Why borrowers should consider a 30-year mortgage

Jay Vorhees at JVM Lending has written an excellent blog about borrowers and their understanding of liquidity, and why borrowers should consider the lower 30-year mortgage payment. Besides the flexibility it offers, it allows a sort of cushion for any borrowers who may find themselves in personal trouble, and is also usually a good long-term investment. Read on below to get the full picture, with two cents from me – can you say liquidity:

Borrowers often underestimate the importance of liquidity. Especially when times are good. When rates are relatively low (under 8%), we always recommend using financing (obtaining a mortgage) to buy real estate, even if borrowers have ample cash. Similarly, we usually advise borrowers who want lower 15-year rates to take a 30-year mortgage. Even though borrowers can afford the higher 15-year mortgage payment, the lower 30-year mortgage payment offers them more flexibility. There are several reasons why borrowers should value liquidity more:

1. Job Loss, Major Illness, Injury, Legal Troubles, Recessions. People often forget how quickly fortunes can turn (especially those of us in sales), and how important cash is when income dries up. This is particularly the case when the economy turns and financial instruments and hard assets drop in value and become difficult to sell. An abundance of cash during unexpected hard times often means the difference between bankruptcy and muddling through.

2. Ability to Buy Distressed Assets. When the economy turns and asset prices tank, there are often tremendous bargains to be had for anyone with even a little cash. After the mortgage meltdown, for example, one of our clients purchased eight rental properties for around $100,000 each. He was out of pocket less than $250,000 for all of those purchases, and all of the properties cash-flowed from the start. In addition, they are all worth close to $300,000 now. I watched many other clients do the same thing in the stock market after both the dotcom crash and the 2008 meltdown.

3. Investment Returns Exceed After Tax Cost of Mortgage. This does not apply to everyone of course, but many borrowers can often invest money that they do not put into their home and earn a return that exceeds the cost of their mortgage, especially after tax benefits are taken into account. Example: Borrowers A and B both have $250,000. “A” puts down 50% on a $500,000 house; “B” puts down 20% and invests the $150,000 he saves. In the long run, Borrower B will have a much higher net worth and more liquidity along the way if his investment yield exceeds his rate by 2% or more (not difficult over the long term).

Interesting, right? I saw this first hand in the down turn, people with cash bought investment properties. They are usually patient and don’t get caught up in all the hubbub. Many can’t see past the downturn and believe it will never improve, however we are not building any new land and history shows us that what does down, goes back up. Remember cash is king, so start saving and get a leg up on the next down turn.

Today’s housing market vs. 2008’s market

Consultant Bob Schwab has a few interesting thoughts on the difference between the housing market in 2008 and the housing market today. He essentially points out that the landscape of today’s market is radically different than 10 years ago, so comparing the two era’s – even if numbers look similar – is tricky. Here are his thoughts below:

Some are attempting to compare the current housing market to the market leading up to the “boom and bust” that we experienced a decade ago. They look at price appreciation and conclude that we are on a similar trajectory, speeding toward another housing crisis.

However, there is a major difference between the two markets. Last decade, while demand was being artificially created by extremely loose lending standards, a tremendous amount of inventory was coming to the market to satisfy that demand. Below is a graph of the inventory of homes available for sale leading up to the 2008 crash.

A normal market should have approximately 6 months supply of housing inventory. As we can see, that number jumped to over 11 months supply leading up to the housing crisis. When questionable mortgage practices ceased, and demand dried up, there was a glut of inventory on the market which caused prices to drop as there was too much supply and not enough demand.

Today is radically different!

There are those who believe that low mortgage rates have created an artificial demand in the current market. They fear that if mortgage rates continue to rise, some of the current demand will dry up (which is a possibility).

However, if we look at supply again, we can see that the current supply of homes is well below the norm of 6 months.

Bottom Line

We will not have a glut of inventory like we did back in 2008 and home values won’t come tumbling down. Instead, if demand weakens, we will return to a normal market (approximately a 6-month supply) with historic levels of appreciation (3.6% annually).

Separate from the Schwab blog, NAR Chief Economist Lawrence Yun says, “It’s important to note that despite the modest year-over-year rise in inventory, the current level is far from what’s needed to satisfy demand levels. Furthermore, it remains to be seen if this modest increase will stick, given the fact that the robust economy is bringing more interested buyers into the market, and new home construction is failing to keep up.”

And First American Chief Economist Mark Fleming says, “Millennials’ lifestyle and economic decisions are some of the main reasons we currently have a lower homeownership rate than expected, based on our Homeownership Progress Index. Yet, it is reasonable to expect homeownership rates to grow as millennials continue to make important decisions, including attaining an education and, later in life, getting married and buying a home.”

Glen Bell, a very analytical realtor in Berkeley, shared some charts with us, which also give additional insights into the disparities in the market:

Bell says he predicts a recession in 2019 or 2020, and that the real estate market will be a minor factor in it. Rising interest rates may offset some buying opportunities. It’s also hard to predict how much tax reform will play into this. Prices continue to rise and might be causing more people in the middle class to flee the Bay Area.

Real Estate is a GREAT investment!

Buying a house can be terrifying. Selling a house can be equally as difficult. The entire process is stressful, but the end result is often worth every second of the struggle. Bob Schwab, a mortgage lender in our office, often shares great information, and points out this is because investing in real estate is a solid decision!

For the fifth year in a row, a Gallup poll showed that real estate is the best long-term investment out there. This year, 34 percent of Americans chose real estate as the best long-term investment, followed by stocks (26 percent). You can see the chart, stolen from Bob’s blog, below:

Just five years ago, gold was the most sought-after long-term investment with 34 percent of votes. Even back then, real estate was in second place, though the economy was recovering from the economic crash that preceded it. Overall, the real estate market is in good shape and people seem to agree that it’s a stable, long-term investing option. Rates are rising, so now may be a good time to buy check out this graph that shows how much buying power you lose as rates go up.

You can always give me a call to help you make that investment – it is, after all, my job!