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, if you want a monthly mortgage payment of roughly $1,100, assuming a 6 percent fixed rate for 30 years, you can afford a $184,000 home; whereas a using a 5 percent interest rate and the same loan terms you could afford a $205,000 mortgage. The implication that for that extra $20,000 in loan amount, you can move up to a nicer home, maybe even a ritzier neighborhood.
I don’t believe that 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, rather, the maximum price you are willing to pay monthly and the time frame in which you discipline yourself to pay off your home.
Traditionally, people shop for their primary residence using the following system:
Get preapproved for a 30-year loan based on tax returns and pay stubs.
Mortgage lender determines how much a family can afford, based on the information they have provided – for example, a $250,000 loan amount.
Family goes shopping in neighborhoods with homes priced $225,000 to $300,000 hoping to find their dream home.
Family buys home and begins to service the 30-year loan.
I would argue that a more powerful system for the homeowner hoping to simultaneously turn their primary residence into a moneymaking investment property would be:
Decide 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 roughly $104,000.
Obtain pre-approval from your banker for the loan terms discussed in Step 2. Once you have your preapproval 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 to 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.