How much mortgage is the right amount?

For the sake of argument, let's say you have enough income to qualify for any mortgage.

Scenario A: You have $2million in liquid assets and you decide to buy a $1.5million home.

A) All-cash? Mortgage after closing?
B) Mortgage at closing? What LTV?

Scenario B: You already own a home worth $1.5million mortgage free and have another $500k in liquid assets. Should you take out a mortgage?

Scenario C: You already own a home worth $1.5million with a $1million mortgage at market rates. You have another $1.5million in liquid assets. Should you take out a bigger loan? Pay down the loan?

Lots of variables here.

My first answer is a question - "What does your Financial Advisor/CPA recommend?" These individuals have a longer term understanding of what your past challenges have been and what your future goals might look like. Based on their recommendations, the right plan forward would appear on it's own.

If this was my deal, here's how I'd play it:

A) Don't pay cash, as cash is king. There isn't a $1.5 to $2m property on the market presently that so desirable that paying cash to "beat the other offers" is required.

Refinancing after paying cash is often sold as "you'll get purchase loan rates so it doesn't matter...." Trust me, that's not quite the case. Also, what happens if you pay cash and for some reason you can't get your loan approved. YOW!

B) Mortgage at closing. Some might suggest putting enough cash down to hit a $750k loan. Perhaps that's a best practice, but that's better answered by your FA/CPA. The loan I'd close with would be at the highest amount I could qualify for, payable on an Interest Only basis. Quite a bit of flexibility on these loans when it comes to repayment. Whatever the remainder of my cash would be, I'd move it to the funding bank to reduce the initial rate. A theoretical 3.75% 7/1 IO might become 3.50% IO by moving funds from holding company ABC to Bank 123. These rate adjustments driven by deposit transfers do not constitute "hostage funds". You could move cash on a Monday, close on a Tuesday, and move your funds back on Wednesday if needed. Most Banks though will have some incentives to keep the $$$ with them for a few months. As it's been said before - your mileage may vary - I'd ask for any and all other benefits before moving $$$.

Why IO? It provides the best options of all other financial tools available. At $1m loan, your payment might be $5k per month compared to $6k per month Principal and Interest. If you want to amortize, you pay the $6k on your own. If you decide to pay the loan to $750k In September, by October your payment would be $4k per month. If there is a lower rate trend developing, you can pay IO for a few months, then flip the loan to a fixed or another ARM.

In this scenario, I'd end up with a loan that I can afford, with a reduced rate, and dry powder for my next investment. If things go sideways, the cash on hand could be used to remedy any number of situations. In my years of structuring loans, it's become clear that the worst time to borrow is when you are compelled to do so by circumstance or rising rates. That liquidity piece is key for me.

My .02c

SGIP

It also depends on what "liquid assets" means.  I would hope someone in this position would have the bulk of his assets in stocks/mutual funds.  In this case there would be a tax consequence associated with selling off the assets. 

My friend just recently did this and did NOT take into account the tax consequences and got hit VERY hard by the tax man.  He should have staggered out the selling over 2 tax years and borrowed against his brokerage and 401k accounts.

woodburyowner said:

It also depends on what "liquid assets" means.  I would hope someone in this position would have the bulk of his assets in stocks/mutual funds.  In this case there would be a tax consequence associated with selling off the assets. 

My friend just recently did this and did NOT take into account the tax consequences and got hit VERY hard by the tax man.  He should have staggered out the selling and borrowed against this brokerage and 401k accounts.

Click to expand...

For the sake of argument, let's say that there are no tax considerations.

What I'm really trying to get at is this. Let's say that you think 50% LTV is an ideal amount. An IO loan obviously is awesome because you don't lower your LTV by paying down the principal.

But if you are giving advice to some who bought their home for cash or paid down the mortgage to zero, would you advise them to now take out a 50% LTV IO loan and diversify/leverage?

If not, why would your advice be different? If 50% LTV is ideal and you are forced to pay down principal while the home value is increasing, you should continually cash-out refi to get back to 50% LTV.