Line of Credit backed by investments

[DanP]

Somewhat new here still so please refer me to the right threads if this is a common one.

So our ER/lifestyle goals have taken us to a place where it makes sense to move to a more expensive home for a 10-year horizon. Huge lifestyle improvement.

Cutting to the basics target home is around 1.5m, we can pay cash but figured put 50% down on a 7/1 arm or so given today's rates.

Much to my surprise we don't qualify for that amount of mortgage despite perfect credit forever and liquid assets exceeding the loan by multiples. Guess mortgage rules have changed in the last 20 years.

So lets forget about mortgages then, we happen to have access to a libor indexed, interest only open line of credit, backed by our investment account in a specific bank. This is more of a privileged product by its nature.

Ok, so with that baseline:

This is an interest-only loan, no term, no floors or ceilings because it is a simple index, month to month. No mortgage help in terms of taxes, although tax guy says interest payments are good offsets for gains, so nice advantage.

Then my question:

Knowing that we can pay this in full anytime (as in LIBOR goes nuts) by taking away from investments (hopefully at a higher rate), is there any reason to pay this down or just keep it forever, until libor / returns turn then pay it off in full?

Given the tax advantage, current rates my logic says to let it ride indefinitely.

 

[robertf57]

Why wouldn't you seek a smaller mortgage that locks in a rate for at least some timeframe (7/1 ARM if that is your desire, or even a fixed 15 given current rates) and gives you the deductibility?


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[DanP]

Thought of that but the LOC was so much cheaper and tax-wise it seems even better than mortgage deductibility, as it is offset as investment costs. Some carry-over benefits too.

The question now is more as to should I roll this monthly interest indefinitely, or pay it down?

And as I type I realize this may not be such an ordinary situation to begin with.

 

[Senator]

I know several people that use interest only loans. Most, if not all, could qualify for a 30-year loan as well. Interest only loans have their place.

It seem that a bank will not qualify you for a mortgage, based on the parameters that you gave them. They have a lot of history, and make a lot of money making loans. They WANT to give you a loan, but the risk was greater than the perceived benefit.

If you use an interest only loan, pay interest only. That is the purpose of the loan.

 

[DanP]

Thanks Senator. Seems that the newer mortgage rules are very strict, in my particular case the limiter was income (counting salary only, could not count investment income unless I withdrew it regularly) plus the fact that I did not want to make selling my current home contingent. With that formula the mortgage I qualified for was < 500k, not worth the hassle.

So one could treat the LOC as a mortgage paying it down monthly or just interest only until there is a reason to pay it off. Curious about your statement about paying interest only, why?

 

[Senator]

Thanks Senator. Seems that the newer mortgage rules are very strict, in my particular case the limiter was income (counting salary only, could not count investment income unless I withdrew it regularly) plus the fact that I did not want to make selling my current home contingent. With that formula the mortgage I qualified for was < 500k, not worth the hassle.

So one could treat the LOC as a mortgage paying it down monthly or just interest only until there is a reason to pay it off. Curious about your statement about paying interest only, why?

The purpose of using an interest only loan is to have more cash flow. Investors use it because they will sell the property later, at a higher price. Paying down principle doesn't make sense, only to get it back in a few months.

The bank says you do not have enough income, unless you sell your current home, or withdraw assets. Likely you will be a bit squeezed if you do take out the loan on the property. There are a lot more expenses in any property, other than the mortgage.

The new mortgage rules are not strict, they are based on risk. There is a reason why the bank doesn't want to lend the money.

 

[pb4uski]

Sounds like the tax benefit will be the same as mortgage interest... 1:1 reduction of taxable income and you have the flexibility to pay interest only or more than that at your discretion.

I assume that you could get a "margin call" if the value of your investments were to decline dramatically?

 

[DanP]

Yes, I liked the flexibility too - very simple to setup and live with.

They use a ratio depending on the specific investment mix, and yes in a bad scenario the equivalent of a margin call could take place. But I am borrowing well below the current value so not concerned even in a big fluctuation.

 

[Trawler]

We ran into the same issue of not qualifying for a mortgage a last year even with 50% down when we were thinking of buying a new home until I actually spoke to a Private Client rep at JP Morgan Chase. Not sure of your age but Fannie and Freddie will use retirement assets to calculate underwriting income if you are 59.5 or greater. The take your total and divide by 360. So for example you have $1,500,000 they would use monthly income of 4,166 to qualify. We are not 59.5 however due to our banking relationship and great credit score they made an exception to the 59.5 rule and approved our 30 year fixed rate loan upon verification of assets. Rates were same no upcharge. We did not have to show any draws . The others I spoke to that said we not did qualify did not deal with high net worth individuals and did not know of this underwriting guide line. If you want to go this route find a lender that deals with retired and high net worth individuals.

 

[DanP]

Good info Trawler. Right, the volume mortgage outfits seemed very constrained and not catering to high net worth individuals, all the weight is on income/expense ratio assets not considered.

The LOC product I got is through a wealth-management relationship. Seems like the best way to go for my situation.

 

[brainsqueeze]

I'd like to know more about your rationale for not paying cash. Understanding your thinking about that may guide you as to the right course of action.

 

[DanP]

I haven't had a mortgage in my last 2 homes, so going for a loan now is a change.

The LOC is very cheap (significantly cheaper than current 7/1 arm rates), simple (no points, escrows, insurance requirements I may not choose), plus has tax advantages.

