There’s a cost to be exacted from homeowners who rely on incomplete financial advice
“You should only buy a house when you can put 20% down with a payment of no more than 25% of your take-home pay on a 15-year mortgage”. That was a Facebook post from Dave Ramsey in May of 2013 which echoes similar admonitions given in recent years. While few advocate buying a home with little or no money down, especially in a declining housing market, is there an opportunity cost for those who could have purchased a home nine or ten years ago with only a ten percent down payment?
For example, a married couple in rural northern California was considering buying a four-bedroom two bath home which was listed for $285,000 in 2013. Having only enough money saved for a ten percent down payment they continued to rent following Ramsey’s advice to wait until they could make a 20% down payment. Was this sound advice.? Well, today that same home is valued at $420,000- a 47% increase. What Ramsey’s advice overlooks is the opportunity cost. This couple lost the opportunity to buy the home at a much lower price and accumulate approximately $135,000 in unrealized equity. That’s quite a cushion against any significant drop in home values. Ramsey is correct to point out that too low of a down payment can result in expensive private mortgage insurance or even worse becoming upside on your home should values fall.
The lesson in this story is that there’s always a cost exacted for the advice we choose to follow.
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It may be to our benefit or loss. This is why the opportunity cost should of any financial advice at least is considered. However, calculating the opportunity cost of buying a home or getting or not getting a reverse mortgage for that matter is purely conjecture in most instances,. It’s only after the fact that we can assess the true cost of waiting. Hindsight is truly 20/20. And speaking of financial advice I am not a financial advisor. I’m a commentator and proponent of the proper and suitable use of a reverse mortgage for those who would see a long-term benefit. Those considering the loan should always seek the advice of a trusted professional.
That said, today, rising interest rates have pushed many potential reverse mortgage borrowers into being short to close the loan. However, others with adequate equity to qualify may consider waiting due to rising interest rates. Should a homeowner postpone getting a HECM loan with a typical six-percent expected rate? First, let’s consider a few important factors. One, while the 10-year Constant Maturity Treasury rate has been climbing the actual interest accrued fluctuates with an adjustable rate HECM, the most popular option presently. Second, If interest accrual is not the primary concern but rather the available proceeds determined by today’s rates would waiting give the homeowner access to more money? Only if home values continued to appreciate and interest rates declined significantly. There’s a phrase in real estate that says, “marry the house, and date the rate.” I would add marry the home’s purchase price or present value. In other words, it may be better to get a reverse mortgage at today’s higher interest rates and current home values than to wait until mortgage rates have moderated and home values have possibly dropped significantly.
Every homeowner considering a reverse mortgage should ponder these questions. What motivated you to look into reverse mortgages in the first place? How would your life change if you eliminated your existing mortgage payments or had access to funds on demand? What will your life look like five years from now if you don’t get a reverse mortgage? How long do you think it will take for interest rates to drop down to where they were in 2021? Do you believe interest rates will ever be that low in your lifetime? If interest rates don’t go down and home values begin to decline, how would that impact you? Would securing a reverse mortgage based on your home’s present value be better than waiting to see where what your home’s worth in one, two, or five years? If you don’t get a reverse mortgage what things would you not be able to do if you had? In the end, there’s often an opportunity cost that will be paid for postponing a decision. What’s the opportunity cost for your potential borrowers?
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6 Comments
Great questions to ask the client.
Very smart analysis !
Thank you, Kathy!
Great Questions for potential borrowers here Shannon!
Thank you, Lori. Please let me know any feedback you may have from the field.
After a HECM c oses, the expected rate will rarely come into play for the vast majority of HECM borrowers. It is the note rate that has the biggest impact on most borrowers. The margin is a fixed “interest “rate over the life of adjustable rate HECMs and has the largest impact on whether the note interest rate is reasonable compared to other mortgages since the index component (presently the one year CMT rate) generally adjusts in line with other interest indexes over time.
Once the HECM L closes, the expected rate does not change for the related active adjustable rate HECM. Despite what the HECM industry says about it, the expected rate is not is a good indicator of what the actual AENIR (average effective note Interest rate) on that adjustable rate HECM will be. There is no empirical evidence supporting the idea that the expected rate provides a reasonable estimate of what the AENIR will be at termination. The expected rate we use is nothing more than a shot in the dark at the beginning of the HECM as to what the AENIR will be at termination. The expected rate is a five day (depending holidays) average of the 10 year CMT, not the rate of the 10 year CMT on a particular day.
Have you ever wondered why the HECM book of business for fiscal 2010 was estimated to be a negative $798 million during the budget process by the Obama OMB (Office of Management and Budget)? One key reason was that OMB did not believe that the expected rates generated during fiscal 2010 were representative of what the related AENIRs would be (or what the Home Price Appreciation would be over the lives of those HECMs).. One Obama OMB official stated in a heated debate over the “pessimistic” results OMB was predicting was that OMB did not trust the interest rates FHA had used in predicting the financial outcome for the HECMs endorsed in the fiscal 2010 budget process.