The vast majority of homebuyers today use a home loan of some sort to assist them in that purchase.
For today’s column, I will assume you already have set aside the funds necessary to purchase the home of your dreams. Whether or not that is the case, you are still confronted with the opportunity to apply for a home loan, and the questions you should be asking are:
1. Even if I don’t need to borrow money to purchase my next home, should I consider doing so?
From my perspective, the question is better framed: “If I can borrow funds for 30 years at, say 4 percent, will I be able to invest the cash I would otherwise use for the purchase in a way that will consistently returns more than the cost of the loan?”
The answer to that question depends on your risk-tolerance level.
If you are extremely risk-averse, you will likely feel better paying cash. After all, anything can happen, and if the worst comes, at least you will own your home free and clear of debt. This is the philosophy of the camp who screams “I’m debt free” when they are able to pay off their house note.
If you are comfortable with a small degree of risk, then it is likely you can obtain an average return of more than 4 percent per year, even in extremely secure investments such as high-grade bonds or safe stocks with high dividends.
And if, like many Americans, you are comfortable with a moderate degree of risk, then it is almost assured that your overall return during a 15- or 30-year period will significantly exceed 4 percent. For example, an index fund of the S&P 500 has typically yielded 8-10 percent (or more) over almost any 15-year period.
At the risk of offending the “debt-free” crowd, I’m going to suggest (strongly) that you consider that home mortgages are currently available at rates that have been held artificially low for purposes of economic stimulus, and that by locking in a long-term fixed-rate today, you can benefit from that rate for many years to come.
2. If I do decide to borrow, what percentage of the purchase price makes the most sense?
Generally speaking, lenders will offer you the best combination of low rate and low fees if you borrow no more than 80 percent of the appraised value of the property. In other words, there is typically no benefit to borrowing less than 80 percent, except that you will owe less of a balance on the loan from the beginning.
3. What repayment term should I choose?
In most cases, you can expect a rate drop of about 50 basis points (half a percent) if you select a repayment period of 15 years as opposed to 30 years. Quicken Loans offers borrowers the option of selecting almost any repayment term, and lowers its rate based on that selection. If the differential between 30 and 15 years is less than 50 basis points, my advice is to go for the longer term, as it lowers your overall risk.
4. If I don’t have the needed cash to make my ideal down payment now, should I wait to buy?
That’s a tough question.
On one hand, if you can save or raise enough cash to make a 20 percent down payment, you will get the best possible rate and avoid private mortgage insurance and other fees.
On the other hand, the Federal Reserve has stated clearly their intention to raise long-term rates over the next several years as it departs from its policy of quantitative easing.
My best guess is we will endure another several years of anemic job growth and lackluster recovery. Nothing substantive can be expected from Washington until after the next presidential election in 2016, and I suspect Fed Chairwoman Janet Yellen will only raise rates slowly and cautiously, fearful of stifling what little recovery we are seeing now.
Even so, housing prices are likely to be higher in the months ahead, and interest rates will likely be higher as well. Overall, it probably makes the most sense to buy the house you want now and lock in the lowest rate you can get as fast as you can do so.
One additional thought:
Most lenders will not allow you to borrow funds to use for a down payment. However, in many cases, you can use “gift funds” as some or even all of your money at closing. The source of these funds must be disclosed and verified in writing by the grantor.
My guess is that you would be surprised at how many first-time borrowers use gift funds for down payments. If that is a possibility in your case, it might make good sense to ask.
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