Written by: Tom Gates
The use of a mortgage debt is critical to the acquisition and financing of a primary or secondary home, and in certain cases, investment real estate. The mortgage world has changed a great deal since 2008: historically low interest rates, downward pressure on real property values, larger down payments, stricter underwriting standards and much tougher appraisal standards. Many of these challenges can be exacerbated if you live in an area that is designated as ‘depressed.’
When looking at a new mortgage, whether it is for the purposes of property acquisition or refinancing an existing mortgage, it is important that you consider the New Normal for mortgages.
Purchase or refinance of a Primary or Second Home:
- On purchases, count on a down payment of 20% for primary residences and 30% or more for a second home.
- Expect strict scrutiny on income ratios with particular reliance on W-2 income. This is tough on the self-employed, business owners and real estate investors who mask their true income and cash flow.
- There is not much leeway in underwriting decisions and much of those judgment calls are not made by the person with whom you are working.
- The New Normal tells us that much of the fraud perpetuated on pre-2008 mortgages came from ‘phantom’ income and lenders do not want to make that mistake again.
- Watch those credit scores. Underwriters are looking at a New Normal of 680 or more. This number falls on the lower threshold of ‘Good’ credit.
- Don’t count on the appraisal to give you much wiggle room on qualifying. The New Normal says appraisers are no longer the borrower’s best friend. Also, because appraisers are now chosen randomly, don’t be surprised if you get an appraiser that has never done business in your city. This can be really tough for second homes on the water, beach or mountains.
- Equity lines and second mortgages are often considered ‘dirty words’ in the New Normal. The securitization market has not recovered from 2008, therefore lending institutions have to keep these loans on their books and using capital.
- Time horizon for the property remains an important consideration when analyzing mortgage options.
- If you think you are going to be in the house for 3 to 5 years, then an ARM product with a lower rate may be your best bet. But don’t cut it too close: give yourself some room. If you think you will be in the house for 3 years, look at a 5-year ARM and get that extra two years of protection.
- Longer than 5 years, or you have found your ‘ideal’ home, then the 15, 20 or 30 year fixed rate options are attractive. If you want to maintain payment flexibility, look at the difference in the 3 rates, and if they are not too far apart, consider the 30 year fixed rate which will carry the lowest payment. If you find that you have extra money each month you can always apply it to the mortgage principal balance thereby decreasing the mortgage term.
- There are other strategies that you can employ to pay down the mortgage faster such as the bi-weekly mortgage payment or making 13 payments each year. If your goal is to build equity in the residence faster, and you need the discipline, then the 10 or 15 year fixed rate mortgage can be selected.
- Real estate tax efficiency. The New Normal has forced us to challenge our prior thinking about residential real estate as an appreciating investment asset.
- Given the time and expense it takes to keep a residence along with depressed real estate prices, in the New Normal we might look at a residence more of a ‘use’ asset supporting our lifestyle rather than an investment.
- Traditionally mortgage financing of a home provided a nice tax advantage in that mortgage interest is deductible against income for tax calculations. In the New Normal this tax advantage may disappear as members of both political parties have discussed ‘reforming’ the mortgage deduction in order to raise $500Billion in additional taxes.
- Investment real estate in the New Normal. Conforming mortgages for investment property ranging from 1 to 4 family dwellings can provide long-term low-rate fixed terms. Count on down payments of 30% or more. Appraisals can be of even less help here than on a primary residence. Generally the real estate and mortgage can be titled in the name of a single purpose LLC, however the owners/managers retain responsibility for the mortgage
- Many condos and time shares simply do not qualify for mortgages in the New Normal. Too many lenders got burned by condo and time share associations who could not afford to meet their responsibilities around upkeep and insurance.
- Closing costs in the New Normal. These costs are generally higher than pre-2008. Much of this increase is due to new regulations around such areas as appraisals and lenders are no longer able to ‘waive’ most of the fees that they used to. Look for lenders who will ‘roll’ the closing costs into the mortgage rate. Many lenders give you the opportunity to ‘buy down’ the rate by paying points. Whether you should pay them or not generally depends on how long you are going to be in the residence. If it takes 5 years to payback the points paid to obtain a lower rate and payment, then you don’t want to pay the rate down if you are only planning to be there for 3 years.
Will the New Normal revert back to the old normal? Time will tell, but history tells us that as we get more comfortable with the economy, politics will nudge us into our old leveraging ways.
Written by: Tom Gates