The short answer is “opportunity cost.” Here’s a real story that’s still unfolding. I got a call from a financial advisor whose high-net-worth client’s daughter was about to buy her first home in the $325,000 price range. The daughter, let’s call her Grace (not her real name) already has enough of her own assets to buy the house for cash even though she recently started her first job at a salary in the mid $50,000 range.
The advisor suggested that rather than paying cash for the home, perhaps the daughter should obtain a mortgage and keep more of her investment portfolio working for her which had been growing for several years at an average rate of return in the 6% to 7% range. In fact, the advisor suggested, funds could be withdrawn out of the investment portfolio on a monthly basis to assist the daughter with her mortgage payments if necessary.
The dad thought that was a reasonable idea, but only if the mortgage rate was 3% or less on a 10-year or 15-year fixed. I emailed several scenarios to the advisor who forwarded them to his client, but to get a 2.99% rate on a 10 or 15-year fixed is an expensive proposition now after the post Presidential election effect of pushing up both stock prices and interest rates. The 3.25% 15-year fixed with no points looked good enough, so we set up a three-way conference call and GoToMeeting session to gather the detailed pre-approval information, obtain her credit report and answer questions.
It’s all about the payment – Based on Grace’s new job and salary, which is no problem to use for qualifying income since she just graduated college, and the fact she has no other monthly debts, I determined she could afford a $2,000 monthly mortgage payment including property taxes and homeowners insurance. But won’t the supplemental withdrawals from her assets allow her to handle a higher payment? In reality, yes. But in mortgage lending, asset withdrawals are not “income” and therefore don’t count in the affordability analysis.
While Accunet has a special bank portfolio loan program that allows us to convert invested assets into qualifying income (without liquidating the assets), that loan program wasn’t a fit for this particular situation. We’ll save that unique loan program for another article.
When is a 3.25% rate not really a 3.25% rate? The dad had set the bar in his mind for roughly a 3% gap between the mortgage rate and the portfolio rate of return. So even the 3.25% rate on the 15-year was a little higher for his criteria. But I reminded him that his single daughter would be paying income tax at a marginal rate of 25% of her income. And since mortgage interest is still deductible, her effective after-tax interest cost on the mortgage would be more like 2.44%*. The after-tax point of view also opened up his mind to consider a 20-year fixed rate at 3.75% (2.81% approx after-tax rate) and a 3.625% 10/1 ARM amortized over 30-years. So the three choices they are currently considering which all have $2,000 monthly payments including taxes and insurance are:
- 15-year fixed, 3.25% $190,000 loan amount
- 20-year fixed, 3.75%, $240,000 loan amount (keeps $50,000 more in invested assets vs. 15-year fixed)
- 10/1 ARM, 3.625%, $260,000 loan amount (keeps $70,000 more in invested assets vs. 15-year fixed).
We’ll let you know how this story ends up in a future newsletter. But in the meantime, if you’d like to work with mortgage professionals who take an educational, consultative approach to the liability side of a client’s balance sheet, please give me a call at 262-252- 5102, and I’ll get you connected with one of our licensed, savvy loan consultants.
*Please consult a tax advisor to determine the marginal tax rate and how the mortgage interest deduction applies to each individual situation.