Colin Breadner's Prince George Real Estate Blog

Mortgage Matters: More Risk Tolerance

Mortgage Matters: More Risk Tolerance
By Bob Quinlan

Wednesday, December 31, 2008 03:49 AM



Now how much risk tolerance do you have as a borrower?

I have heard many people tell me: “why does the bank think I can’t afford this?

Answer: Because the bank wants to make sure you are not exceeding your level of “risk tolerance.”

The guidelines and limits they use to try and approve a loan for are not just because they want to make money from your loan. The only make money as long as you can repay the loan.

Those of you who read my last entry (December 11th) should have been able to understand that mortgages are designed to be a “win/win” situation. If you succeed in making your required mortgage payments, you not only own your own home but you also gain from the market appreciation. Historical data will show that over the past 50 years the average real estate market decline has lasted less than eight months, while the average increase has lasted more than 42 months. Add to that the average decline has been less than 15% while the average increase has been more than 70%. There will always be ups and downs. The key is to be able to survive the downs so you can benefit from the ups.

Everyone needs a home to live in. Therefore residential real estate values are the life blood of our economy. The trick is to be able to weather the storms. Go ahead and buy at the peak of a market. As long as you can get to through the tough times you will be able to coast in the better times. That is why we all need to determine our level of “risk tolerance”.

Many people I talk to have come from the school their parents and grandparents were raised in. “Pay off your house and you will be safe. You will always own your home and no one will be able to take it away from you.” That’s fine as long as you don’t have any other debt. Credit cards, lines of credit, vehicle loans, student loans, etc. Prior to 1970 credit card debt was virtually non-existent. Then CHARGEX came along. That was changed to VISA and MASTERCARD and American Express was added. Instant gratification. You can have what you want now and pay for it later. The expansion of credit allowed the economy to grow and flourish. Goods were traded on the promise of payment tomorrow. Businesses grew and with that the promise of more jobs turned into higher incomes, the assurance that mortgages could be paid, demand for better housing and the rise in property values.

Of course, what comes with that is the inevitability that some people will exceed their “risk tolerance level” and default on their debts. Their desire to own a home and all that goes with it overshadowed their ability to make the payments. That usually happens when the market goes into a decline and as I explained earlier the value of their home is less than what they owe. Foreclosure and bankruptcy.

The evolution of credit over the last 40 years has changed the way we should be thinking about the ownerships of our homes. For the most part, we need debt to grow financially. We just have to choose the proper type of debt that enhances us and doesn’t drag us down. We need to be able to manage our expectations and ultimately the level of our debt (our risk tolerance). Are you managing your debt or is your debt running you?

Our parents and grandparents never had the extra debt other than the mortgage on their home and maybe the loan on their vehicle. These were secured by the lenders who could seize those assets if the loan wasn’t paid and they were able to get all or most of their money back. That process of seizure was swift and heavily in the favour of the creditor (bank) so the fear of losing your home was great. If your home was paid for (clear title) then since you probably didn’t have any other debt, your home was secure.

Now fast forward to 2008. Let’s say you have your home paid for and you are keeping it that way because you learned from what your parents taught you. However, you have a couple of credit cards, a line of credit and vehicle loans that you are paying on. Say you fall behind and can’t keep up the payments. Do you really think having your house paid for is going to save it? When push comes to shove what do you think your creditors are going to do? Force you to mortgage or sell your home maybe? Your credit is now shaky from the late payments so what are the chances of getting a mortgage on your home at a reasonable rate? That leaves a “high risk” lender (because you have become a “high risk” borrower) at an outrageous rate that isn’t much better than the payments you haven’t been able to keep up in the first place. It’s easy to say one shouldn’t have gotten into the debt in the first place, but sometimes life just isn’t that easy. Stuff happens. Maybe you should have considered a more manageable payment to cover all the debt with a mortgage on your home.

This is why using your home is the safest form of debt. The security is highest so the interest rate is the lowest. The life of the security is long term therefore the payments can be spread over a longer term (up to 35 years in most cases) and are more manageable. Over time your house value should always increase therefore as long as you are making your payments, your equity (cash value) will continue to grow (tax free).

The bottom line is:

1. If you have debt you will have to repay it.
2. Manage it so it can be repaid at the lowest cost (interest rate).
3. Protect yourself from setbacks (loss of income) by having the lowest payments available if needed. (make sure you have the option to accelerate your payments without penalty).

Once again, thank you for taking the time to read my comments. I hope they helped. And I would like to wish everyone a happy, healthy and prosperous 2009.

Bob Quinlan is a Mortgage Broker with Mortgage Alliance Prince George, you can reach him by email :bob@pgmortgages.ca or by calling the office at 250-564-9161

posted by Colin @ 10:35 AM