Asset Based Mortgages: A Flexible Home Financing Option

Buying a home is one of the most important financial decisions that many people make in their lives. However, securing a mortgage can be challenging, especially for those who do not have a steady or sufficient income. In such cases, asset based mortgages can be a viable alternative to traditional income-based loans.

Asset based mortgages are loans that use the borrower’s assets, such as savings, investments, or retirement accounts, to supplement or replace their income for loan approval. They are also known as asset depletion loans, because the lender assumes that the borrower will deplete their assets over time to make the mortgage payments.

Asset based mortgages are different from asset based lending (ABL), which is a type of business financing that uses the company’s assets, such as inventory, accounts receivable, or equipment, as collateral for the loan. ABL is not applicable to consumer mortgages, as the assets used are not liquid or easily convertible to cash.

In this article, we will explore the nature, workings, benefits, and considerations of asset based mortgages, and how they can be a flexible home financing option for certain borrowers.

Demystifying Asset Based Mortgages

An asset based mortgage is a loan that uses the borrower’s assets, rather than their income, to qualify for the loan amount and interest rate. The lender evaluates the borrower’s assets and calculates how much monthly income they can generate from them, using a formula that factors in the asset type, value, liquidity, and depletion rate.

The lender then adds this income to the borrower’s actual income, if any, and determines the borrower’s debt-to-income (DTI) ratio, which is the percentage of their monthly income that goes towards paying their debts. The lower the DTI ratio, the higher the chances of getting approved for the loan.

Asset based mortgages are ideal for borrowers who have substantial assets, but low or irregular income, such as retirees, self-employed professionals, freelancers, investors, or business owners. They can use their assets to boost their income and qualify for a larger loan amount or a lower interest rate than they would otherwise get with a traditional income-based loan.

For example, suppose a borrower has $1 million in a retirement account, but only $3,000 in monthly income from a part-time job. A traditional lender may not approve them for a mortgage, as their DTI ratio would be too high. However, an asset based lender may consider their retirement account as an additional source of income, and estimate how much they can withdraw from it every month to pay the mortgage. Assuming a 4% annual withdrawal rate, the borrower can generate $40,000 per year, or $3,333 per month, from their retirement account. This increases their total monthly income to $6,333, and lowers their DTI ratio, making them more eligible for the loan.

How Do Asset Based Mortgages Work?

Asset-based mortgages offer a tailored approach to home financing, where your assets, rather than your regular income, serve as the basis for loan approval. Here’s a streamlined overview of how they function:

Application and Verification: Applicants seeking an asset-based mortgage must approach a lender that provides this financing option, submitting details about their income, assets, credit score, and intended property purchase. The lender then verifies the provided information, assessing the value and liquidity of each asset with the help of documents such as statements and appraisals.
Asset Valuation and Income Calculation: The lender evaluates the borrower's assets, applying a formula that accounts for the asset's value, expected rate of return, depletion rate, and the loan's term. This formula may also factor in a discount rate to account for market volatility, taxes, or fees, aiding in the calculation of the monthly income the assets can generate. Lenders typically permit borrowers to leverage up to 70% of the value of retirement and investment accounts, and 100% of liquid assets. The monthly income from assets is determined by dividing the total eligible assets by 240, a method applied regardless of the loan term. For an in-depth explanation on calculating your total assets, consider our comprehensive guide available here.
Loan Approval Process: The lender combines this asset-derived income with the borrower's actual income to calculate the debt-to-income (DTI) ratio. This ratio is a critical determinant in the loan approval decision, alongside the borrower's credit score and other financial parameters.
Loan Agreement and Payment: Upon loan approval, the borrower signs the agreement, receives the funding to proceed with the property purchase, and begins making monthly mortgage payments. Borrowers maintain control and ownership of their assets, provided they do not default on the loan.
Types of Eligible Assets: Asset-based mortgages can be secured using various asset types, including:

Retirement Accounts (401(k), IRA, Roth IRA): These accounts must be accessible without penalty, typically post-59.5 years, with tax implications considered in the asset income calculation.
Investment Accounts (stocks, bonds, mutual funds, ETFs): The lender assesses these securities for performance and liquidity, possibly requiring liquidation to ensure payment funds.
Liquid Assets (cash, savings, checking, money market accounts): These are considered highly stable and may require a reserve equivalent to six months of mortgage payments.
Other assets, such as annuities, life insurance policies, trust funds, or inheritance: These are assets that may provide a regular or lump sum income to the borrower, depending on the terms and conditions of the asset.

