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Wealth management considerations for spring home buying

If you or someone you know is in the market for a new residence during this buying season, consider looking at this all-important purchase through a wealth management lens. While one’s primary residence is hopefully a “home,” it is also a financial asset. For most, even the significantly wealthy among us, a primary residence is likely the most expensive personal asset anyone ever purchases and therefore necessitates careful financial management.

Following determination of property location, type and price range, a natural next step is to focus on what rate can be had if borrowing is part of the purchase plan. The good news is that although mortgage rates are currently in the higher end of their five-year range, they remain at historic lows. According to Freddie Mac data (freddiemac.com/pmms/pmms30.htm) the average 30-year mortgage rate since 1972 is 8.1 percent As of June 6, the rate published in the Wall Street Journal, a broad national average, is 3.9 percent – just under half of this 45-year average.

In spite of the fact that the average residential mortgage is in place for around six years, the 30-year mortgage remains the most popular mortgage type, making its rate the benchmark against which all other mortgage rates are measured. But there are a variety of other mortgage types, with different and often lower rates, so finding both the best mortgage type and lowest rate possible are key to successfully managing the financial aspects of a home purchase.

The subject of mortgages raises two related items: whether to use debt or pay cash, and the debt source itself. To pay or not to pay cash is always an important question. Carrying the least amount of debt possible — or none at all — is generally advisable. But depending on the circumstances, easily serviced low-rate debt can be hugely beneficial to a borrower. The opportunity cost of tying up capital in an illiquid asset can be huge.

For example, if a $1-million home can be purchased with cash, it may be worth considering whether the borrower would be better off in the long term if, say, 25 percent to 50 percent of the $1 million is invested in securities, a business or elsewhere, with the balance made up by a low-interest loan that potentially provides some level of mortgage interest deduction as an added benefit. Depending on one’s overall financial profile, nearly infinite combinations of leverage amount, loan source and type, interest rate and many other balance sheet and cash flow factors can be made to work virtuously in meeting one’s wealth management goals.

When it comes to taking a loan, a bank or mortgage broker are obvious choices. But private individuals can and do lend using their own balance sheets. Sometimes a loan against one’s security portfolio can make sense, too. Both alternatives come with their own idiosyncrasies and risks.

If an individual lends, then he or she should be able to withstand loss of the capital. If he or she is not prepared for this outcome, then the capital should probably not be lent. From the other side of the table, if a borrower takes a loan from an individual, it is a private-market transaction and while IRS rules and common sense apply, the terms are not covered by formal banking rules and regulations. Any personal relationship between the borrower and lender should be part of the equation, too.

As for security portfolio lending, an individual with a sufficiently large and conservative portfolio can use it to collateralize a loan of significant size — middle to high six figures and beyond — at an exceptionally competitive rate. Nevertheless, a borrower should be prudent with the leverage amount even if he has a large, conservative portfolio as collateral.

In addition to judicious use of leverage, careful attention should be given to the fine print to understand the loan terms. These include, but are not limited to, what the lender’s rights are to call collateral and/or sell securities in the portfolio should its value decline in a down market or should the borrower default on the loan; what the fees are for items such as prepayment, late payments and selling securities under duress; who the actual lender is (broker/dealer or affiliate bank); and whether or not the custodian can lend securities in the portfolio, called security hypothecation.

While on the topic of security portfolio loans, it is important to note that when a borrower uses a leveraged security portfolio as an asset for mortgage underwriting at a bank or mortgage broker, it is common for the lending institution to either grossly discount the portfolio value or disallow the portfolio as an asset altogether. Even the value of a portfolio without a loan against it will likely be discounted to account for portfolio volatility and tax and transaction costs should it ever be liquidated to service the prospective mortgage debt.

Needless to say, there is a lot to think about when purchasing a residence. Detailed conversations with a team of qualified financial, legal, and tax professionals can help one to most favorably address these and the many other points that will no doubt arise along the way. When the purchase of a residence is accretive to a well-executed wealth management plan, more time and financial resources are left to derive fulfillment from turning the new residence into a home.

Rob Longsworth is a wealth adviser at Greenwich Wealth Management LLC in Greenwich. He can be reached at Rob@greenwichwealth.com.


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