by Emilio Kalmera
“A person can be highly educated, professionally successful, and financially illiterate.” Robert Kiyosaki
Home ownership can be a very controversial topic albeit it is very simple. Some believe that a home is an asset and some believe it is a liability. But is homeownership for everyone? Hopefully you will be able to draw your own conclusion from this article.
Anyone who knows me knows I try to break things down to the molecular structure in order to get a better understanding of how things “really” work. So let us start off by defining the typical financing structure term, which most persons will come in contact with which is a mortgage. The word “mortgage” comes from the French “mort-gage”. Mort means death and Gage means pledge (debt). So in essence a mortgage can be literally defined as a death-pledge or debt till death. The French peasants were working until they died for the privilege of owning a house. Historically, when the oldest son of a nobleman needed large sums of money, which his father refused to give him, he often turned to borrowing. In arranging the loan, he would gage or “pledge” to repay the debt when his father died (at which time the son expected to receive his inheritance).
Let us define the word “asset.” Googling the word “asset” I found the following definition: “property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies.” Let us look at another definition: An asset – as defined by Robert Kiyosaki, “is anything that you acquire that puts money into your pocket.” As you can see, both definitions are quite different. In the first definition, it looks at assets from a stand point of having resalable value. In the second definition, it refers to an asset as having the ability to generate cash flow in your pocket. I will expand Robert Kiyosaki’s definition a little broader and say having the ability to save you money can also be considered an asset. I subscribe to Robert’s asset definition, and the broader definition of the ability to save you money. We need one more definition before we can move forward. The definition of net worth or equity position generally refers to all your assets, less your liabilities. In other words, the saleable value of your assets, less all debts of the persons and institutions you owe. So if you own saleable assets of US $10,000, but owe persons and/or institutions US $6,000, then your net worth would be US $4,000.
At my prior function at SMHDF, we referred to our mortgage qualification calculation as “your bag of money.” Your bag of money depends on a number of variables such as the amount you have in savings you can put into the home purchase or construction, your age versus the pensionable age, your existing credit situation (no loan(s) or existing loan(s) or/and credit card payments), average market mortgage interest rate, and your steady monthly income. If it is not obvious at this point I will make it explicit. Based on the variables just mentioned, each person’s situation is different, and hence home ownership really depends on your personal situation. For example, as a scenario, let us say someone wants to know their bag of money to buy a home and their situation is as follows: Monthly income is US $3,000, age is 28, savings of US $10,000, interest rate of 6.5% fixed, pensionable age is 62, and no existing debt payments. This individual could qualify for a mortgage of US $172,454 excluding their US $10,000 savings. So their total bag of money to buy or construct a home would be around US $182,454. We are excluding notary fees, mortgage fees, other fees, and home owners insurance, for simplicity. Let us say that this individual has a US $250 car loan monthly payment. Revising the calculation would bring the bag of money amount down to $166,030 or $16,424 less. Let us take the first scenario and assume the individual in not 28, but 35. The total bag of money will be $170,170 or $12,284 less.
What is not talked about, however, is that there are two most common kinds of mortgage interest rates and there are two most common kinds of repayment mortgage types. There are fixed rate and adjustable rate mortgages. Luckily, in St. Maarten most of the mortgages I have seen are fixed rate mortgages. Fixed rate means that the mortgage interest rates remains fixed until the life of the mortgage. Adjustable rate mortgages mean that the interest rate can adjust up or down depending on market conditions. The common repayment methods are: amortized and even total payment, also known as straight-line.
In my almost five years of banking experience I have only ever seen one straight-line loan. The typical amortized mortgage method is more popular among banks locally. In an amortized loan, you pay the same payment each month where the bank system splits the payment in a part to reduce the principle and a part to pay interest (cost to you, but income for the bank). For the first ten years, however, most of the payment goes towards interest for the bank. To give you an example, if you borrow US $172,454 to purchase a home with a 30-year amortized payment, you will pay $1,090.03 monthly for 30 years for a total of $392,411. The interest paid to the bank will be $219,957. I hope you realize that the interest paid to the bank is more than the amount borrowed from the bank.
There is another big issue with this, but I won’t go into it here. Another issue with amortized loans longer than ten years is that you get very little equity out of the deal for the first ten years. In other words, if you paid $1,090.03 per month for the first ten years you would have paid $130,803.60, however, from that amount paid to the bank, $104,549.01 would have gone to the bank as interest income, and the $26,254.59 would have gone towards reducing the balance of your loan. The same scenario in a straight-line loan would be that $93,568.27 would go to interest for the bank and $57,484.67 would have gone towards reducing the balance of the loan.
In the straight-line loan you get more equity in your property for the same time frame as an amortized loan while also paying less in interest. Is this a bad or good thing? That would depend on each individual’s circumstances. A person in a high income bracket would benefit from paying higher interest for the first ten years, which will offset his taxes. Of course, if you live in a wage tax free country such as Anguilla there would be no benefit from paying higher interest to offset income tax.
Another problem with long-term mortgages, which I have yet to see any of the financial institutions advise clients on is what happens after a typical 20 to 30-year mortgage period. Most building structures, if built correctly and maintained well, can last you up to 25 to 30 years. Hereafter a complete refurbishment is needed. The problem with taking long-term mortgage exceeding 20 years is that by the time the home is ready for refurbishment, you would have reached retirement age. And if you did not manage to save up money during the time of the mortgage to do the refurbishment, you will have to rely on your pension income to do so. Banks will be reluctant to lend you money the closer you are to the pension age, and hereafter unless your pension income is suitable. Also, the financial predictions do not look favourable. Hence it can be risky to go into a long-term mortgage if you are only relying on employment (a job) for income. That is why I don’t believe in the typical home mortgages financing structures and prefer another way of doing things. I am busy planning a home ownership seminar where you can get more detailed insights on home ownership, alternative ways about going about home ownership, and answers to your specific questions.
Source: 721 news Home ownership in Sint Maarten