Don't Forget About The Mortgage!
In most cases, an individual that engages the services of a Certified Financial Planner or CFP™ considers that person to be his or her “Financial Quarterback”. That is to say, the client relies heavily on the CFP™ to manage the affairs of his or her entire financial estate. This includes liquid investments, retirement assets, insurance and real estate just to name a few. However, since a mortgage on real estate is debt, many times this piece of the puzzle is not considered as part of the financial affairs to be managed and is simply overlooked by both the client and the planner. As a result, clients are left to making decisions about which type of mortgage to use, on their own. This can be a significant mistake for several reasons. For one thing, there are many different types of mortgage programs available today and making a wrong choice for a particular transaction profile can cost thousands of dollars and in some cases can mean the loss of a client.
Take John and Mary Johnson (not their real name) for example. They spent several years working with and developing a relationship with a CFP™. However, when it came to having knowledge of mortgage programs and their appropriate application, he was not adept and would refer his clients to one of the mega banks in town. That is exactly what he did with the Johnsons. They did the simplest thing, which was to purchase a 30-year Fixed Rate mortgage at the prevailing market rate from the bank. We all know that these banks spend tens if not hundreds of millions of dollars each year in “drip marketing” campaigns to cross-sell their full suite of services to each customer. The Johnsons received mailers advertising everything from banking services to consumer loans to wealth management services. At first this did not affect them, but after a while, the drip became like Chinese water torture and they saw something that piqued their interest. They called the bank and set up an appointment to meet with one of their in house CFP’s and before long it was all over. They bought into the bank’s “All services under one roof” concept and the CFP™ they had been working with for several years, lost a client. Does this sound familiar to you? I would submit that it probably happens more often than any of us would care to admit. As the financial quarterback for your client, it is critical that you have a functional knowledge of every element that has the potential to impact your client’s financial future. I believe that the mortgage is a gaping whole that is often neglected by financial planners and is an area you can use to assist you in managing their financial affairs at a deeper level.
I don’t know about you, but when I lose a client, I take it very personally. If your mindset as a businessperson is similar to mine, then you should do everything within your power to build a “moat” of protection around the “castle” that you affectionately refer to as your CLIENT.
The way to do this is to have a functional knowledge of the various types of mortgage programs that are available along with a high level understanding of their appropriate application. It is not necessary for you to be an expert in mortgages. You and your clients will benefit tremendously if you have developed a relationship with a mortgage professional who can assist you in evaluating various loan programs in light of your client’s scenario along with the real or tangible costs associated with each one. This will help you and your client decide which is really the best option. An affinity partner in this industry will add value and credibility to you and will enhance your relationship and solidify your status as
your client’s financial quarterback.
Below is a listing of several of the more common types of mortgage programs that are available followed by a brief definition and an application example. This matrix will give you the high level knowledge that you need to become familiar with them.
| Mortgage Program |
Definition |
Application Example |
Fixed Rate |
Loan is fully amortized; interest rate is fixed for the life of the loan. |
Risk averse; debt averse; plan to own property for more than 10 yrs. |
Adjustable Rate (ARM) |
Interest rate adjusts periodically based on the selected program and index. |
More aggressive/sophisticated borrower; property typically to be owned for a period of time <10yrs. |
Interest Only |
Minimum monthly loan payment is based solely on interest. Borrower can usually pay principal as well. |
Borrower does not plan to own the property too long and appreciation is expected to be high. |
Balloons |
Amortized based on 30 yr mortgage, but balance is due (balloon payment) at end of loan life (typically 5 or 7 yrs). |
Do not plan to own the property very long or plan to refinance or extend the loan at the end of its life. |
HELOC |
Home Equity Line Of Credit. Payments are usually interest only and fluctuate based on the Prime Rate plus a margin. Interest charged only on amount drawn. Typically a 2nd mortgage. |
Many uses including home improvement, debt consolidation, investment. |
Hybrid |
Starts out as a fixed rate and converts to an ARM. Configurations can vary from 1 to 7 yrs fixed. |
Expect to own property for a fixed number of years. Take advantage of lower rates in early years. |
Convertible |
Starts out as an ARM, but gives you the option to convert to a fixed rate within a certain number of years. |
Rates are low currently, but borrower wishes to hedge against rate increases. |
Reverse |
Lender makes payment to borrower and loan increases each time a payment is made. |
Retired borrower desiring to supplement income; borrower has no heirs to their estate. |
Pledged Asset |
Investment assets are used to collateralize down payment. |
Borrower has “A” profile and significant assets. |
Mobile Mortgage |
Mortgage “travels” with you from one property to the next. |
Interest rates are expected to increase significantly within the time frame you plan to purchase more real estate using the same loan terms. |
Expandable |
Simultaneous 1st and 2nd mortgage. 1st is fixed, 2nd is HELOC. HELOC grows as property value increases. |
See HELOC above. |
When it comes to Adjustable Rate Mortgages (ARMs), there are several indices to choose from. This adds another level of complexity to the decision. It is too easy to advise a client to “stay away from ARMs”, without having a real reason to to so. There are several situations where they are the best alternative.
With all of these options to choose from, how do you know which one is best? The answer really depends on a careful evaluation of the client and the profile of the scenario. What is the risk profile of the borrower? Is the property a primary residence or for investment? How long does the client plan to keep the property? What is the interest rate? Should I pay points (One point is 1% of the loan amount. In many cases, paying points can save the client thousands of dollars over the life of the loan.)? More important than that, what is the “Real Cost” of the loan over its expected life? Carefully evaluating the answer to these questions and others will help to identify the correct program for the client.
When it comes to advising a client and choosing between a 30-year or a 15-year mortgage, it is important to understand the considerations involved. First of all, the payment for a 15-year mortgage is typically 30 to 40% higher than that of a 30-year. What are the opportunity costs? What is the investment value of the cash flow savings related to a 30-year vs. a 15-year loan. How about the projected appreciation of the property? Further, what are the tax savings over the life of the loan?
By gathering the knowledge discussed in this article and by developing a relationship with a professional in the mortgage industry, you will add another tool to your toolbox and will give your clients more confidence in you as the CFP™ and the point person for all of their financial planning requirements.
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