The M-Word Mortgages

If you are going to do real estate, you are going to need mortgages. Even if you don't do it as a business, you will most likely need one on your home.

I wrote the next two articles awhile back because so many of us get into trouble with our mortgages. Knowing a bit about what is going on can save you from major headaches, financial distress, and possibly even save your home. Enjoy.

Article #1

There is a wealth of financial and mortgage information available today. Unfortunately it is often a nightmare because the information is based on an agenda and is written by specialists that make their view appear to be the best one.

The nightmare of mortgages results from ending up in a mortgage that does not fit in your personal financial goals. Being in the wrong mortgage can result in bankruptcy and foreclosure. The problem for most of us is that there really is no truly bad mortgage.

There are a wide variety of programs, literally thousands, that can be used and there are good ones for each homeowner and bad ones for each homeowner, with the exact same mortgage being the best one for homeowner “A” and the worst one for Homeowner “B.”

So what the heck are you supposed to do?

While there are some truly unethical mortgage professionals around, most mortgage professionals do the best they can for their clients. The problem arises when they have a client with a different set of financial goals than the mortgage professional and he or she doesn’t understand that they are different.

Thinking we know better than our spouse, family, neighbors, other religions, other cultures is part of the human condition. Mortgage professionals just happen to be human too.

Lets see if I can make that a bit clearer.

At the two ends of the mortgage spectrum are wealth building through debt and safety through ownership without debt. Mortgage professionals recognize that your home is probably your greatest investment.

The confusion comes in because of the “investment” and “safety” terms. What is an investment to me may simply be a home to you and safety may be far more important to you than wealth.

If I'm a mortgage professional and I set you up in a wealth building mortgage I have done you a disservice. On the other end, if you want to build wealth and I put you in a safe conservative mortgage that limits wealth building, I have done you a disservice.

Your needs and goals should determine the type of loan you get, not my personal determination of what your goals should be! So let’s investigate a bit so you can determine what best fits you!

Each of us has a safety criterion that affects how we evaluate investment risk. Donald Trump is at the far end of debt investment to build wealth. He prefers not to go bankrupt but has done so spectacularly more than once and has no fear of debt. Debt is how he builds wealth.

We may not all be able to get to the level of Donald Trump but anyone can use the debt method of building wealth. It is quite effective. There are mortgages and investment opportunities that are tailor made for this type of wealth building.

And if you are afraid of debt this is not the best way for you to go unless you enjoy bleeding ulcers!

At the other end is my Father. He worked all his life, raised 5 children, and left his wife a pension and a free and clear home. He was never wealthy but he provided for his family. Safety was his goal.

He stayed in the same job 35 years so he would have a good pension and stayed out of debt. He paid his house off so it would be available for his family, including each of his children who needed a place to stay periodically when life dealt them a blow.

Of course pensions are going the way of the dinosaur making it rougher for the safety minded. And if you would like to go on an occasional cruise or shop on Rodeo Drive this is not the best way for you to go unless you have a truly spectacular income!

Most of us are somewhere between these two extremes.

Building Wealth Through Debt

There are two kinds of debt: Debt that bleeds you and Debt that feeds you. Lets look at one way of using debt that feeds you and you'll understand how the confusion in mortgages can happen.

As I discussed before, home loans today can be used for wealth building through debt. The “option ARM” loan is one of the most popular for this type of investment.

An option ARM has a very low start rate, from 1% to 3%. This is not the interest rate however it is the payment rate. The interest rate is adjustable, it is considerably higher than the payment, and it is one of the most expensive loans you can get if you keep the property and loan for the full 30-year period.

So why do investors love it?

Cash flow into an investor’s pocket each month is king!

Investors generally use the option ARM for a potential rental property. The difference between the payment for the mortgage and the rent they receive is cash flow for them each month (debt that feeds you).

They are not concerned with eventual payoff and will refinance periodically to keep their monthly cash flow as high as possible. The interest that is not paid each month is tacked onto the mortgage amount, however, so instead of going down your mortgage goes up over time.

The risk with this type of mortgage is that the interest will rise too high and payments will go way up after the initial 3 to 5-year period that the option ARM covers.

Buyers who do not understand what is going on are in real trouble.

This loan can also be great for a disciplined homebuyer though.

Please note the word disciplined. Because the payment is low the homeowner can use the difference between the low start rate and a traditional 30-year fixed rate to pay down the principle of the home much faster than it would be paid down using the 30-year fixed loan.

At the same time the homeowner has flexibility to make only the low start rate payment when necessary. Commission salaried people can really use that type of flexibility.

The money saved each month could also be used for investments in other real estate, stocks, etc., other debt that feeds you. (In fact a Colorado investment company was offering 4% a month for start-up cash last year, good feeding)

This can be a great loan for a homebuyer or an investor and it can be your worst nightmare.

Consumers get into trouble with this loan because they do not understand it.

If we go out and buy a big screen TV, car, trip to the Bahamas, etc. instead of saving or investing the difference we have just created debt that bleeds us!

The mortgage amount goes up every year, the debt load goes up every year, and the payment is also rising but not by much until the end of the option ARM term.

Then wham *#@*%# the payment can jump way up, the mortgage is higher and may be too high to sell the house, the debt load may be too high to refinance, and the homeowner is too embarrassed to tell anyone because they thought they had gotten a great deal and their finances are crumbling.

This can be the road to bankruptcy or foreclosure or it can be a well planned path to wealth building. The difference is in how it is used – does it feed you or does it bleed you!

I do not do mortgages, do not contact me. This information is here so you can determine your own safety needs. If you are not disciplined or get ulcers at the thought of putting your house at risk, do not go for an adjustable rate mortgage.

If you are somewhere short term a short 2-3 year fixed term may be for you.

If you are looking for cash flow an option arm may be for you.

What's critical is your desires, discipline, and need for safety.

There is absolutely nothing wrong with deciding to do investing that is not real estate and leaving your home off the table. I know a lot of investment advice says you should get the cash flow and make extra payments but if you are not likely to make extra payments don't do it.

You know yourself. You decide what you need and then go see your mortgage professional.

If you want more information about the types of loans available and what the requirements are you can call Leroy Daily 303-399-3454, who is a mortgage professional as well as a real estate mentor, and he will explain them to you.