November 10, 2007
The Truth About First Mortgage Home Equity Lines of Credit
Posted by marktapp under Mortgage Blog | Tags: mortgage, HELOC, LOC, First Mortgage, my bank my loan my way, tom martino, Adjustable rate, |I’ve been in the mortgage industry for more than 13 years. In that time I’ve seen some ups and downs. I’ve seen many product developments, and I’ve seen many different ways to package the same old products to make them look fancy and innovative. The dominating factor that the consumer must always keep in mind is that most professionals in the mortgage industry are, first and foremost, sales people. As such, they need to sell you a product to earn an income. In and of itself that is not a bad thing. There are many good people who are also sales people. It is important, however, to understand the difference between a salesperson, and an advisor. A sales person sells a product or service regardless of a client’s need. Many of them don’t have the expertise to know the impact of one loan vs. another on your personal finances. An advisor gives advice on the available products and helps the client make an educated and appropriate decision. Your individual situation will dictate which type of professional is appropriate for your needs.
An interest only loan on your home is in and of itself not a bad loan. There is nothing evil or unethical about it. It can, in some cases, be a very good choice. As a matter of fact, I personally have an interest only loan financing my home. It is not a new concept, and in and of itself, it is not a gimmick. I do, however, believe strongly that it is not a good option for the vast majority of the people financing their homes.
Let’s analyze some of the information surrounding the Home Equity Loan First Mortgage concept. The basic loan is a home equity line of credit (HELOC). You are leveraging the equity in your home to pay off your first mortgage balance, and further leveraging your home to pay your monthly obligations. This strategy is great if you are one of the few people in the country that has more money coming into your asset base than exiting. The average American spends more than they earn. Consumer credit increased at an annual rate of 5-1/4 percent in the third quarter of 2007.* While average hourly earnings rose by 3.8 percent, and average weekly earnings rose by 3.5 percent over the same period.** This means that every month you pay your bills with your home loan you actually see an increase in the level of debt that is leveraged against your home. It consequently means that every month this occurs you are reducing the amount of equity in your home. An advertisement for one such loan “My bank, My loan, My way” compares the loan with a checking account, from which you make withdrawals to pay your monthly obligations. A checking account is filled with cash not debt and never do you have to pay to withdraw from it, assuming you have a positive balance. Also, at no time is the equity in your home effected by your failure to stay within your budget. I know from years of experience that people have the best of intentions when they make financial decisions. I also know that more often than not those intentions fall by the wayside to the lure of spending. The American consumer spends on average in excess of 80% of every dollar they receive in income. Depending on the age and income bracket that number can be as high as 140.93%***. The reduction of debt is recognized just as in increase in wages would be by the consumer. When the American consumer lowers the monthly outflow of debt the perception is that they received a raise in income and in turn see that as a green light to take on more debt.
An additional concern that all consumers should have with this loan is the fact that it is an adjustable rate mortgage that adjusts, not annually, but monthly. Every time the Federal Reserve changes interest rates the rate on this loan will change. There are no adjustment caps either. If the Federal Reserve increased rates say 17 times in a row by .250%, your rate would change by 4.25% in the span of less than a year and a half (the Fed raised rates 17 times from 2005 through June of 2006).
The final issue is that the loan doesn’t require you to pay principal. Not only do you have a free pass to write checks on your home equity at will until the equity has been tapped out to the maximum allowed by the loan (often in excess of 80% of your homes value), but your interest rate can increase without any protective caps, and you are not required to make any principal reduction payments. This is a recipe for disaster. In a market where banks are going out of business left and right, foreclosures are at an all time high, property values are falling, and the former Fed Chairman Alan Greenspan has recently stated that he expects rates to move to the double digits in the coming decade, I can think of nothing worse than this particular loan for the financing of your home. It wouldn’t be adding fuel to the fire, it would be more like dumping a truck load of C-4 onto the fire.
*Statistic taken from the Federal Reserve Statistical Release on 11/07/07.
**Statistics taken from the Department of Labor Bureau of Labor Statistics 11/02/07.
***Information has been taken from James Shambo’s studies on Marginal Propensity to Consume in his development of the Hedonic Pleasure Index™.
January 4, 2008 at 12:52 am
“I personally have an interest only loan financing my home. It is not a new concept, and in and of itself, it is not a gimmick. I do, however, believe strongly that it is not a good option for the vast majority of the people financing their homes.”
I strongly disagree. Having an interest only mortgage and using a Home Equity Line of Credit (HELOC) to accelerate the equity in one’s home is a win-win situation.
A home becomes an asset once it has been paid off “free and clear” — until then it is a liability.
A mortgage is the largest obstacle that one has in wealth creation. This is primarly due to the front-end interest load on a mortgage amortization schedule.
