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Choosing Your Ideal Mortgage Loan Program
Sep. 24th, 2009
YUMA, AZ – Contrary to popular belief, there are no good or bad loan programs, however there are correct and incorrect loan programs depending on a borrower’s personal, financial, and credit situation.
Choosing the most beneficial loan program requires careful planning and product education.
Before deciding on one of the literally thousands of loan programs, one should have a general understanding of the possibilities. Loan programs can range from the traditional 30 year fixed rate mortgages to monthly adjustable rate mortgages with negative amortization and anywhere in between. Before deciding which loan program is correct, one should take time with a true mortgage professional to discuss not only the loan options, but also the financial goals for the borrowers as well as the life events that may take place in the future.
There are three basic types of mortgages: Fixed Rate Mortgages, ARMs, and Hybrid ARMs.
Fixed Rate Mortgages: As the name indicates, the interest rate, and thus the payments are fixed over the life of the loan.
ARMs: Adjustable Rate Mortgage’s are mortgages in which the interest rates fluctuate based upon two components, a base index (of which there are many) and a margin which is determined by the lender/underwriter based on credit, income, documentation style, and loan program. These base indexes have names such as:
MTA—or Monthly Treasure Average
LIBOR—London Inter Bank Offering Rate
COFI—11th District Cost of Funds Index
COSI—Cost of Savings Index
The fully indexed rate is then based on adding your margin and index together. If your fixed margin is 3% as determined by your lender and program and at the time of an adjustment the varying index is 4%, then your interest rate is 7%. All of these indexes can be found printed in the Wall Street Journal or online at www.mortgage-x.com.
Hybrid ARMs: Are Adjustable Rate Mortgages which have a fixed term during the initial period of the loan. The fixed period can be anywhere from 6-months to 10 years. After the initial fixed period, the loan then becomes an adjustable either annually or bi-annually depending on the index chosen and the loan program.
CAP Rate: This is the maximum an adjustable mortgage can increase. Most ARMs have a designated set of numbers in the loan product such as 2/5. If a borrower selects a 5-Year ARM with CAPS of 2/5, the consumer would then have a loan fixed for the first five years. At the end of the first five years the 2 of the 2/5 means the loan then adjusts a maximum of two (2) percent in any given adjustment period which is most often annually. Finally, the 5 of the 2/5 means the maximum adjustment total for the loan is 5%. So for those borrowers who took a rate of 6% initially, in year six the rate could be 8%, in year seven the rate could be up to 10%, and in year eight, the rate could top out at 11% which is equal to 5% above the initial note rate.
Added to the three basic types of mortgages are the many “features” or add-on’s, such as (but not limited to) interest only, negative amortization, and balloons.
Interest Only: As the name sounds, the borrower is paying only the interest due, and will not reduce the loan amount until such time as additional principal payments are made or the interest only portion of the loan is over and the lender begins to collect the fully amortized payment which would then include principal payments.
Negative Amortization: Negative amortization loans are some of the most misunderstood loans available in the market place. The negative stigma (no pun intended) comes from a lack of education to the consumer by mortgage professionals. The only way to get into trouble with a negatively amortized loan is if one truly does not understand how the loan program works, or lacks the financial discipline to make sure as to not fall into a compromising position. In a regularly amortized mortgage payment, part of the payment goes toward a portion of the principal and part goes toward interest payment. In a loan that involves the potential for negative amortization, you have several payment options each month. You can make a low introductory rate payment which will be LESS than the interest due, an interest only payment, or a fully amortized payment. This type of loan works very well for borrowers with a seasonal income, or income that fluctuates. Certified Public Accountants, investment advisors, and sales people who work on a commission basis often go with this type of a loan because it allows them to have greater control over their cash flow on a month−to−month basis. Once again, each and every month you must choose between three payment options. Negatively amortized loans typically adjust on a monthly basis, which means that every single month the lender takes the fixed margin and adds it to the varying index to derive the current interest rate. Should the borrower decide to make the introductory payment options, the borrower will then defer the balance of the interest due to the loan amount. In practice, one will owe more each and every month than they originally borrowed unless they make at least the interest only payment and not the “advertised payment.”
In today’s market place the average consumer is inundated with marketing efforts claiming to offer what seems to be hundreds of thousands of dollars in a purchase price for mere hundreds of dollars per month. Those radio/TV/print commercials are offering a Negative Amortization product or NegAm. Today’s borrower should ask themselves, how can they offer a payment for little more than a $36,000 car payment? This is why dealing with a mortgage professional that works as a trusted advisor is so important.
Balloons: These are loans that are generally amortized like a 30 year fixed mortgage, but have a “balance due” clause after a specific period of time. That period is generally five, seven, or ten years.
In general, the longer the fixed portion of the loan, the higher the interest rate will be. The sooner the balanced comes due or the sooner the adjustment period starts, the lower the interest rate will be.
Unlike previous generations, today’s current generations are much less likely to purchase a home, payoff that home with the original loan, and retire in that home when it is free and clear. Today’s consumers don’t generally keep their loan until payoff for many reasons including: refinancing to consolidate debt, refinancing to removing mortgage insurance, cashing out profits, upgrading to a larger home, downgrading to smaller homes, and a whole host of other reasons. FannieMae reports the average home owner now owns his/her home 7 years. First time home buyers own their home on average less than 5 years. These figures are important because they clue the borrower in to look long term at their family plans and goals.
One solution to the myriad of choices and products is a special tiered−rate mortgage program. This special program has no margin and no index associated with it at all. Let's examine a loan scenario where the prevailing interest rate is 6.75% on a 30−year fixed. For the first year of the loan, the borrower would pay a rate of 4.75%, which is 2 full percentage points below the current prevailing rate. This enables the borrower to save money and address monthly cash flow needs. The second year of the mortgage, the borrower would pay a rate of 5.75%, which is 1 full percentage point below the prevailing rate, enabling even greater savings. From years 3 to 30, the loan will cap out at a rate of 6.75%, which is much lower than the current cap rate for the adjustable rate mortgages (ARMs). This helps to create stability and frees the borrower from having to wait for an unpredictable turn in market conditions before refinancing.
It is of utmost importance to work with an experienced loan consultant that understands some of the practical aspects of financial planning as well as one who will take the time to get to know the ultimate goals of the borrower. A well versed consultant will ask many questions about short and long-term goals, and assist in choosing a loan program truly suited to your needs.
Derek Egeberg is affiliated with Nova Home Loans, a Licensed Broker #0902429. For a free copy of our “Home Buyers Handbook” send an email to dereke@novahomeloans.com and an electronic copy will be emailed to you. For a FREE printed copy stop by the Nova Home Loans office located at 1730 S. 4th Ave Suite B.
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