Liquidity · February 22, 2024

Mortgage Insights For Entrepreneurs

Your acceptance of risk as an entrepreneur makes your personal balance sheet profile greatly different from most professions. For starters, you have a non W-2 earning lifecycle where cash flows and earnings vary greatly.

Also, things like financing a home warrant a mortgage lending discussion with a distinct understanding of atypical finances. That's why it may be beneficial to have a private banker familiar with venture financing, private equity and business planning who can help make home financing a simpler, smoother process.


A holistic financial review

With the help of a trusted private banker, you can navigate home financing decisions, optimize interest rates, maximize purchasing power, strategize on expenses and highlight expected liquidity events. The goal is to explore home financing in a way that supports your immediate needs while being mindful of long-term projections.

Together, you'll review how stock options, bonuses, consulting income, fund distributions and other variable income sources are considered through the lens of qualifying income. In a scenario where income is considerably strong compared to debt, the post-close liquidity requirement is less of a concern for approval. The opposite is true when cash flow is tight because more reserves are required to mitigate the risk of income loss.

With much of your worth tied up in private assets, you're in a unique position. In addition to rarely understanding the entrepreneurial life cycle, non-portfolio or retail lenders often run into roadblocks once they learn that a borrower owns less than 25% of a company. These same lenders often sell the mortgage to third-party institutions and may or may not service the ongoing payments themselves, which adds another layer of scrutiny.

The right loan structure

A traditional 30-year fixed rate mortgage is often the only option from mortgage lenders because it's one of the most conservative loans available. This type of interest rate protection often has a tradeoff in the form of a higher rate or pre-payment penalties.

When you're comfortable self-insuring against interest rate exposure due to a plan to rebalance debt and assets in the coming years, paying a rate premium for a longer-term fixed rate may not be ideal. This is especially true for first-time homebuyers, those expecting future liquidity events or those planning to sell a property in less than 10 years.

While it's still a 30-year loan term, a 5/1, 7/1 or 10/1 adjustable-rate mortgage, or ARM, may be a better solutionD. Most entrepreneurs prefer an ARM because of its lower initial rates and monthly payments, rate adjustment maximums and interest-only payment options. After the initial fixed-rate period, the interest rate adjusts annually to a specified index plus margin.

However, these rate adjustments are capped, which can offer you some protection. Typically, there's a 2% maximum rate increase per year and a lifetime rate cap of 6% above the initial fixed rate.

ARMs can be structured with a set amortization schedule consisting of principal and interest payments for the full 30 years or with interest-only payments, typically for the first 10 years of the loan. Fully amortized structures can help maximize your purchasing power through lower down payment requirements and a longer amortization schedule, while interest-only structures will offer lower initial monthly payments and greater flexibility with cash flow planning for principal reduction.

A personal financial statement deep dive

In partnership with a private banker, you can not only more easily navigate the pre-approval process but also have the ins and outs of your personal financial statement, or PFS, documented to prepare you for negotiating. With a documented PFS, you can demonstrate your preparedness and focus on negotiating the purchase terms rather than on your ability to obtain financing. It can also help give both you and the seller confidence when you decide to forego a finance contingency in your offer. Through the underwriting analysis, you and your private banker will learn whether you have additional borrowing capacity or if you need to reevaluate your maximum purchase price.

If you have a meaningful equity position in your existing home or are expecting a windfall of liquidity, you may be able to strengthen your negotiations by offering on all-cash purchase by leveraging a short-term bridge loan or securities-based line of credit. Discuss these tailored strategies with your private banker—it just might give you the differentiation you need to win a bidding war when purchasing your next home.

Refinances and HELOCs

Many factors play a role in deciding how much and when the timing is right for you to refinance. Refinancing for an attractive rate or new term, pulling cash out through a new mortgage or layering in a home equity line of credit, or HELOC, can be advantageous in any rate environment. It also might be a good way to finance a home remodel or provide additional capital for investment fund commitments.

A HELOC is unique because you'll only pay interest due on the principal balance of the loan amount. If you layer in a HELOC while refinancing your mortgage, you can potentially save on additional closing costs—including appraisals and title fees.

Just be sure to review the current rate against prevailing rates, consider whether to consolidate short-term debt into a lower rate and evaluate expected changes in cash flow and interest deductibility.

Other considerations

Tax implicationsD are a key consideration when obtaining a new loan. It's important to review interest tax deductions available to you with a tax professional, whether you're buying a new home or refinancing an existing mortgage.

Asset protection through estate planning is another important discussion during any real estate financing exercise. Planning experts recommend vesting title to your home in the name of your family trust. If you don't have a trust established in time for the closing, you can still transfer the title into the name of your trust post-acquisition. Work with a trusted estate planning attorney as you consider your options.

As part of holistic planning, also be sure to discuss other life events that can impact your decision. This can include starting a family, having a spouse re-enter the workforce or working for a stealth startup with fluctuating cash flow.

Subject to credit approval.

Consult your tax advisor regarding the deductibility of interest.

For example: An amount financed of $200,000 with a 7/1 ARM with a 15-year amortization and an initial rate of {product.MSM.DISC_INIT_PF_RT} fixed for 7 years with the possibility of adjusting annually after the initial fixed period would have an APR of {product.MSM.Promo_APR_RT}. The borrower would make 84 monthly payments of {product.MSM.DISC_PMT_RANGE1_DL} followed by 96 payments of {product.MSM.DISC_PMT_RANGE2_DL} based on the index on {product.MSM.DISC_APR_DT}, plus a margin and pay total interest of {product.MSM.DISC_TTL_INT_DL}. After the 7-year introductory period, the APR could adjust annually, is variable and is based upon an index plus a margin. That change can increase or decrease your monthly payment.

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