VOL. 128 | NO. 225 | Monday, November 18, 2013
Purchasing Power as a Mental Construct
I frequently hear radio ads by mortgage companies touting the importance of “locking in low interest rates,” which will theoretically increase your “purchasing power.”
The idea is that with a monthly mortgage payment of $1,100 – assuming a 6 percent fixed rate for 30 years – you can afford a $184,000 home, whereas using a 5 percent interest rate and the same loan term enables, you can afford a $205,000 mortgage.
So for an extra $20,000 in loan amount you can move up to a nicer home.
I disagree and make an argument that many may consider radical: the greatest determination of purchasing power is not the favorable interest rate that you can obtain on your home mortgage, but the maximum price you are willing to pay monthly and the timeframe in which you discipline yourself to pay off your home.
Traditionally, people shop for their primary residence by getting pre-approved for a 30-year loan, at which point the lender determines how much you can afford. If the pre-approved loan is for, say, $250,000, you go shopping in neighborhoods with homes priced $225,000 to $300,000 hoping to find your dream home.
I would argue that a more powerful system would be deciding how much you want your monthly payment to be based on today’s interest rates for 10- or 15-year loans. Let’s assume the rate is 5 percent fixed.
See how much your total purchase amount would be for a 10- or 15-year loan based on your desired monthly payment amount. Let’s assume the payment is $1,100 a month.
For reference, a $1,100 monthly payment at 5 percent fixed on a 15-year mortgage would be a loan of $140,000. A $1,100 monthly payment at 5 percent fixed on a 10-year mortgage would be $104,000.
Once you have your pre-approval in hand, go shopping – but limit your search to foreclosed or distressed homes.
The foreclosed home provides a unique opportunity to extend purchasing power by buying a home with high potential equity value but with an at or below market value price tag due to deferred maintenance or needed repairs.
It is not uncommon today to find properties with a potential fair market value of $200,000 listed for $100,000 (or less!) due to maintenance and repair/vacancy issues.
By disciplining yourself to make budget-friendly monthly payments that will pay your primary residence off in 10 – 15 years, coupled with the REAL purchasing power of foreclosed real estate, you develop a powerful financial stratagem – you can enjoy the type of property many people elect to pay full price for, and pay it off in one-half to one-third of the time.
For Americans seeking true financial security, a fully paid off primary residence is the essential first step.
Robert Feol is the host and founder of “Pieces of the Puzzle: Journeys in Creative Real Estate Investing,” talk radio show on FM 98.9 WKIM and owner of Discount Property Warehouse.