegas, use that money as a down payment. It is more prudent especially because it will enable you to obtain a lower interest rate. However, if you invested the $60,000 in a vehicle that could out-earn the cost of that debt, then it could be a formula for success. That is why putting as little down as you possibly can, maximizing your tax write-off, and investing the rest. The key component is taking the money you would have used as a down payment and putting that money to work by owning more appreciating assets like other real estate or securities.

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/or no financial difficulties. Choosing to pay off all your debt can reduce stress and help you to gain freedom of cash flow for investment opportunities. A 15-year mortgage 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 off your home, 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. 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 more easily at night knowing they have a plan in place to pay their loan off quickly.

Wealth Through Real Estate, Be Prepared

There are more millionaires created through the ownership of Real Estate than any other investment. If you were fortunate enough to own Real Estate over the past few years, you have seen a dramatic rise in your wealth. The more you owned the greater the gain.

Real Estate will continue to rise in the long term even if we do see a market correction in the short run as many anticipate. Today may not be the time to jump in and buy investment homes due to the volatility of the market today, but it won’t be long again before home prices stabilize and it is time to start buying again.

My suggestion would be to get your funding in order to be able to step in and take advantage of the opportunities of a soft market. Those able to react fast will be the ones that will benefit the most when the landing is over and the market is again taking off.

Some ways to prepare would be the use of the home equity in your primary residence to purchase other real estate. Credit lines may be right for some while others will find value in cashing out by refinancing into a larger first mortgage.

When values are low is the best time to move up.

If you are considering moving up, now may be the time. Although you may have to be aggressive in the sales price of your home to sell it, bear in mind that there are a lot more homes available to buy now, also at discounted values.

If you assume that you would have to sell a $250,000 home at 10% off for $25,000 less that you anticipate, also know that you would be able to buy a $500,000 at 10% off for a saving of $50,000, netting you a savings of $25,000.

If you wait until the market is hot again, there will be less homes to choose from and your likelihood of finding a bargain are slimmer. So, go out with your Realtor and take a look around first to confirm that it is a true buyers market for the homes you desire, then get your home on the market at an aggressive price. It’s a buyers market, take advantage of it.

Remember the Rule of 72s

The rule says that to find the number of years required to double your money at a given yield; you just divide the yield into 72. So if a home is gaining 6% per year, 6 divided into 72 equals 12 years.

With 6% being about the average appreciation of housing over the long run, that means that if you own a home today worth $500 Thousand, twelve years from now the home could be worth $1 Million for a gain of $500 Thousand!

With today’s tax law, for a married couple that gain is TAX FREE! There is no better investment that your own home, not your 401K, IRA or any other investment available.

Interest Only-It's Just An Option

'Interest only' is just an option that is added to many loan programs. It allows a customer to determine when they want to pay the balance of a loan instead of requiring the payoff through amortization. It is a nice feature to add to a loan to minimize the required payment each month. Interest is what a borrower pays a lender as compensation for the use of the money over a specified period of time. An interest only loan requires a payment that pays the interest that has accrued on the loan, but with no principal reduction required for a specified time frame. Interest only products offer a way to lower monthly cash flow, but do carry some risk and must be evaluated to make sure they fit for the particular borrower. They are ideally suited for the borrower who can use the lower cash flow to maximize financial leverage by pursuing other financial opportunities.

Trade-Up While The Market Is Down

If you were thinking about buying a larger home for your family, but decided to wait until the market improves, you're wasting money. Mathematically, the best time to move up is when prices are down.

Let's say the value of real estate has declined by 10% for your current residence as well as the homes you would like to buy. Assume your current home that was worth $500,000 last year, can now only bring in $450,000 and that the home you want to buy was selling for $800,000 last year, but today can be picked up for $720,000. Last year the cost to upgrade from your home to the new home would have been $300,000. Now the difference is only $270,000 which is a 10% savings of $30,000!

In addition to the decreased cost difference in today's market, there are other advantages to moving up at this time. In the 2005 seller's market, homes were often selling in just hours at prices well above the asking price. There were limited homes to choose from and no reason for sellers to make any concessions. It was simply a take it or leave it market, but not anymore.

In today's buyer's market, with the larger supply of available houses, the odds of finding a home more suited to your needs are much higher. In addition, with the saturation of housing, sellers are now required to stage their homes for the market. They are spending money repairing and upgrading their homes so they have greater appeal to the limited number of buyers in today's market. This has further improved your chances of finding a better home that is clean, well-maintained and ready for occupancy without the need for you to pay additional expenses.

Moreover, you may be able to capitalize on the slowing market by finding a highly motivated seller. You may even be able to draft a contract that requires concessions from the seller that enhance your purchase. What about having the seller pay all of your closing costs, repaint, or re-carpet the entire house hurt to ask for what you want.

So, if you are planning to upgrade, find an aggressive real estate agent and price your home fairly based on todays market value. Make the move now while the price difference is minimized and there are still great buys to find in this short-term market decline.

Mortgages, Markets, and Money

Experience has taught me that mortgages are intimidating financial instruments for many people, that markets can and do change requiring a rethinking of mortgage planning, and that saving money is always a good thing. I have been a mortgage professional advising borrowers who need residential mortgage financing for over twenty years.

In your current situation, you probably have an excellent rate on an adjustable rate loan and are aware that rates have been on an upward swing. It's likely you are waiting for the expiration of the fixed period of your loan or possibly the end of a pre-payment penalty phase before restructuring your mortgage obligation.

I am in that situation with my current mortgage. I have a 3.875% interest rate on a 5/1, (5 year fixed then annual changes), interest-only loan on my home that is set to begin adjusting in mid 2008. I know that based on the current market, if I let the loan automatically adjust, my rate will automatically adjust to about 7.5%, nearly doubling my interest cost. I will lose money if I sit tight and do nothing. So, refinancing my mortgage is going to be the best solution for me based on today's interest rates and the market and this ensures that I save money.

I know that if I refinance now, I will lose out on the remainder of the tremendous rate advantage I have compared to the market today. So, I am waiting, closely watching the market, trying to determine when the most opportune time will be for me to refinance my mortgage so that I can save money and invest it elsewhere.

There are several other factors that I need to consider to maximize my strategy in addition to the rate change:

-----Because my interest-only period will also expire at the time of my mortgage reset, amortization will begin, increasing my payment.
-----I also am looking at other financial obligations I have and trying to determine if while restructuring the mortgage, I pay these debts off as well to reduce after tax interest cost and improve cash flow.
-----Housing depreciation has me somewhat concerned. My home has appreciated nicely in the four years since I secured this debt. However, if my home value declines, my borrowing power will be diminished.

There is no absolute answer today to what lies ahead. What I will be doing for my family and me is creating a plan that will:

-----Assure that I have the liquidity and credit reserves to make the payments into the distant future to weather any unforeseen situation that may arise.
-----Utilize my equity to maximize my financial growth, diversity and wealth.
-----Optimize the tax advantages provided by Uncle Sam.

This may not be the time for you to make such a move with your current adjustable rate mortgage, as it is not the perfect timing for me. However, it may be time for you to establish a plan to prepare for the upcoming changes.

Please visit my website www.AmericasMortgageStore.com and check out the current market rates, read informative articles, and learn more about mortgage financing and your current situation. I welcome your call so we can begin reviewing your situation now to formulate a timeframe best for your particular situation.