What You Don't Know about Mortgages Can Hurt You
Over the last five years, momentum in home buying has reached historic levels. Ever ask yourself why? The usual answer is "rates are so low we need to take advantage of the opportunity." While this may seem like a rational reply, coming from an informed and knowledgeable consumer, what I see in the marketplace does not reflect knowledge or rationality. As a residential and commercial mortgage lender, I am concerned about the quantity and quality of the debt that consumers are assuming.
The statement, "buy low and sell high," applies to all purchases, not just stocks on the New York Stock Exchange. Every consumer in America understands that when the corner grocer buys a lot of turkeys for Thanksgiving and offers them at rock bottom prices, it might be a good idea to get one or two more and freeze them. It's just smart day-to-day money management. But, buying a home is a more complex decision than buying a turkey.
Since it's often our largest monthly obligation, our homes can have a profound effect on the quality of our lives. As such, whether one is a potential homebuyer or a current homeowner with a mortgage, there are a few things we need to know about the current status of mortgages in America today. When buying a home or utilizing mortgage financing, in our current market environment, there are five main concepts to consider:
1: Where did this "buy more house for less" opportunity come from?
This opportunity didn't just happen. Following the stock market crash of 2000, the Federal Reserve shifted economic policy as part of a plan to keep our economy from falling into a recession. To stimulate the economy, the Fed began reducing the interest rates to bolster economic activity, and in so doing, initiated an incredible buying opportunity in housing. But, this economic policy did not just lower rates; it also lowered lending criteria and opened the door for (economically) weaker buyers. The wise buyer not only notes that the interest rate policy has changed, but also realizes that conservative lending rules may resurface, potentially trapping buyers in dangerous debt products, with no way out.
2: If "Smart and able money moves first," how does that apply to housing?
When rates moved down, consumers who pay attention to economic change, saw a "blue light special" in housing. Since bargain financing reduces the overall cost of home ownership, the affordability index shot to all time highs. That is to say, initially, the ticket price did not change, but the mortgage financing cost dropped dramatically. As more and more of the "smart money" buyers bought, the word spread until it became common knowledge that it was "a good time to buy" and an easy time to qualify for a loan. Many who already owned, refinanced, to cut overhead, or sold and bought more home for less monthly cost.
We are five years into a housing boom and, although Texas has not seen as much of the mania, in some parts of the country, prices have been bid up to extremes. In June of 2004, once again, the Fed shifted its policy of lower rates to a policy of higher rates, and after a year and a half of quarter percent increases in the discount rate, the opportunity has changed.
Like most financial opportunities, the late arrivals enter the market because, "everyone is doing it; so, it must be a good deal." If that is, or was, your reasoning, be careful. If your credit is weak or your job security is uncertain, all debt is high risk. Also, just because the start rate on an adjustable rate mortgage loan is low, does not mean that you have a good deal; and conversely, just because another rate may be higher than you want it to be, that does not mean that financing is a bad deal either. Smart money evaluates the pros and cons of financial choices over the long run and attempts to make a rational decision. We should too.
3: The government, our Realtor, and our lenders are not our protectors -- we are.
After the market crash in 2000, Fannie Mae and Freddie Mac fostered aggressive new lending rules, and B-paper lenders were not far behind. The lending assumption was, and is, that FICO credit scoring would protect investors from losses through risk rating loans and elevating rates to offset higher probable defaults. This assumption will be tested! The mortgage market has returned to the law of "Caveat Emptor." Simply put -- "let the borrower beware." The risks of higher rates, volatile loan products, and excessive mortgage debts have been shifted totally back onto the unsuspecting public. Gone are the days when a mortgage lender would not allow one to buy more than he or she could reasonably afford.
4: Leverage and debt financing can be a friend or foe.
Debt, as leverage, can propel you forward or slam you to the ground. Ultimately, home ownership is a financial decision that can improve or endanger your lifestyle. It is a judgment call - risk versus reward. Though most homebuyers look exclusively at price or payment, the financing cost and the purchase price of a home must be evaluated together to determine whether one is buying more house for less or not. Whether it's a home or an auto, very few consumers understand how debt can enhance or diminish a bargain. Unfortunately, it seems that this is not widely taught in schools or in the home.
5: Think long term.
Shelter is a lifetime need, and mortgages for homes are long-term debt obligations. Think about where rates may be in the future and how those interest rate shifts will affect the cost of your mortgage debt and your cash flow. Then you will be able to determine which is more appropriate, a fixed rate or an adjustable rate loan.
Think about the possibility of lifestyle changes and how your mortgage debt will impact those future decisions. A late payment on a mortgage is not treated as lightly as a late payment on a credit card. A single payment over thirty days late on a mortgage can create future lending havoc for a long time.
In summary, the biggest purchase that most Americans make is a home, and the majority of us must utilize a mortgage obligation to get the job done. I suggest you spend as much time deciding how you will finance your purchase as you spend looking for a home. Better yet, determine your financing strategy before you look for a house, so that the excitement of a potential purchase does not move you to an imprudent decision. In the end, remember, things will change, and we must anticipate and prepare for what lies ahead.