In past decades, many people have been trained to think that a 30-year fixed-rate mortgage is the only way to go when it comes to getting a mortgage. They look negatively on adjustable rate mortgages because they fear the adjustable part. But there are advantages to having an ARM and times where a long-term fixed-rate mortgage doesn’t really make as much sense.
Lower Rates and Payments
An ARM, or adjustable rate mortgage, is similar to a 30-year fixed-rate mortgage in that it is also amortized over a 30-year period. But it’s usually for shorter-term situations and generally carries a lower interest rate than fixed-rate mortgages. So if you’re trying to keep your interest rate and payment low, an adjustable can be a sensible choice. And since it’s a short-term mortgage, it’s useful to have a lower rate and payment if you know you’re only going to be in your home for less than 10 years–especially when most American families generally move within nine years or less.
Some adjustable rate mortgages give you even more financial flexibility if they are available with interest-only payments. During the interest-only period, you decide if you want to pay interest plus principal or just interest alone. The rest of your money can go elsewhere, say, toward other bills or just extra spending money.
A Closer Look at ARMs
Many people tend to shy away from ARMs for the fact that the rate is adjustable. However, there are a few caveats to this:
- While ARMs do have an adjustable rate, the rate is fixed for six months, one, three, five, seven, and sometimes even nine years, depending on which term you choose. The rate doesn’t begin to adjust until after the fixed-rate period.
- Although the rate can adjust up, don’t forget that it can also adjust down as well.
- Most people who have an adjustable rate mortgage usually refinance it when it’s time for the rate to adjust. That way, they have some control over their interest rate.
Caps and ARMs
If you have an adjustable rate mortgage and can’t or don’t want to refinance when it’s time for the rate to adjust, it’s important to understand what happens to the rate after the fixed-rate period.
When the rate on an ARM adjusts, there are limitations on how much it can increase or decrease. These limitations, called “caps” include the “initial cap”, the “periodic cap”, and the “lifetime cap”. The initial cap is the limit on how much the rate can adjust the first time it adjusts. The periodic cap is the limit on how much the rate can adjust after the first adjustment. The lifetime cap is the limit on how much the rate can adjust over the life of the loan. Different ARMs carry different caps, depending on the program.
Let’s say your ARM has caps of 5/2/5. The first five is the initial cap; the second number is the periodic cap; and the third number is the lifetime cap. If your rate is 6.5 percent, then the initial cap says the first adjustment is your rate plus or minus five percent–so it can go as high 11.5 percent or as low as 1.5 percent (though it’s pretty unlikely that rates would change that significantly). The periodic cap says the second and subsequent adjustments are your rate (6.5 percent) plus or minus two percent–so no higher than 8.5 percent and no lower than 4.5 percent. The lifetime cap says the rate can never go higher or lower than your rate (6.5 percent) plus or minus five percent.
There are times when you’d want to refinance and times when you don’t. So why would you not refinance your ARM when it’s going to adjust? Well, as we said, rates can go down as well as up. There are some people who are not afraid of risk and are willing to gamble that their rate could go down. To be somewhat savvy, it’s wise to follow what’s happening in the market to know whether short-term rates will go up or down. The Federal Reserve is usually the entity that affects short-term adjustable rates. They meet eight times a year and decide whether to increase, decrease or maintain short-term rates as a control measure over inflation.
Deciding whether you should get an ARM and/or whether to refinance it is really your own decision. But if you can answer a few questions–whether or not you want a lower rate and payment; whether or not you’re only going to be in your home for less than 10 years, and whether you can stand a little risk in terms of the interest rate–then, you’ll be closer to making the right decision. Either way, you should confer with an experienced mortgage expert to be sure you’re making the right decision.
The Federal Housing Administration is making it easier for once-struggling homeowners to qualify for a mortgage backed by the agency.
For borrowers who meet certain requirements, the FHA is trimming to one year the amount of time that homebuyers must wait after a bankruptcy, foreclosure or short sale before they may qualify for a FHA-backed mortgage.
