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Developing a Mortgage Strategy

Purchasing a home can be a thrilling and costly adventure.  Developing a mortgage strategy that fits your financial plan can save you hundreds each month and perhaps hundreds of thousands over the course of thirty years.  By tailoring your mortgage debt to fit your specific goals and financial picture you can achieve more in life by limiting wasteful spending.

One common mistake among homeowners is that some become “home rich” meaning too much of their monthly expense or net worth is tied up in an illiquid asset.  Due to the slow (and costly) process of restructuring mortgage debt, it is important not to overspend on a home in order to keep your payments manageable.  While lenders will typically loan you 35% of your gross income for mortgage debt, it is smart to cap that number closer to 20-25%.  By determining what you can afford in your monthly budget prior to looking for a home, you will keep from overbuying.  Interest rates, down payments, and the type of mortgage will factor into how much principle a particular monthly payment will support, but what ultimately matters most is the monthly payment.

The second question you should ask yourself is ‘How long do I intend on staying in the home?”  By determining how long you plan on owning the property, you can structure the down payment and mortgage properly which can save you hundreds each month.  If you in a temporary location for the next five years, then maybe a mortgage with a fixed rate for seven or ten years would be more appropriate than a conventional thirty year mortgage.  Each type of mortgage carries its own risks so be sure to understand which risks you are exposing yourself to and when they may appear.

Understanding where we are in the interest rate cycle is also important in developing a mortgage strategy.  While shorter term adjustable rate mortgages often carry a lower rate, they can expose you to dramatic interest rate changes if rates rise during your initial lock up period.  With interest rates being as low as they currently are, you would be well served to lock in the rate for a period that is longer than your expected ownership.  The current level of interest rates is not sustainable and as the economy slowly recovers, interest rates will begin to rise and can come up dramatically over the course of ten years, for example.

Determining the size of your down payment is also important to creating a viable mortgage strategy.  You must recognize that this is not an expense, but instead a balance sheet adjustment where liquid funds you may hold in your bank account convert to illiquid funds held in your home.  In the event that you would ever need to access these funds as a home equity line of credit, you must pay interest to the bank on funds which are officially yours.  Whether you are a first time homeowner or late stage retiree, your personal situation will determine what down payment is appropriate.

Developing a viable mortgage strategy is a key element to creating a comprehensive financial plan.  With one plan, you are able to properly manage your largest monthly expense and your largest liability; both of which can have a significant impact on your overall financial health.  Mortgage products each carry their own risks from overspending to interest rate adjustments so familiarize yourself with the risks associated with each so you can make a educated decision.  Proper financial management is not about avoiding risks, but instead knowing what the risks are and managing them.  By having a cornerstone mortgage strategy, you will be able to achieve more in life.