I’m sure you’ve heard that incredulous gasp or moment of silence on the other end of the phone when you tell someone that they might benefit by considering an interest-only adjustable-rate mortgage (ARM). It’s as if the very mention of an interest-only ARM places you in a category of being, “One of THOSE”—a big bad mortgage broker who singlehandedly caused the whole housing, financial and economic crisis.
So, I have two questions for you:
1. What role, if any, do interest-only ARMs have for today’s borrower?
2. If they do have a role, what is the most effective way to present this option to clients, prospects, and referral partners without looking and sounding like a lunatic?
The case of the missing $100,000
Consider a situation where a client has a 4.5 percent, $200,000, 15-year mortgage on a home that would be worth $500,000 under normal market conditions. The client wants to buy a new home immediately. They want to take advantage of the $6,500 long-time resident tax credit; they want to participate in the Fed’s $1.25 trillion mortgage rate subsidy; they want to get a fantastic deal on the purchase of a new home given the low housing values and buyer’s market.
However, due to the foreclosures and distressed sales in their neighborhood, they could only get $400,000 if they sold their current home today. If they wait a few years, the neighborhood values should recover to the point where they could get $500,000 for the house and pocket an extra $100,000. However, they don’t want to wait a few years to buy a new place.
What, if anything can be done for these people??
Assume they could qualify for two mortgages, the one on the old home, while they keep it and wait for home values to recover, and a new mortgage on the new home that they purchase. Here’s a strategy that could make a lot of sense:
► Keep the old home and turn it into a rental, charging just enough rent to cover expenses.
► Refinance the $200,000, 15-year mortgage on the old home into a 70 LTV non-owner-occupied $280,000, seven-year interest-only mortgage. The borrower would need to pay about four points plus closing costs to get a 4.5 percent interest rate. They would walk away with about $66,000 in net cash-out proceeds that would be used as a downpayment on the new home.
► The monthly payment on the $280,000, seven-year, interest-only mortgage would be $1,050, compared the client’s current $1,530 monthly payment with their 15-year mortgage. The client saves $480/month in cash flow—which means they can charge below market rent on that property and still break even. This will result in finding a tenant more quickly, and avoiding the negative cash flow associated with having the property stay vacant.
► The client can sell the old home at any time within the next seven years once market values recover. At that time, they will pocket the $100,000 they would have lost had they sold the home today instead of refinancing into the interest only mortgage strategy outlined above.
In spite of the brilliance of this strategy, you may be wondering, “How in the world do you get a client with a 720 credit score, who has never paid points in their life, to pay four points plus closing costs?” In this example, the four points plus about $2,500 in closing costs would total $13,700. This is a large sum of money to ask a borrower to pay—especially if they are used to getting “no cost loans” and/or not paying points.
The best way to illustrate this for clients is to frame it in the context of an investment:
“Mister or Missus Client, this strategy involves your making an upfront investment of $13,700. You are not making this investment out of pocket; it is being taken out of the loan amount. In other words, it’s like a no-money-down investment—it’s all being financed for you. So, the main question we need to answer here is: ‘What is the rate of return on this investment?’ If the rate of return is attractive to you, this investment opportunity would be very worthwhile and we should move forward. If the rate of return is unattractive, pass on this opportunity and find another use for your $13,700. Now, assume that this strategy allows you to sell the home in five years for $500,000 instead of selling the home today for $400,000. This means that we are paying $13,700 today, in order to end up with an extra $100,000 in five years. The rate of return on your investment in that scenario would be 48.81 percent annually. In other words, Mister or Missus Client, if you are happy earning 48.81 percent per year on a $13,700 investment, it would make perfect sense for you to implement the strategy that I have outlined here.”
Can you imagine the impact you would have if you were able to have this type of a conversation with a client? I’ve got to tell you, this is much more invigorating than haggling with people over 1/8th of a point in interest rate or a $100 difference in appraisal fee versus the mortgage company next door.
What makes you different than the competition is that you focus on the overall mortgage and housing strategy and what the strategy can do for the client’s life. In this case, the strategy involves a seven-year, interest-only ARM with a whopping $13,700 in fees. The result is an extra $100,000 in your client’s pocket over a five-year timeframe. What can they do with an extra $100,000?
Anything! They could use the $100,000 to send their kids to a better college without getting too far into debt; they could use the funds to help care for elderly parents, retire earlier, buy a boat or a car, or make some home improvements … the list is endless.
The bottom line here is that yes, interest-only ARMs do play a role for today’s borrower; and yes, you can effectively present this option to clients, prospects and referral partners without looking and sounding like a lunatic.
In fact, Certified Mortgage Planning Specialist (CMPS) certification is focused on helping you make 2010 your best year ever, using killer strategies and scripts like the ones outlined above—not only with interest-only ARMs, but also with “plain vanilla” fixed-rate loans and other strategies.
Gibran Nicholas is the founder and chairman of the CMPS Institute, which administers the Certified Mortgage Planning Specialist (CMPS) designation. The CMPS Institute has enrolled more than 5,500 members since its founding in 2005. Gibran is also the chairman of Published Daily, a customizable online magazine, newsletter and marketing service that helps professionals transform their clients and prospects into a referral-generating sales force.