Affordable Non-Traditional Mortgage Products Returning - Interest Only Mortgages

Welcome back!  Before you read any further, I encourage you to read about Adjustable Mortgages here: http://homebuyingguru.blogspot.com/2013/09/affordable-non-traditional-mortgage.html Interest only loans often are adjustable loans so it is good to fully understand an adjustable mortgage before you go on to read about interest only options.  

I find that often, clients will confuse an interest only loan with what is called a "Negative Amortization" loan.  This was most commonly called the "Pay Option" loan or the "Pick-a-pay" loan.  With this loan you had four payment options, one that was a 15 year loan payment, a 30 year loan payment, an interest only payment and a "Minimum Payment."  The minimum payment in a pay option loan would actually increase your balance every month because you were actually paying less than the monthly interest.  For example, if your interest only payment was $1,000 and your minimum payment was $600, the bank isn't going to just hand you that extra $400 in interest for free. So, it gets tacked on to the balance of the loan.  A regular interest only loan DOES NOT DO THIS.  

Now that we clarified that, let me explain that what a typical interest only loan is.  Let's start with a standard fixed rate interest only loan.  Most people know what a 30 year fixed loan is, but let me explain to make sure.  Most home loans have either 15 or 30 year term.  That means if your loan is fixed for 30 years, you have the same rate the whole 30 years of the loan and typically the same payment.  However, a 30 year fixed interest only loan usually will not have the same payment for the life of the loan as the interest only feature is only offered for a maximum of 10 years.  

Let's look at some numbers to explain.  Take a $200,000 30 year fixed loan at 4.625%.  Traditionally the mortgage payment for this loan will be $1,028.28 for 360 months (30 years).  With the interest only option, if the rate is the same, you can pay as little as $770.83 per month for the first 10 years.  After that, it "Recasts" meaning whatever your balance is at that time determines what your payment is over the remaining 20 years.  So, if you don't refinance and you have made only the interest only payment during that period, you essentially have a 20 year fixed loan at that point at a rate of 4.625%.  That would mean your payment would be $1,278.83 for the remaining 240 months.  

The advantage of this option is that typically people will be making more money in ten years than they are currently.  So, they exchange the comfort ability of the lower payment now, for the higher payment later but still retain a fixed loan and pay their house off in 30 years.  However, people rarely keep a loan longer than 10 years.  Typically they move or refinance during that period so often I encourage the 10/1 ARM Interest Only loan as it will usually have a lower rate than the 30 year fixed.  There is also a 5/1 ARM Interest Only option as well as a 7/1 ARM Interest only option. (If this doesn't make sense to you, I encourage you to read the article I linked at the top of the page or contact me).  

The advantage of the 10/1 ARM Interest Only loan is that the rate adjusts at the same time you loose the interest only feature.  Typically this is when people will refinance anyway because many don't want to pay the 20 year payment even if the loan was fixed.  As explained in the previous article, it is possible that your payment may even drop with the adjustable mortgage as well.  

I hope this helps to clarify this loan option.  If you would like to know more, please contact me at 1-866-777-1865 or email me at shawnkrumpe@gmail.com.  You can check me out more at www.financehomestoday.com.  

Affordable Non-Traditional Mortgage Products Returning - The ARM

Between increasing interest rates and rising home costs, many of you are feeling like you are getting squeezed out of the home-buying market.  There are many non-traditional mortgage products available I will be explaining to you in detail in the next few articles to help you; explaining the positives and negatives of each so you can make an educated decision when you go to buy, or refinance your home.  

Today I will discuss a basic option for you; The Adjustable Mortgage.  Many people run scared when they hear this option.  If you are one of these people it is very important you read further.  I wont stand here and tell you this mortgage is for everyone, but many people I talk to only plan to stay in their first home for four to five years.  Even clients who are buying their second or third home often will move prior to their ten year mark.  I've even helped clients buy a second home less than two years after buying their first.  So let me ask you; if your home loan is $200,000 why would you pay an extra $116 per month to have your loan fixed for 30 years, when you plan on moving before your rate adjusts?  (Based on current rates and differences for a 5/1 ARM v. a 30 Year Fixed with similar loan costs)

However, many people tell me they aren't sure they are going to move in less than five years. I understand that life is full of surprises and it is hard to plan around all of them.  In these cases, perhaps you might look at an adjustable that is fixed for seven years, instead of five?  Or maybe 10 years?  The savings isn't as large but I very rarely run into a client that buys their first residence and occupies it longer than 10 years.  Usually, in that time-frame, there is some need or desire to upgrade. Another thing to consider is that in a normal real estate market, home prices typically rise about five percent per year.  This opens the door to refinancing.  Guess what, if you paid higher loan costs, or took that higher 30 year fixed rate so your mortgage was fixed for 30 years, and now you want cash out, and you refinance again, you are going to have to pay the higher loan cost all over again.  

Now, I'd like to look at what happens to an adjustable mortgage AFTER the fixed rate expires.  First lets look at conforming loans.  Let's say you got an adjustable mortgage that was fixed for five years in June of 2006.  At that time, this mortgage, called the 5/1 ARM was averaging about 6.22% and the 30 year fixed loan was around 6.68%.  So the payment on a $200,000 loan would have been $1,227.53 and the fixed loan would have a payment of $1,287.90.  So in 2006, it didn't save as much at first, but lets look what would happen if you still had that same loan. 

First, let me explain, these loans have three important characteristics when determining what the adjustment will be; the Index, the Margin, and any Caps.  The index most commonly called the Six Month LIBOR (London Inter Bank Offering Rate), is the base rate.  This is what adjusts monthly.  The margin is essentially the profit the bank makes on the loan, and on a typical adjustable mortgage is 2.25% but this does vary between banks and loan programs. (Subprime margins could get as high as 8-9% which is why adjustable mortgages have developed such a bad stigma)  To get your actual rate you would add the index to the margin.  So, if your loan adjusted five years after you got it in June of 2011, your rate would would have dropped to 2.65313% (2.25% + LIBOR which was 0.40313% at that time).  Then in June of 2012, it would have adjusted to 2.9864%, and in June 2013 to 2.66426%.  So currently, you would be paying $807.43 per month instead of $1,287.90.  Not bad, right?  

The final important component of an adjustable loan are the caps.  Usually you will see three numbers after the 5/1 ARM designation.  Most commonly on conventional loans, you will see 5/2/5.   The first number is the maximum amount the loan can change the first time it adjusts.  The second number is the maximum it can change each year after it adjusts the first time, and the third number is the maximum it can change in TOTAL.  So, if you rate started out at 6.22% like in our example.  The first time it changes the highest it could go to a maximum of 11.22%; the lowest it could go would be 1.22%.  After that first adjustment, it can only go up or down a maximum of 2% so even if rates skyrocket or plummet, it wont change more than 2% annually.  And the absolute highest it will ever go is 11.22%.  So you are thinking 11.22%! That is high!  Well I can tell you in the past 10 years, LIBOR has never been high enough to make your rate anymore than 7.8882% with that 2.25% margin we've been using.  Not bad, right?  In fact, the AVERAGE LIBOR rate over the past 10 years is only 2.2838% which would make your mortgage 4.5338% which is far lower than the average 30 year fixed loan over the past 10 years.

Hopefully this helps clarify some key points with Adjustable Mortgages. Please note, not all adjustable mortgages are associated with LIBOR.  For example, most FHA loans are tied to the Treasury note.  I would be happy to explain this in more detail with you if you like.  Please feel free to call me at 1-866-777-1865 or email me at shawnkrumpe@gmail.com or check me out at www.financehomestoday.com.