Today’s Real Estate market means that folks can no longer count on appreciation to build home equity. Those who realize that they need to pay down their current mortgage debt are looking for alternate ways to aggressively (yet safely) build equity.
And they’ve discovered a perfect online system to do that; they can focus on their wealth accumulation goals while accelerating their equity simply by using a HELOC to ‘power’ the Money Merge Account™ financial solutions program.
A typical 30 year loan (of whatever type) can be paid down in 1/3 to 1/2 the time — it’s a great way to save *huge* amounts of income by eliminating a mortgage amortization front-end interest load. (On a million-plus dollar home, I’ve personally seen where the Money Merge Account™ program will save the homeowner $750,000 in interest charges!)
And the best thing – homeowners don’t have to refinance their existing mortgage or, in most cases, make any adjustments to their lifestyle.
I’d be happy to provide further details…
January 4, 2008 at 9:57 am
ppdeagle,
I am glad you contacted me. It is obvious by your shameless plugs that you are selling a product. In other words, if you fail to sell this product you will fail to create income. My guess is you would sell this system to anyone with a mortgage and enough money or credit to purchase it. Your product is just the thing I am warning the public about on this blog. It is this mentality that has led to the housing disaster we now have. I personally have met with representatives or “agents” from United First Financial(TM) (the company that created The Money Merge Account(TM). The math, the product, the sales pitch is all designed to confuse the public with a bunch of hocus pocus numbers and techniques. The reality of your product is that it is a glorified (and very expensive) budget tool combined with the sale of a HELOC which your organization calls an ALOC - more hocus pocus. Anyone with a mortgage and extra cash-flow can accomplish the same thing (actually better) by themselves. All they need is discipline. Now, you may be a great person who thinks by putting people into this product you are actually doing them a favor. Maybe you listened to the sales pitch and bought all the hocus pocus. I have to admit, the presentation is well put together and very convincing. You need to do your homework though. Put the numbers down on paper and work them out on a calculator; you know, the old fashioned way. I mean really, Do you actually think that by using an adjustable rate mortgage with a higher interest rate than your existing fixed rate you can speed up the payoff? I have done the numbers. After figuring the cost of your product into the mix, my clients, with their boreing 30 year fixed mortgage and a little discipline with their budget will have better results with no out of pocket expense for a fancy piece of software and no additional cost, time, or inconvenience for an “ALOC.” Hey, here’s a thought, they might actually get reacquainted with their money and how it should be used in the process.
Look, if you want to sell your product as an effective way to keep the American homeowner on a budget designed to get them out of debt faster - kudos to you. I would support your product for that, even if it is a littlelot expensive. Leave the hocus pocus out of the sales pitch. If your product is good for people you shouldn’t have to use all of the smoke and mirrors currently in your sales pitch.
If you disagree with me I challenge you to send me proof that the same results you proclaim your product to achieve cannot be achieved without the software and without the ALOC and without the smoke and mirrors. If you can prove it I will gladly post it.
Your comment about a home being an asset only once it is paid off is just plain crazy. How can you begin to tell the millions of Americans that have more value in their home than debt that they don’t actually have a positive net worth (assuming the home is the only asset and the mortgage the only liability) unless the mortgage is completely paid off. Mathematically your statement has no foundation. Sure, if a homeowner has a home that is worth less than the combined mortgage and expenses associated with the sale of that home your point is valid, but only in that case. Oh, I guess you could attempt to make the argument that the borrower will pay hundreds of thousands of dollars more than the balance of their mortgage in interest over the life of their loan. You are assuming then that home appreciation never occurs, that everyone can be a cash buyer, and that the homeowner doesn’t have a better place for their money. It’s an opportunity cost thing; economics 101.
The statement you made about the “mortgage being the largest obstacle that one has in wealth creation” is even more crazy. If it weren’t for mortgages the vast majority of people wouldn’t even begin to have the chance of owning a home. Additionally, the truly exceptional gains that we have seen in the last 100 years in real estate values (you know, the gains that have made millions of people wealthier) would have been minuscule in comparison if it weren’t for the mortgage. That’s a supply/demand thing; still economics 101.
Your next comment, as to today’s market no longer affording the consumer the ability to “count on appreciation to build home equity” is interesting; couple that with the first two statements - the home being a liability, and the mortgage being the largest obstacle in wealth creation, are you sure people should even own a home? I think if you really want to do people a service, by your logic, you should try to talk them into selling that anchor to poverty and rent until they get rich.
As for my original post, I stand by it. The majority of homeowners would be ill served by being placed into a first mortgage HELOC. To put the average homeowner in a product that has an interest rate currently more than 2% higher than the average 30 year fixed rate that adjusts monthly and gives the option of not paying principal at all is ludicrous at best and in my humble opinion should be criminal.