There is an old joke that goes something like this:
A tropical storm ravages a small seaside town. The levees are soon overcome and a devoutly religious man is forced onto his roof to escape the flood. As the water begins to splash at the lip of the roof, a man in a canoe rows by and pleads, “Jump into the boat and I’ll save you!”
The man says piously, “No thank you. I’ll stay here, the Lord will save me!”
Soon the water begins to splash at the man’s feet. A motorboat comes by, and shouting over the howling storm the people plead, “Jump in before it’s too late!”
The man looks at them solemnly and says, “Fear not friends. I know God will save me!”
Now the water is almost up to his chest. A helicopter flies overhead and drops a ladder in front of the man. As the Helicopters bobs and sways against the force of the storm, the pilot yells over the loudspeaker, “Grab the ladder and pull yourself aboard! I can’t hold off the storm much longer!”
The man waves away the pilot proclaiming, “Thanks, but no thanks dear neighbour! For I know God will save me!”
The man chuckles to himself as he closes his eyes and stretches out his arms waiting for salvation.
All at once the man is broken out his reverie as the flood waters begin to lap menacingly at his chin. Finally the man begins to panic. Standing on his toes and fighting for breath, the man looks toward the heavens and out, “Lord, I’m a good man. My faith has never waivered. Why won’t you save me?”
Suddenly, the man hears a great resounding sigh as the voice of God booms, “What more could I do? I sent you a canoe, a motorboat, a helicopter…”
Though I’ve always considered myself a man of faith, I’ve always liked this joke because it is less a commentary on faith than it is on pride. Ultimately, it is the poor man’s ego which causes him to abandon reason in the face of imminent peril. He turns his nose up at certain opportunities to save himself because he thinks he is entitled to something better.
Additionally, I can’t ignore how perfectly this joke parallels the current lending environment. Last February, after two years of erratic rate swings and an uncertain lending climate, the Federal Reserve’s announcement that they would be committing over a trillion dollars toward purchasing bad loans, pushed rates down to their lowest levels in 50 years. By purchasing these non performing mortgage backed securities, the Federal Reserve would reduce the banks liability and free up additional money for them to lend.
Rates began to drop, and many borrowers were finally able to secure the financing needed to lower their payments to manageable levels. Those borrowers fortunate enough to be in FHA or VA mortgages saw even greater relief, taking full advantage of the opportunity to defer two months mortgage payments, gain access to a refund of their escrow account balances and to apply these funds to higher interest rate debt on credit cards. In doing so, these borrowers had increased their net income each month by more than 15% before they had even made the first payment on their new loans. Consider the following scenario based on the experience of a borrower I worked with last month:
John Smith – VA Borrower making $4000 per month
Mortgage Rate: 6.5%
Mortgage Payment: $2448
Credit Card Debt: $14,000 costing $450 per month
Net Income: $4000 monthly income – $2448 mortgage – $450 credit card payments = $1102 Net Income
Cash Freed up by Refinance: $7396 (Two Months not having to make payment of $2448 + Escrow Refund of $2500)
Mortgage Rate: 4.5%
Mortgage Payment: $1962 (Saves $486 per month)
Credit Card Debt: $6604 Costing $210 per month (After applying Two Months Deferred Payments and Escrow Refund toward Credit Cards)
Net Income: $4000 monthly income – $1962 mortgage payment – $210 credit card payments = $1828 Net Income OR Net Increase of $726 per month
As significant as this veteran borrower’s increase was, his experience is not unique. I’ve personally watched hundreds of VA loan borrowers who have been struggling to make ends meet turn a bleak situation into a roadmap toward financial freedom. These borrowers understand that a decrease in their mortgage payment is only part of the benefit afforded by a refinance to a lower rate. They understand that the refinance represents an opportunity to leverage their mortgage as a tool to make an incredible impact on their entire monthly budget. As a mortgage professional I’ve helped to execute these loans for many borrowers, but I must give credit where credit is due. I help borrowers by processing transactions. Ultimately these veteran home borrowers have recognized the impact low VA rates can make and have decided to help themselves.
There is a flip-side to this story, however; one that echoes the plight of the man in the aforementioned joke. There are those who say, “The rates are good but I’m not going to refinance until rates hit 4%. I think they will hit 4%. I don’t want to refinance and miss out on the opportunity to save another .5% on my mortgage.” These borrowers ignore the fact that the Fed can’t continue to print money to keep rates down forever. They fail to recognize that if you keep printing dollars to keep rates artificially low, soon the value of those dollars will diminish and rates will have to rise to offset this effect. We are seeing this affect as I write this. Rates have risen sharply and the language of industry analysts is getting darker and more uncertain with every passing day.
“No matter,” these borrowers say, “At some points rates will HAVE to come back down if the economy is to recover.” Once again though, these borrowers fail to recognize that the Fed doesn’t actually set mortgage rates, they can only influence them. This is a fundamental truth of any free-market society. At their most essential, rates are determined more by factors of supply and demand, of risk and reward. Even government loans, aren’t really “government” loans at all but loans from banks that are only insured or guaranteed in some form or another by the federal government.
“The government wouldn’t let the rates get out of control.” These borrowers say. “Sure, I’ve got pressing bills but there is no way I’ll lose my home. The Fed will step in. Besides, with rates rising how much will $50 dollars off my payment really help me if I have to pay closing costs?” These borrowers fail to recognize that the issue isn’t whether or not the Fed is willing to help manage the situation, it’s really whether or not the Fed is able to. If the Fed were able to properly and effectively influence the market in an efficient fashion, wouldn’t it stand to reason that we wouldn’t be here in the first place?
And let’s not forget those borrowers who believe a $50 a month savings on their mortgage isn’t sufficient to justify closing costs for a VA loan. Aren’t they ignoring the fact that they can leverage their deferred payments and escrow refunds to even greater savings? The problem is that these borrowers see their mortgages as separate within the framework of their monthly expenses. These borrowers prioritize their debts in order of the highest balances first instead of the highest interest rates. They fail to consider that a refinance saving them $50 on their mortgage could quite easily facilitate (as the example above suggests) a significant reduction in their overall expenses. By freeing up even an extra $50 per month though, couldn’t these borrowers divert these savings to credit card debt? We all know the some of the downsides to credit cards are their high interest rates and penalties. The upside is that, unlike a mortgage, credit card payments are based off whatever the monthly balance is. As such, aren’t these borrowers failing to consider that even $50 of additional payment diverted toward a credit card could mean a steady increase in overall monthly savings over time?
The statistics do not lie. Homeowners are suffering, the housing market is uncertain, and the job market is nebulous at best. If some of the most venerable “blue-chip” companies of the last 100 years can find themselves hobbled by insolvency and financial woes, can we really be sure of what the future will bring? I don’t presume to know the answer. I only know that I see greater meaning in the joke that began this blog post. Given the current climate, it now reads more like a cautionary tale than a joke. Maybe this is because something only qualifies as a joke if it rings true with some sort of generally accepted viewpoint. How many of us then, are willing to help ourselves by evaluating our options with reason. And if we are being honest with ourselves, how many of us are standing on our roofs, watching the floodwaters rise, closing our eyes waiting for something better to come along?