When purchasing or refinancing a home, your main goals should be to
1 – Get the lowest monthly payment to meet your financial objectives,
2 – Maximize your federal income tax benefit,
3 – Conserve as much capital as possible to meet your financial objectives, and
4 – Meet your risk tolerance.
The mortgage you select to use is a valuable financial instrument that should not be taken lightly. While considering the mortgage that is right for you, use the above to consider which will meet your short and long term strategies. Most people consider a mortgage a loan to buy a home. I can’t stress enough that this is a misconception!
It is said that purchasing a home may be the largest investment a person ever makes in their life. The financial instrument you choose – your mortgage – is a long term debt instrument that needs to fit into your financial plan.
1 – The lowest payment – There are many different mortgage programs that exist today. Not only are there terms ranging from 5 – 40 years. There are also different loan types to consider. There are stable fixed rate mortgages which the payment stays the same over the term of the loan. There are also mortgage programs that allow for interest only payments or loans that allow variable interest features.
Most people get hung up on what the lowest interest rate is without consideration of two very important details – the Annual Percentage Rate and the financial instrument product. My belief is the general public associates the lowest interest rate with the lowest monthly payment. Now, more than ever, your lowest monthly payment actually depends on your credit score, your down payment, your risk tolerance and your short and long term needs.
As an example a 5% fixed rate FHA mortgage actually has a higher payment than a 5.375% USDA Rural Development mortgage. Even when the down payment is 3.5% more for the FHA loan!
Another example would be a 10 year fixed interest rate is much lower than a 30 year fixed interest rate, however the monthly payment is close to double.
2 – Maximize your federal income tax benefit – This may be one of the most overlooked goals when considering the financing options available to you. One of the only tax deductions you may have at the end of the year are the property taxes you pay on a home and the interest associated with the financing for the home. Currently, mortgage insurance is tax deductible through 2011. Once that exception expires, it most likely will not be expanded, as the USA needs as much income as possible these days.
Make sure that you are maximizing this benefit of home ownership.
3 – Conserve as much capital as possible to meet your financial objectives – Most homebuyers and people looking to refinance a mortgage generally look to have the lowest monthly payment. A way to decrease the monthly payment is to invest more money in a home so that they are borrowing less. A simple analysis would suggest if your money is better spent being invested in the home or invested in paying off another debt. You should also consider is your money better spent pre-buying interest instead of an increased down payment.
Choosing to pre-buy interest would actually give you a lower payment by decreasing your interest payments each month for the life of the loan instead of decreasing the loan balance…and it actually conserves your capital that may be used to pay down other, higher yielding debt instruments or the conserved cash could be used to invest in a higher yielding asset.
4 – Meet your risk tolerance – The program that would give you the absolute lowest payment would be a variable rate mortgage that changes as frequently as possible. However, most people do not have the appetite for this much risk when it is tied to their biggest investment. Determining what your risk tolerance is generally will help lead you to the right program for you.
Risk tolerance does go farther than choosing a fixed or variable rate mortgage. If I asked you why you want a fixed rate mortgage, I would expect to hear because it’s “safe”. I agree, having the same, stable payment does lend itself to safety.
With safety being considered, do you think having a larger down payment invested in your home is a “safer” option because the payment will be a little lower? If you answered yes, I would disagree. Having capital in your home makes it a non-performing investment that is far more at risk because you do not have any control over your capital.
As a mortgage planner, my job is to help clients objectively determine their needs by considering these goals. If you would like to take advantage of a complimentary 30 minute needs analysis, please call me to schedule an appointment.
Vin Biscoglio
MLO#6954
860 305-1609
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