The waiting period had been two years after the completion of a bankruptcy and three years after a foreclosure or a short sale.
But only certain consumers who’ve been in those circumstances will be able to meet the criteria attached to the eased restrictions. Borrowers must be able to show their household income fell by 20 percent or more for at least six months and was tied to unemployment or another event beyond their control. They also must prove they have had at least one hour of approved housing counseling and, among other things, have had 12 months of on-time housing payments.
“FHA recognizes the hardships faced by these borrowers, and realizes that their credit histories may not fully reflect their true ability or propensity to repay a mortgage,” said FHA Commissioner Carol Galante, in a letter to mortgagees announcing the changes.
FHA-backed mortgages are a popular option for first-time buyers and for consumers with lower credit scores who might not otherwise qualify for a loan backed by Fannie Mae or Freddie Mac. However, the agency has recently increased the fees tied to FHA-backed loans.
Some people may say yes!
Upward sloping yield curve. It’s important to understand that due to the time value of money and inflation, the longer you borrow the higher your interest rate. If you borrow money from me today to pay me back tomorrow, I won’t charge you interest. But, if you want to borrow money from me today, to pay back over the next 30 years, you better hell believe I’m going to charge you an interest rate above inflation to counteract inflation, make some money, and bake in some risk of default.
Average length of stay. First of all, the average duration one lives in and owns a home is 7 years. If that’s the case, what on earth are you doing borrowing a 30-year fixed rate mortgage for? A 23 year + overestimation of ownership is a serious miscalculation based on the statistics at hand. With a 5/1 ARM, your underestimation is only 2 years, but you already have baked that in.
Match fixed rate with length of stay. If you plan to live in your house for 10 years, take out a 10 year fixed rate (amortizing over 30 years) as the most conservative loan duration. A 10 year fixed rate is cheaper than a 20 year or 30 year fixed rate. It is only logical that you match your mortgage fixed rate with your expected duration of stay. Sure, you might stay longer, but you might also stay shorter as well. If you know you plan to stay in your house forever, it’s more justifiable to take out a 30-year fixed, but I still wouldn’t because 1) You will likely pay down your loan faster than 30 years, and 2) The spreads are unjustly high in this environment.
Adjustable rate loans have an interest rate cap. People think, thanks to fear mongering by the media and mortgage officers, that once the adjustable rate loan period is over, your mortgage rate will skyrocket and make things super unaffordable. This is not the case because everything is relative and rates are capped. I’m refinancing to a 5/1 ARM at 2.625% with all fees included, and after 5 years, the interest rate can reset one time to a maximum of 7.25%. Whoopdee doo! After 5 years, if I don’t pay any extra principal, my principal mortgage amount is about 10% less. A 7.25% mortgage rate on a 10% lower principal amount is very digest-able.
If rates rocket higher, you will be celebrating. Things don’t happen in a vacuum. The 10-year yield is a reflection of inflation expectations. If the 10-year yield, and therefore mortgage rates are skyrocketing, that means inflation expectations are at the very least skyrocketing. However, you don’t have inflation expectations going higher unless demand for real goods and services going higher. Higher demand is a reflection of a stronger economy, and your real assets (property), by very definition or inflating! So what if inflation rises from 2% to 5%, causing your mortgage to reset to 7% due to the 2% spread? If your home is now inflating by 5%, and you have a 80% loan-to-value ratio, your cash on cash return is going up by 25%!
0 years in a row of deflation. Look at the historical 10-year treasury yield. Rates have gone down for 30 years in a row. That’s right folks. THIRTY YEARS! Are you telling me there’s no trend here? Are you saying that we are going to see massive inflation spikes on the way (which are fine as I just wrote) all of a sudden? In these 30 years, we’ve become a much more efficient society who enacts monetary and fiscal policy in anticipation or with shorter lead times. Yes, there will be occasional upward blips in pricing, but I highly doubt there will be a 5-10 year continuous ramp in inflation, which means your 5-10 year ARM is just fine.
