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Financing Luxury - Post Financial Crisis

With this month’s issue of Hilton Head Monthly being focused on luxury, I thought it might be interesting to investigate how the “average Joe” or “average Josephine” on Hilton Head Island might afford luxury even if they were a tad short of cash!

 Don’t you remember only a few short years ago when, based on the steep run up in home prices, we were all rich and the sky was the limit? Cash wasn’t a problem because we could just tap our “ever increasing” home equity to pay for that Mercedes Benz, fancy vacation or country club dues.

This is not so true today as home equity has gone the way of the buggy whip and banks are increasingly looking for customers who intend to repay their loans.

So what to do? Is it remotely possible that consumers will return to bygone days of paying cash for all those luxury items that advertisers continue to put in front of us? The American consumer has fallen in love with credit and leverage, so I suspect lenders will find a way to facilitate another round of increased levels of consumer debt.

We all know that luxury begins at home with a home. I just heard this morning that there is an $85 million “spec home” on the market in Beverly Hills, Calif., with lots of lookers and two offers in the first week on the market. While Hilton Head Island certainly isn’t Beverly Hills, we do have a nice oceanfront home in Sea Pines currently on the market for $14 million. All told there are 294 properties in the Hilton Head Island/Bluffton market that are offered for $1 million or more.

So one asks how are potential buyers coming up with the cash to buy these properties?  For buyers in the $4 million and over category it is fairly common for these transactions to be all cash but, what to do if you need to finance a part of the transaction?

This is actually one of the best times in my memory for potential home purchasers to be looking for “jumbo” loans. A “jumbo” mortgage is a loan that is in excess of the conforming loan limit of $417, 000. What conforming means is that the loan would be eligible for purchase by Fannie Mae or Freddie Mac and as such guaranteed by the United States Treasury. 

Traditionally, “conforming” loan amounts are considerably lower than “non-conforming” or jumbo loans. Today a 30-year fixed rate jumbo mortgage carries an average rate of 4.29 percent, which compares very favorably with a 30-year conforming loan at 4.27 percent.   

“Jumbo” mortgage borrowers are today’s beneficiary of low demand for mortgages and the banking industries desire to lend money in the residential mortgage space. Even more attractive rates are available if you are willing to consider a 15-year fixed rate, priced at 3.45 percent on average.

Of course there is much more to a mortgage transaction today than just knowing the rate.  You may even recall that earlier this month former Federal Reserve Chairman Ben Bernanke revealed in a speech that he was turned down for a mortgage earlier this year.  

When applying for a jumbo mortgage, you can expect a number of things that are different from a conforming loan. 

First, you will be required to make a larger down payment. Based upon the size of the loan, the required equity will be between 20 to 35 percnet of the lower of the purchase price or appraised value. 

Second, it is likely that the lender will require two appraisals of the property and, you guessed correctly, they will use the lower of the two in calculating the lendable loan-to-value. 

Third, it is typical in jumbo lending that the borrower must demonstrate that they have “liquid assets” in an amount to cover at least six months of loan payments. Remember the loan payment will be calculated by including interest, principal amortization, taxes and insurance.  

In both Hilton Head and Bluffton you will be required to purchase standard property and casualty coverage as well as flood insurance. Most other underwriting requirements are consistent with conforming standard and include a calculation of debt-to-income, review of your credit score and documentation of employment and income.

Today is a fantastic time to buy one of the many luxury homes on the market in the Hilton Head Island market. Supply is good, homes are attractively priced, mortgage rates are at historic lows and as our economy continues to improve, the likelihood is that these luxury “bargains” will be a distant memory.

Elihu Spencer is a local amateur economist with a long business history in global finance.  His life work has been centered on understanding credit cycles and their impact on local economies. The information contained in this article has been obtained from sources considered reliable but the accuracy cannot be guaranteed.