We often have clients who come to us looking for their first home, very proud that they’ve “never had an ounce of debt” in their “entire life.”
No credit cards, no car loan, not a dollar financed – ever.
These poor people are then shocked to find out that they can’t finance their first home – because they either have no credit scores or too low of a credit score.
Yes, they can get alternative financing with a large down payment, but the best financing options always require good credit scores.
Isn’t Debt A Bad Thing?
As a mortgage lender, we will admit the immediate bias we have when answering this question.
We are, however, happy to make the case that taking on debt in a responsible manner can be one of the strongest and most underappreciated financial tools available.
Leverage
The power of leverage, for example, enables clients to finance purchases with fewer out of pocket dollars, and thus save their remaining cash for other purchases or investments.
Real estate investing is a great example of healthy leverage, as investors can use minimum down payments and financing to purchase multiple properties instead of just one or two if they paid cash.
Cash On Cash Returns
Leverage also greatly augments “cash on cash” returns.
For example, if an investor buys a $500,000 house with $75,000 down, and that house appreciates 10%, she will earn 67% on her cash investment/down payment (I am assuming her rent covers her housing payment).
If she instead pays $500,000 of cash for that home and it appreciates 10% over the course of the year while she is netting $3,000 in rent, her cash on cash return will only be 17%.
Credit Cards, Installment Debt & Credit Scores
This is of course where debt can be a “bad thing.” And, we see borrowers all the time who are so mired in credit card and installment debt, like auto loans, that they are unable to save for down payments and/or qualify for the mortgage they want.
BUT – used wisely, credit card debt can also be a financial godsend!
As we all know, savvy credit card users can leverage their credit card debt to reap some amazing perks (such as hotel and airline points) – BUT, MORE IMPORTANTLY those credit card accounts are also the ticket to sky-high credit scores!
The key of course is to keep the balances paid off or under 30% of the limits.
And, as I mention often in my blog, credit scores can impact mortgage rates by as much 1%!
The Best Jumbo Rates Require “Tradelines”
The best jumbo loans require a specific number of “tradelines.”
Tradelines are any type of credit account, such as a student loan, auto loan, credit card, or personal loan.
Most jumbo investors (that buy our loans) require at least 1 tradeline, but our investor with the lowest rates requires 3 total tradelines per borrower, a 24 month total history, and 1 tradeline that is currently open and active.
Unfortunately, we have many perfectly qualified borrowers with excellent credit scores who are unable to qualify for our best jumbo rates – simply because they do not have enough tradelines.
The difference in rate for a borrower with 2 tradelines vs a borrower with 3 can be as much as 1%.
Inflation & Debt
Last but not least is the beauty of fixed-rate debt in an inflationary world.
Many debtors have become very wealthy because they were able to pay off debts, with much less valuable currency, in an inflationary environment.
I illuminated an extreme example of this in a November blog: The Richest Man In Germany Got Rich From Inflation.
Summary
Properly managed debt can be a very good thing for: (1) Leverage; (2) Credit Scores; (3) Trade Accounts; and (4) Inflation Hedging.
Jay Voorhees
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167
