Two consumer mindsetsJoe Cornoold school, new school, equity, inflation, The Tax Reform Act of 1986, debt
When it comes right down to it, there are basically two consumer
schools of thought present among the loan financing public - the
"old school" and "new school." The key is to know and understand
Old school consumers say to pay your home off so that you will
not worry about losing it. During the Great Depression, consumers
could lose their homes, even if they were current with their
payments. However, consumer protection acts were put into place in
the 1930s so that only delinquent payments could initiate default
and foreclosure. The new school group understands these laws.
The old school says, "My equity is already giving me a great
return on investment." On the other hand, the new school says,
"Equity in the home provides no return on investment unless you
utilize the equity by drawing it out." Inflation depreciates equity
in the home. Appreciation is the same on a home that is free and
clear as the home that is financed to the maximum allowance.
The old school says, "Paying off the mortgage worked for my
grandparents; it will work for me," while the new school takes into
account multiple factors before formulating a position. Prices back
then were more in line with borrowers' wages, people worked for one
company all of their lives and had their retirement mapped out, and
appreciation has grown faster than incomes.
The old school people stay with one loan for the entire term,
whereas new school people change loan programs every seven years
(or even less). The new school people refinance frequently to
utilize equity for investment purposes. While the old school people
relax with one loan, the new school people tap into various loan
programs to return interest to them.
The old school says that all debt is bad debt. They want to pay
off their mortgages as quickly as they can. The new school people
develop debt management so they can use debt to create wealth. The
Tax Reform Act of 1986 restricted deductible interest to mortgage
interest only. The new school people structure debt through
mortgage interest for the reduction of taxable income.
The old school people want a 30-year fixed loan. The new school
people elect for a cash-flow-maximizing loan, such as an option or
intermediate adjustable-rate mortgage. The new school people wish
to capitalize while rates are on the rise. The increase improves
the return on their investments.
The old school consumers think that negative amortization is
bad, and they stay far from it. The new school types understand
this concept thoroughly. Rolling in closing costs or consolidating
consumer debt actually creates deferred interest. In reality, the
old school group uses it too, without knowing it, while the new
school people incorporate negative amortization into their
The old school people are conservative with debt and do not take
risks or pursue opportunities with mortgage loans. The new school
people want to maximize return on investments and use mortgage
loans as part of their financial planning. The two schools of
thought are at completely different ends of the spectrum here.
It really comes down to how an individual defines risk. Risk can
be not having enough for retirement or banking on the markets to
create better than average returns over a period of time. The old
school and new school look at risk differently, and probably
somewhere in between the two mindsets is a comfortable medium.
However, do not attempt to close a loan program that the
borrower does not like or does not fit within his mindset. Times
have changed since our parents and grandparents bought their first
homes and started their financial planning for their latter years.
Prior to 1972, there were basically three loan programs. With a
plethora of loan programs available now, be sure to evaluate a
borrower's mindset and school of thought before explaining programs
that he might stringently object to. The old school does not want
to know about short-term options, and the new school will walk out
of your office if you preach fixed-rate, 30-year loans.
Joe Corno is president of Utah-based We Be Consulting and
Seminars. He may be reached at (801) 836-2077 or e-mail [email protected]