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 the differences.
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 planning.
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].