Risk Aversion and Mortgages
Dave Ramsey is rapidly becoming one of America’s most popular financial planning personalities. While I agree with most of what he says, when it comes to mortgages I have an issue.
Ramsey is highly conservative when it comes to finances and believes people should only use 15 year fixed mortgages when it comes to buying a home. I don’t disagree with him in theory. He’s right…if your goal is to pay off the house as fast as possible. However, in reality, the 15-year fixed doesn’t appeal to very many people. Why? The payment is too high!
This is the reason there is a variety of loan programs available to help people get the best loan for their objectives, their price range and their tolerance to risk.
There is a group of people out there who agree with Dave
Ramsey and will only do 15 year loans. They plan on living in their house until their mortgage is paid off, usually longer. They have a low tolerance to risk and debt, play by the rules and will always have a significant down payment. This group of people will also utilize 30 year fixed loans to lower the monthly payment, but will usually end up making additional payments to pay down the loan faster. They simply don’t like the concept of debt.
On the other hand, there are three other groups of people who buy homes that see things differently. The opposite to the first group don’t care about the term, the rate or the type of loan. They only care about the payment amount. They want a payment that allows them to live in the house they want while still leaving money left over for fun. Their income levels vary, but the bottom line is lifestyle. For these people a 15 year loan is automatically out because the payment will be automatically higher.
The third group of people are truly risk sensitive. Buying a home is fearful for them, and they will always opt for a fixed rate loan. Additionally, they will be concerned about the monthly payment as well as the loan amount. Risk is a big deal for this group and they will opt for the loan that is safest, with the lowest payment - a fixed rate loan with an amortization period of at least 30 years. As house prices have jumped, more “exotic” fixed rate products are coming to market with 40 and 50 year amortization terms. Again, this group of people have a variety of financial circumstances, but will always have a concern for safety and security.
Lastly, there is a group of people out there who don’t care about any of this stuff. Like group two, they care only for the home. They don’t consider risk because they believe their earning, or earning potential trumps any risk out there. They want the most bang for their buck. These are the people Option ARMs were originally designed for…people with high earning capability that usually fluctuates dramatically during the year. People in this group want their home to make a statement. They will take the riskiest loan that allows them to meet their housing goal.
What’s particularly interesting about these different groups is they’re fairly evenly split - 25%, 25%, 25% and 25%. So while Mr. Ramsey’s advice for only using 15 year loans is good, 75% of home buyers don’t, won’t or can’t listen to him. I know that had I taken his advice, (had I known when I bought my first house) I’d probably still be saving for a home. I would have missed out on the appreciation gains earned and I’d still be deeply in debt. In the instance of debt and mortgages there truly is more than one way to “skin that cat.”
When shopping for a mortgage take all these factors into consideration. Don’t get stuck with a mortgage that doesn’t fit you or your goals because you’ve heard everyone should only have one type.