Asset Based Income Calculation - An Example

For a borrower with $500,000 in an investment account expecting a 6% annual return and facing a 20% discount factor on a 30-year mortgage, the asset income calculation would be:

Asset Income = 500,000 × 0.06 × (1−0.2) / 12 = 24,000 / 12 = $2000/month

Thus, the borrower could add $2000 per month from their investment account to their actual income for loan qualification purposes.

Alternatively, as a practical guideline, when applying the rule of dividing total eligible assets by 240 for a quick calculation, $1 million in assets would yield an estimated monthly income of approximately $4,167 from those assets, streamlining the loan qualification process.

When Does an Asset Based Mortgage Make Sense?

An asset based mortgage can make sense for borrowers who have one or more of the following characteristics:

They have a large amount of assets, but a low or irregular income: This can include retirees, who live off their savings or pensions, self-employed professionals, who have variable or seasonal income, freelancers, who work on project-based contracts, investors, who rely on dividends or capital gains, or business owners, who reinvest most of their profits into their business.
They have a high net worth, but a low credit score: This can happen due to various reasons, such as identity theft, bankruptcy, foreclosure, divorce, or medical bills. A traditional lender may reject their loan application, based on their credit history, regardless of their wealth. An asset based lender may overlook their credit score, and focus on their assets, as a more reliable indicator of their repayment ability.
They want to buy a second home, but do not have enough income to qualify for another mortgage: This can include vacation home buyers, who want to enjoy a getaway property, or investment property buyers, who want to generate rental income. A traditional lender may consider their existing mortgage as a liability, and reduce their borrowing capacity. An asset based lender may consider their assets as an income source, and increase their borrowing capacity.

An asset based loan can offer flexibility and potential benefits for these borrowers, such as:

They can qualify for a larger loan amount or a lower interest rate than they would with a traditional income-based loan. This can help them buy a more expensive or desirable property, or save money on interest payments over time.
They can avoid selling their assets or paying taxes on their gains, and instead use them as collateral for the loan. This can help them preserve their wealth and enjoy the benefits of their assets, such as growth, income, or tax advantages.
They can choose from a variety of loan terms and options, such as fixed or adjustable rates, interest-only or amortizing payments, or conventional or jumbo loans. This can help them customize their loan to suit their needs and preferences.

Benefits of Asset Based Mortgages

Asset based mortgages can offer several benefits to borrowers who have substantial assets, but low or irregular income. Some of the primary benefits are:

No regular income requirement: Unlike traditional income-based loans, asset based mortgages do not require the borrower to have a regular or sufficient income from employment or other sources. The borrower can use their assets to qualify for the loan, regardless of their income level or stability.
Potential for higher loan qualification: Asset based mortgages can allow the borrower to qualify for a larger loan amount than they would with a traditional income-based loan. This is because the lender considers the borrower’s assets as an additional source of income, and adds them to their actual income, for the loan qualification. This can help the borrower buy a more expensive or desirable property, or access more equity from their existing property.
Applicability for second homes: Asset based mortgages can be used to buy a second home, such as a vacation home or an investment property, which may not be possible with a traditional income-based loan. This is because the lender does not consider the borrower’s existing mortgage as a liability, but rather as an asset, for the loan qualification. This can help the borrower diversify their portfolio, enjoy a getaway property, or generate rental income.

Downsides of Asset Based Mortgages

Asset based mortgages can also have some drawbacks, which the borrower should be aware of before applying for the loan. Some of the potential downsides are:

Higher interest rates: Asset-based mortgages often feature higher interest rates than traditional loans, reflecting the lender's risk assessment of borrowers with unconventional income patterns. This risk, compounded by market fluctuations and the administrative costs of managing such loans, can lead to increased monthly payments and a higher total loan cost over time. With mortgage rates anticipated to oscillate between 6% and 7% for much of 2024, borrowers considering asset-based financing must be acutely aware of these projections and their potential financial implications. For strategies on managing higher interest rates, a guide offering practical advice is available here, providing borrowers with essential tools to navigate these challenges effectively.
Credit requirements: Asset based mortgages may have stricter credit requirements than traditional income-based loans, as the lender may want to ensure the borrower’s creditworthiness and repayment ability. The lender may require the borrower to have a minimum credit score, such as 680 or above, to qualify for the loan. The lender may also check the borrower’s credit history, and look for any red flags, such as late payments, defaults, or bankruptcies.
Extensive documentation: Asset based mortgages may require more documentation than traditional income-based loans, as the lender may want to verify the borrower’s assets and their value, liquidity, and depletion rate. The lender may ask the borrower to provide statements, appraisals, or other documents to prove their ownership and worth of the assets. The lender may also require the borrower to update their asset information periodically, to reflect any changes in their asset value or income.

