Talk to clients about mortgage risks

The situation

Your clients have been approved for a mortgage. Everything looks good on paper, but you’re not sure they’re ready.

One spouse works in a volatile industry, making his employment situation precarious. The other has confided the couple doesn’t have an emergency fund.

Plus, interest rates have nowhere to go but up. A home is a big responsibility, so investigate their motivations, especially if this purchase plan has come up out of the blue.

To broach the subject, try posing these questions:

ASK How does buying this house fit into your long-term goals?

NOT Are you sure you know what you’re doing?

ASK So we’re all clear, can you tell me how rising interest rates will affect your payments?

5 possible discussions:

• Discuss emergency funds and contingency plans. Emergency funds should cover between three and six months of living expenses.

• Ask them to tie up other debts before adding a mortgage to their load. Provide a timeline based on their current situation and ask if it’s realistic. They may only have to delay a year or two.

• Ask how stretched they feel from a budget standpoint. Can they pay their credit-card and utility bills in full, or are they only paying minimum balances?

• If they’re looking at an income property, ask how long can they go without collecting rent.

• Ask what their long-term goals are for the property.

NOT Have you looked into all your mortgage options?

ASK What is your contingency plan in case your job changes?

NOT Do you really want to retire with that size of mortgage?

ASK How has buying property worked for you in the past?

NOT Do you think real estate is the best investment for you?

Especially for first-timers, you’ll need to explain the financial implications of large repairs or (should push come to shove) unloading the house when the market is down.

Short-term expenses like a new roof or a foundation repair may necessitate shifting cash flow away from a retirement fund, and you may have to switch their risk profiles from speculative to low. If that’s the case, make sure you update their KYC information accordingly.

It also helps to explain the numbers. A $400,000 30-year mortgage at 3.25% on a five-year fixed term has monthly payments of $1,736.

If the interest rate is 2% higher when renewal occurs, your clients’ outstanding balance will be $357,089 and their monthly mortgage payments will jump to $2,128.

That’s a difference of almost $400. Ask: Can they stomach that increase?

Did you know?

• The usual maximum mortgage loan is 44% of gross income.

Clients can offset the risk of interest-rate hikes by increasing their monthly payments, making biweekly accelerated payments, and making lump-sum payments. But they’ll have to find the cash to do so.

Finally, present worst-case scenarios, like job loss for one or both spouses, or an unexpected, costly illness. Tell stories of others who’ve experienced unexpected setbacks, and explain what they had to give up to keep their houses.

Their reaction helps you find out before the big purchase if clients are prepared to sacrifice to keep up with their mortgage payments. If they’re not, they may decide—or you’ll have to tell them—the purchase isn’t realistic.