Who’s Paying Your Mortgage?

As a homeowner, you obviously pay for your mortgage but as an investor, your tenant does. Equity build-up is a significant benefit of mortgaged rental property. As the investor collects rent and pays expenses, the principal amount of the loan is reduced which increases the equity in the property. Over time, the tenant pays for the property to the benefit of the investor.

Equity build-up occurs with normal amortization as the loan is paid down. It can be accelerated by making additional contributions to the principal each month along with the normal payment. Some investors consider this a good use of the cash flows because interest rates on savings accounts and certificates of deposits are much lower than their mortgage rate.

In the example below, is a hypothetical rental with a purchase price of $125,000 with 80% loan-to-value mortgage at 4.5% for 30 years compared to a 3.5% for 15 years. The acquisition costs were estimated at $3,000, the monthly rent is estimated at $1,250 and $4,800 for operating expenses.

Notice that both properties have a positive cash flow before tax. The cash on cash return is the revenue less expenses including debt service divided by the initial investment to acquire the property. The 15 year mortgage will obviously have a smaller cash flow and lower cash on cash but the equity build-up is significantly higher.

If the goal of the investor is to pay off the property to provide the highest possible cash flow at a later date, a shorter term mortgage with a lower interest rate will help them achieve that. A simple definition of an investment is to put away today so you’ll have more tomorrow. Sacrificing cash flow now, during an investor’s earning years, is a reasonable expectation to provide more cash flow in the future when it might be needed more.

Contact me if you’d like to explore rental property opportunities.

 

Why Borrowers Pay Different Rates

Lenders, like any business, have to make a profit. The cost of acquiring the funds, the operating costs to service and the expected profit margin are easily identified. The variable in pricing is the type of mortgage and the credit worthiness of the borrower.

A loan with a 3.5% down payment is riskier than a loan with 20% down payment. If the lender has to take the property back to recover their expense, the margin is greater between what is owed and what the property is worth on an 80% mortgage.

Credit scoring is a risk-based pricing method that allows a lender to be competitive in the market for the best loans from different borrower groups. Individual lenders set their own levels for what they consider “A” credit which is reserved for the best rates. If good credit is approximately 710 to 740, scores below that are considered higher risk and will have higher rates.

Risk must be assessed for both the borrower and the property that collateralizes the loan. The borrower’s credit history and income stability are strongly evaluated by the lender but if a default should occur, the property must secure the loan to avoid a loss to the lender.

The challenge for some buyers is they are unaware of what their credit score is and how it will affect the interest rate offered by the lender. It is to the buyer’s advantage to be pre-approved by a reputable lender prior to starting the process of looking for a home. In some cases, the lender can actually improve the borrower’s credit score to help them qualify for a lower interest rate.

Contact me for a recommendation of a trusted mortgage professional – Aembry@remaxlubbock.com

 

FHA & VA Assumptions

Not many buyers have assumed a mortgage in the past 25 years. Most people think it was because FHA and VA in the late 80’s began to require that buyers qualify for the assumptions. Not having to qualify for a mortgage would certainly benefit certain buyers.

If a homeowner must qualify for an assumption like a new loan, they’ll generally choose the mortgage with the lower interest rate. Over the past 25 years, rates have been trending down but it appears that rates have bottomed out and will gradually increase. As they continue to rise, the lower rates on the FHA and VA loans created in the last few years will appeal to buyers even if they do have to qualify for the assumption.

There are significant advantages to assuming one of these government insured mortgages if the current interest rate on a new loan is higher:

1. Mortgage is further into amortization schedule
2. Lower interest rate loans amortize faster than higher interest rate loans
3. Lower closing costs than a new mortgage
4. Easier to qualify than on a new mortgage
5. No appraisal required

FHA assumptions are only allowed as owner-occupied residents. The borrower must meet current FHA guidelines for borrowers. The total debt ratio including house payment to be assumed cannot exceed 41% of borrowers’ monthly gross income.
VA loans are also assumable with buyer qualification. However, in order for the veteran Seller to have their eligibility reinstated, the buyer must also be a veteran with eligibility.

A 1% difference in the current rates and a lower assumable mortgage rate begins to make it very attractive to assume a mortgage. When the differential becomes even greater, assumptions will become more prevalent than they’ve been in over twenty years.