Accessing an Asset Based Mortgage

Navigating the process of securing an asset-based mortgage requires a strategic approach, taking into account various lenders' criteria and market conditions. Here’s an integrated pathway, combining general steps with specific qualification criteria and lender options:

Assessment and Decision-Making: Begin by evaluating your financial status and the assets at your disposal. It’s crucial to determine if an asset-based mortgage aligns with your financial objectives. Compare this option against conventional mortgages and government-backed loans (FHA, VA, USDA) to decide which suits your needs best.
Lender Comparison and Selection: Shop around to compare terms offered by different lenders specializing in asset-based mortgages. Assess their reputation, customer feedback, and regulatory compliance to ensure a trustworthy partnership. Keep in mind that lenders vary significantly, from portfolio lenders, which may offer more flexible terms due to holding loans in their own portfolios, to private banks and standard lenders like Freddie Mac and Fannie Mae, each with unique requirements and benefits.
Application and Documentation: Prepare to submit a comprehensive loan application, including all necessary documentation to demonstrate asset value and meet lender-specific criteria. Be prepared for additional inquiries as lenders assess eligibility beyond asset valuation, considering factors such as a down payment (typically 25%-30%), a credit score (minimum of 700 recommended), and a debt-to-income ratio (preferably under 50%).
Loan Processing and Approval: Await the lender’s decision, which might span several weeks based on the loan's complexity and the lender's review process. Upon receiving a loan offer, meticulously review the terms and closing costs. Don’t hesitate to seek clarifications or negotiate terms if necessary.
Finalization and Funding: Once the loan is approved and the closing formalities are complete, sign the loan agreement to access the funds for your property purchase. Commit to timely mortgage payments, drawing from both income and assets, and regularly monitor your asset valuation and loan balance to maintain financial health.

Types of Lenders for Asset-Based Mortgages

Portfolio Lenders: These lenders offer potentially more adaptable terms by keeping loans within their own portfolios. However, terms can vary widely, so engaging with several lenders is advisable.
Private Banks: Offering asset-based mortgages often contingent upon substantial deposits or maintaining a financial advisory relationship, private banks cater to clients seeking an all-encompassing banking solution.
Standard Lenders: Institutions like Freddie Mac and Fannie Mae set specific asset-based mortgage guidelines. Familiarizing yourself with and adhering to these standards is crucial for applicants choosing this route.

Monitoring and Managing Your Total Asset Value with Kubera

One of the key factors that can affect the borrower’s eligibility and affordability for an asset based mortgage is their total asset value. The borrower should track and manage their asset value, and ensure that it is sufficient and stable to support their loan payments and financial goals.

One of the tools that can help the borrower with this task is Kubera, a portfolio tracker that allows the borrower to monitor and manage their assets, liabilities, and net worth.

Kubera can help the borrower with the following features:

Kubera can connect to the borrower’s bank accounts, investment accounts, retirement accounts, and other assets, and automatically update their values and balances. Kubera can also support manual entries for assets that are not connected, such as real estate, art, jewelry, or collectibles.
Kubera can provide the borrower with a comprehensive and customizable dashboard, where they can see their total portfolio value, asset allocation, and asset performance. Kubera can also show the borrower their liabilities, such as mortgages, loans, or credit cards, and their net worth, which is the difference between their assets and liabilities.
Kubera can help the borrower prepare for an asset based mortgage application, and future mortgage payments by planning ahead for future financial scenarios using the Fast Forward feature which can help them make better and more informed financial decisions.

Kubera is a powerful and user-friendly tool that can help the borrower manage their total asset value, and make the most of their asset based mortgage. Kubera can also help the borrower with other aspects of their financial life, such as financial planning, beneficiary management, and portfolio diversification.

See how easy it is to set up Kubera to track, grow, and share your asset value when applying for an asset based mortgage.

Conclusion

Asset-based mortgages offer a unique financing pathway for those with significant assets but inconsistent income, enabling the use of retirement accounts, investments, or liquid assets for loan approval. This option is especially beneficial for those lacking regular income, aiming for higher loan amounts, or considering second homes, despite potential drawbacks like higher interest rates and stringent credit and documentation requirements.

Before proceeding, it's crucial for borrowers to evaluate their financial standing, explore various loan alternatives, and meticulously compare lenders to secure the best terms.

Effective asset management is essential to sustain loan commitments and achieve financial objectives. Tools like Kubera can assist in overseeing assets and liabilities, ensuring a well-informed decision-making process. Asset-based mortgages can serve as a strategic choice for qualified borrowers, facilitating homeownership or investment opportunities while underscoring the importance of a thorough understanding of its advantages and limitations.