There is a great debate within the inner-mortgage circles these days. Should we, as loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if we helped them to understand the advantages of 15-year amortization schedules and pre-paying principal? Let’s examine the pros and cons of both strategies.

Leveraging Your Property. In order to understand why you’d want to borrow as much as possible for your home purchase, you must first grasp the concept that equity has a zero rate of return. Here’s an example:

If Consumer “A” buys a home for $300,000, and puts 20% down, then they have $60,000 in equity. Over the next 5 years, the property appreciates $100,000 in value. Consumer “A” now has $160,000 in equity.

Consumer “B” buys a home for $300,000, and puts no money down. At the end of 5 years, that same home is now worth $400,000. Consumer “B” has $100,000 in equity, which is the same appreciation as Consumer “A”, a net $100,000.

As you can see, your down payment has nothing to do with your rate of return. What becomes important is how you choose to manage the $60,000 you didn’t use as a down payment. If you use it for frivolous activities, such as buying toys or going to Las Vegas, it would be more prudent for you to use that money as a down payment. Especially since this will enable you to obtain a lower interest rate.

However, if you were to invest the $60,000 in a vehicle that can out-earn the cost of that debt, then this could be a formula for success. This is why some lending professionals suggest putting as little down as you possibly can, maximizing your tax write-off, and investing the rest. This principle has been applied for many years in the life insurance game. The old saying goes, “Buy term and invest the rest.” The key component is taking the money you would have used as a down payment and creating an asset accumulation account. This account should earn a significant enough rate of return to enable you to pay your mortgage off entirely and achieve the ultimate goal of being debt-free.

Paying Your Home Down Rapidly. There are very few times over the course of my career that I have seen a client with zero debt and no financial difficulties. Choosing to pay off all of your debt can reduce stress and help you to gain freedom of cash flow for investment opportunities. A 15-year mortgage or a bi-weekly payment strategy provides structure. It can also put you on track to have your mortgage paid off within a set timeframe. Simply put, it contains built-in discipline.

It’s important, however, to understand that regardless of how rapidly you pay your home off, you’re not getting any greater rate of return on your investment than if you paid it off slowly.

Conclusion. So how does one determine which scenario is best? The choice depends entirely upon the individual. Savvy consumers who are disciplined, and are comfortable taking chances from an investment perspective, would do well with the first scenario. Over the course of time, it’s been proven that your rate of return over the long-haul will be far greater than the rate you’d pay for a mortgage in today’s rate environment. It’s important to seek the advice of a skilled investment advisor to ensure success with this strategy.

The second scenario is best for those who have a difficult time managing their money or who’ll sleep easier at night knowing they have a plan in place to pay their loan off more rapidly. Be sure that your budget can handle accelerated payments. When consumers “bite off more than they can chew” with a 15-year mortgage, they frequently end up having to refinance back into a 30-year schedule.

If you find this subject intriguing and would like to know more, I recommend that you read a book titled, Missed Fortune 101, by Douglas Andrew. It’s an outstanding read that is very simplistic and goes into far greater detail than I can cover in this column. Douglas is a financial planner who advises safe-structured investments such as whole life policies and tax-free fixed income instruments.

There’s a site called www.gizooggle.com that translates any website into ghetto colloquialism. Here’s an example take from my site:

EXPECT MORE FROM YOUR MORTGAGE PROFESSIONAL

Whether you’re looking to build your dream home, purchase a home, or refinance you should expect more from your mortgage professional. I work as a mortage broker and mortgage banker. As a mortgage broker, we have access to a vast array of loan programs so we’ll find the right one for you. As a mortgage banker, we have control over the lending process and fund your loan with our own money.

was converted to:

EXPECT MORE FROM Yo MORTGAGE PROFESSIONAL

Whetha you’re look’n ta build yo dream home, purchase a home, or refinance you should expect more fizzle yo mortgage professizzle. I wizzay as a mortage drug deala n mortgage playa with the gangsta shit that keeps ya hangin. As a mortgage playa , we hizzle access ta a viznast array of loan programs so we’ll find tha right one fo` you. As a mortgage wanna be gangsta , we have control over tha lend’n process n fund yo loan wit our own money.

All right, i’ll admit there’s nothing gangsta about the mortgage business. However, I do my best to represent and keep it real! Fa shizzle!

I wanted to revisit Paying for Points. Recently I encountered savvy borrowers who understood the benefits of paying for points. When we discussed each option I presented, they understood that there was a difference between the rate I offered and the APR.

What is APR?

APR stands for “Annual Percentage Rate” and is the cost of credit expressed as an annual rate. APR is one of the most misunderstood numbers people come across when applying for a loan.

As consumer loans, and mortgage loans in particular have become more complicated, it became necessary to help standardize the ways lenders advertise and quote interest rates. APR was created to help people compare similar loans from different lenders and to explain the ultimate cost of credit. Quoting APR is required by Regulation Z of the Federal Truth-in-Lending Act.

Why is the APR higher than the interest rate?

Because you may be paying loan discount “points” and other “prepaid” finance charges at closing, the APR disclosed is often higher than the interest rate on your loan. This APR figure can be compared to the APR on other loan programs to help you compare the cost of credit for each type of loan.

How do I find the APR on my loan?

Once you have applied for a mortgage loan, the Federal Truth-in-Lending Disclosure Form (TIL) will be sent to you. If you have applied for more than one type of loan, you will receive a TIL for each loan type. At the top of the form, you’ll find your “APR.”

Revisiting our example from Paying for Points Part II, here are the rates and their corresponding APR’s

Points come in two varieties, origination and discount points. Generally a “point” is a fee that the lender charges to buy down the interest rate and is equal to one percent of the loan amount. “Discount points” vary inversely with the rate quoted-that is, the lower the rate quoted, the higher the amount of points charged. Discount points are used to adjust the yield on the loan to the institution providing the money. Origination points, such as is common for FHA and VA loans, are generally charged by the lender to offset the lender costs of administering the transaction.

Does it make sense to pay the points? The answer is…it depends. There are many factors to consider. One of the primary items to review is the overall long term cost of a zero-point loan versus a loan with points. One easy way to determine the value of paying points is to determine how many months (payments) it will take to recoup the original expense. The math is easy. Simply, divide the cost of the points by the monthly savings to arrive at the number of months it will take for yourinvestment in points to pay for itself. Here is an easy example:

The example is a simple approach to compare the difference between a zero-point loan and a loan with points. However, there can be other factors to consider. Some consumers may try to calculate tax implications of the different amount of points and interest paid and the subsequent tax deductions. Other borrowers may consider the present ‘value’ of the dollars spent on points today, versus the future ‘value’ of the dollars if they were invested instead of being paid to the lender. A great majority of consumers will be able to determine the advantages or disadvantages of a zero-point loan by using the above scenario.

NO COST LOANS There is no free lunch, even in mortgage lending. Every real estate financing transaction has costs for processing the application, appraising the subject property, administering the transaction escrow, securing title insurance, etc. In a typical “no-cost loan” the lender agrees to pay all of the costs of the transaction for the borrower in exchange for the borrowerpaying a higher price for the loan. Depending on the individual borrower’s circumstance, this may or may not be a “good deal.”

You will make the right financial decisions today if you have a plan for your future. In other words, your mortgage professional can plan your mortgage around your goals and aspirations. If you plan to move or refinance your mortgage loan within the next five years you most likely should not pay points. If, however, you know you are going to be in this home for a long period of time, you can definitely save money by paying the points. Take a few minutes and think about where you are going to be in the next 3-5 years. The answers you come up with will help you make the right decision about paying points.