I believe that keeping the money invested instead will net a gain, and should that change its a simple payoff. There are no setup, entry or exit fees on the LOC.

 

[brainsqueeze]

Since your goal is to maximize your leverage, I agree you should take the largest LOC you can.

 

[athena53]

Good info Trawler. Right, the volume mortgage outfits seemed very constrained and not catering to high net worth individuals, all the weight is on income/expense ratio assets not considered.

We ran into that last year. I was one year post-retirement and DH had been since 2003. Excellent credit ratings, we wanted to borrow $150k on a $250k house, and our investments had increased by $100k since I retired despite withdrawals.

I swear they were fixated on our documentable income, which was $34k between DH's SS and my small pension. They loaned us only $100k. Silly.

In retrospect it worked out; we have a low mortgage payment and pulled the extra $50k out of our investments just before the August crash. Good timing.

We have no other debt but the 3% rate was low compared to our average returns and we have enough deductions that we can itemize the interest.

 

[gcgang]

We used LOC as bridge loan between the purchase and sale of homes. Paid it down because the rewards of leverage weren't worth the extra risk for my situation. Usually leverage, especially at today's low rates, increases your returns. Until it doesn't.

 

[rayvt]

the limiter was income (counting salary only, could not count investment income unless I withdrew it regularly)

So what's the problem? Set up a monthly withdrawal plan, get a couple of month's history, apply for the mortgage, when the mortgage closes cancel the monthly withdrawal plan.

That's what all us retirees have to do. That's how I refinanced 4 times after I retired.

I even pointed out to one loan processor that I could cancel the withdrawal plan after I got the mortgage. She said, yes and somebody with a job & regular paycheck could get laid off 2 weeks after they got their mortgage.

What they want to see is something that looks & feels like a steady paycheck.

 

[athena53]

Well, I'm hoping that this won't be a concern anymore since we just downsized to our dream house and I can't imagine getting a much lower rate than our 3% 15-year fixed.

I don't like the idea of a fixed draw because, while I have a good handle on our everyday expenses, I prefer to withdraw as needed for major expenses such as a new furnace. Keeps the money working in the meantime.

 

[robertf57]

Well, I'm hoping that this won't be a concern anymore since we just downsized to our dream house and I can't imagine getting a much lower rate than our 3% 15-year fixed.

I don't like the idea of a fixed draw because, while I have a good handle on our everyday expenses, I prefer to withdraw as needed for major expenses such as a new furnace. Keeps the money working in the meantime.

And why couldn't someone just move the same 10k in and out every month or maybe hide the returning of the money a little better by doing it every other or every third month? Whole thing seems asinine, IMHO.......


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[RobbieB]

Not really.

A person could have massive net worth but not "liquid" eh?

A bunch of limited partnerships, RTIF's and real estate? Some "questionable" equities?

The bank really doesn't want to hire an expert to go over your bag doing a "can he pay the bill each month" analysis. They just go by the charts.

 

[athena53]

The bank really doesn't want to hire an expert to go over your bag doing a "can he pay the bill each month" analysis. They just go by the charts.

That's what credit reports are for! In our case the answer would have been decades with no late payments on anything. I just told our mortgage broker, who's a member of our church, that I knew if he were George Bailey in "It's a Wonderful Life", he would have loaned us the full amount. He laughed. Too bad banks are so in love with their inflexible little tick boxes. We just didn't fit into them.

 

[RobbieB]

On how much credit? Half a mill? And recently?

 

[rayvt]

Too bad banks are so in love with their inflexible little tick boxes. We just didn't fit into them.

Weren't you around during the finacial meltdown in 2008? There is a reason they have all those little tick boxes. Loan volume is what keeps mortgage rates low. For loan volume they need to have a simple, no thought, no work cookie cutter approval method.

Your job, if you want one of those loans, is to shuffle your finances around so that you fit in the little boxes. Which means you need to show an income stream that looks & behaves very much like a steady paycheck -- coming from a well-known institution. Which means a broker who you have instructed to send you $X a month, and you can show those deposits hitting your checking account for 2 or 3 months.

Yu can either go with the flow and get the mortgage, or you can rail at the lenders and get turned down.

 

[athena53]

You can either go with the flow and get the mortgage, or you can rail at the lenders and get turned down.

I draw the line at making financial moves that didn't make sense to me just to improve my credit. When I was first starting out I was told I'd never get credit if I didn't take out an expensive personal loan or carry a balance on some credit card so I could get a mortgage. I don't take out unsecured personal loans and I don't pay credit card interest. Somehow I got by, including a quarter-million dollar mortgage when I was a single mother. And, at this point I don't need to worry about getting a mortgage anymore and it's fun to rail at the lenders because they've done so many stupid things in the past!

Back to the OP- I was so busy railing at the lenders I didn't answer your question. I'd be inclined to pay some principal regularly even though it's interest only. Maybe make principal payments when the market is down. Real estate doesn't always go up and I like building equity, especially in retirement.

 

[DanP]

As the OP, thanks everyone agree the thread took a side turn.

My comment about volume mortgage folks being constrained to a very limited formula was incidental, took the brunt of the replies, including questioning qualifications. And those constraints may be overdone but needed some reigning in after 2008.

Real question was related to whether or not use a cheap LOC while it made sense to do so rather than using cash. Now realizing maybe not that different than a mortgage except the LOC has no points or fees and is a month to month thing, easy to shed.

I close on my new house next week LOC now funded happy with my decision, thanks for the insights.