Monday, August 28, 2006

Interest Only With A Bit Of Security

There's been much ado about interest only mortgages, payment option adjustable rate mortgages (ARM) and other mortgages considered risky by some. The fear is that once these mortgage payments adjust the homeowner will immediately go into foreclosure and their families will be living on the street. At least that's what I'm hearing.

The example Ms. Clinton used on the Senate floor to argue in favor of legislation to curb the "predetory" practices of mortgage brokers was a West Virginia waitress with a 6th grade education. This woman lost her husband and began a series of refinancings that ended in her losing her home because she couldn't make her house payment. It's a terrible thing. But is a person with a 6th grade education who repeatedly pulls the equity from her home to spend recklessly truly indicative of the American populace? Is she the typical consumer? Or is this one of a few isolated cases?

I don't have any problem with the legislation that was passed, or any that I've read is coming. The more the consumer knows the better. That's the reason I've joined the blogging fray. To give information on mortgages and the process of borrowing money against one's home. I'm just asking if this is another example of a alarmist call to pass laws too hurriedly to address the real issues?

There is a place in the market for all the mortgage products available. Some people here in New York live mostly on their end of the year bonus. That bonus is often more than 75% of their yearly income. That means that throughout the year, these high net worth individuals are getting a much smaller paycheck each month. Add that to the fact that they are savvy investors who know where they want to put their money. So sometimes these individuals will prefer a payment option ARM, perhaps even with a negative amortization feature that allows them to pay a smaller monthly payment throughout the year (especially in the last couple of months before bonus time) and then when their bonus comes, they will make a principal payment that erases all the negative amortization they have built up and creates an equity build up instead.

Is every mortgage for every consumer? No, absolutely not. That's why there is a vast array of mortgage options. Yes they can be complicated. People don't deal with mortgages everyday. That's why mortgage brokers and loan officers exist. We have to step up and learn the products and their implications in the lives of homebuyers. One question that a mortgage professional should always asked is "How long do you intend to stay in the property?"

Americans are on the move, upwardly mobile is our credo. We don't stay in a home for long (I think the average is somewhere between 4 and 7 years), that's the fact, so it may be more expensive for a homeowner to finance a home purchase with the standard 30 year fixed rate mortgage than a 7 year hybrid ARM (rate is fixed for 7 years then adjustable, frequently the initial fixed rate is a lower rate than longer fixed term mortgages like the 30 year fixed rate). But if when working with a client the mortgage professional is given the sense that for peace of mind, the homeowner needs a fixed rate mortgage, then that's what should be quoted. Ultimately it's the homeowner's choice, it's their home, their security, all we can do is advise, inform and allow the homeowner to make their decisions after learning the alternatives.

So what's the title of this blog all about? Given today's somewhat flat yield curve, the 30 year fixed rate mortgage is a very similar rate to the 5/1 hybrid ARM (same explanation as the 7/1 above just that the initial rate is fixed for 5 years then adjusts - and by the way, the interest rates on these mortgage can go down as happened in 2000-2004 when everyone with an adjustable rate mortgage was a "real estate genius" because they were paying mortgages with a 1% interest rate).

By adding an interest only feature to the 30 year fixed rate mortgage, homeowners may be able to get it all. A lower payment for the first 10 or 15 years of the mortgage because it's interest only and the security of a fixed rate mortgage. Another strong feature of this mortgage option is that the payment will recalculate (or recast) when a principal payment is made. That means that when the homeowner gets their tax refund check, they can pay down their loan balance and the very next month see a reduction in their monthly mortgage payment.

Since the first few years of a mortgage are mostly interest anyway, this will result in a principal reduction on par with a fully amortizing mortgage in the end anyway. And no, I'm saying that all homeowners need to throw their whole tax refund at their mortgage to make a principal reduction. They can still buy some of those consumer items they had their eye on all year, just not all of them at once.

Again no single mortgage solution is right for every homeowner or homebuyer. We are all in different situations with our lives that impact our financial, personal and professional lives. A home is a big investment, but once you check out your Truth-in-Lending disclosure, you'll see that a mortgage is a bigger investment. Make sure you know your options, put some thought into where you are in your life, what your plans are and make an informed decision.

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