Section 129B(d) of TILA, as added by the Dodd-Frank Act, permits consumers to bring actions against individual mortgage loan originators for violations of certain provisions of TILA. For example, while LO’s can be held personally liable for receiving compensation in violation of the Rule, they are not personally liable under TILA/LO Comp for failing to maintain the records of compensation required by the rule. The LO Comp Rule, which implements the DFA’s statutory authority confirms this personal liability through its changes to Reg. Z’s definitions. Specifically, the change to § 1026.36 (a)(1)in the LO Comp Rule clarifies the definition of “loan originator” to mean either the individual LO or the company. The following is from the CFPB’s small business compliance guide which seeks to use plain language explanations for the Rule (although it still warns you that you need to see the actual Rule for details): “A “loan originator” is either an “individual loan originator” or a “loan originator organization.” “Individual loan originators” are natural persons, such as individuals who perform loan origination activities and work for mortgage brokerage firms or creditors. “Loan originator organizations” are generally loan originators that are not natural persons, such as mortgage brokerage firms and sole proprietorships”
TILA is confusing for a lot of reasons, but one of the biggest areas of confusion in the LO Comp and Ability to Repay rules are the differing obligations imposed on “Creditors”, “Loan Originators”, and “Loan Originator Organizations”. These definitions are critical in determining who is responsible for any obligation under TILA. LO comp is one of the few times where the obligation extends all the way down to the individual LO, but the liability is potentially huge. I don’t know about the issue from the LO’s perspective (ask an attorney; see below) – does the borrower have a life of loan defense? As best I understand it, the life of loan defense is true as it relates to foreclosure but the remedy is not a free house, it is three years of interest and other fees (loan, attorney) – a monetary judgment. So there shouldn’t be any runs on any particular company.
Attorney Brad Hargrave (MedlinHargrave) writes, “Loan originator compensation is one area of Truth in Lending and Regulation Z wherein someone other than a creditor; namely, the loan originator, can also be held liable for a violation. The citation in support of this proposition is found at 15 USC §1639b(d)(1) which provides, in pertinent part, that ‘for purposes of providing a cause of action for any failure by a mortgage originator, other than a creditor, to comply with any requirement under this section, and any regulation prescribed under this section, section 1640 shall be applied with respect to any such failure by substituting ‘mortgage originator’ for ‘creditor’ each place such term appears in each such subsection.’ And, §1640 is that section of TILA that imposes civil liability for various TILA violations, including those sections regarding LO Compensation. (I have not addressed the recoupment and setoff issues in the event of foreclosure in the context of the LO, given that an LO would not be the party initiating the foreclosure; and thus, this section really isn’t applicable to an LO).”
Mr. Hargrave’s note continues, “The penalties are potentially severe. In an individual civil action brought by a consumer, the creditor who paid the violative compensation could be liable to the borrower for actual damages, plus twice the amount of any finance charge in the transaction (capped at $4,000), plus an amount equal to the sum of all finance charges and fees paid by the consumer (unless the creditor can demonstrate that the failure to comply is not material), plus reasonable attorneys’ fees and court costs if the borrower were to prevail. The loan originator’s exposure to such a claim (per 15 USC § 1639b(d)(2))is the greater of actual damages to the consumer or three times the total amount of direct and indirect compensation paid to the LO in connection with the subject loan, plus the costs to the consumer of the action, including reasonable attorneys’ fees. In addition, the CFPB could sue the creditor and the loan originator in Federal District Court and seek any one of a number of remedies, including restitution and/or disgorgement, and appropriate injunctive relief, as to all loans wherein the LO received unlawful compensation. It is also possible that the matter could be referred to another agency for enforcement.”
These days, it seems like there are no homes for sale in Los Angeles. The end of the year though, has and continues to be a great time to buy because although most people are busy with the holidays – you can capitalize on a great deal! Another driving force is the expiration of the Mortgage Debt Relief Forgiveness Act. This Act is set for expiration at the end of the calendar year.
The federal government created this Act in 2007 to allow struggling homeowners to avoid being held responsible for the “income” they received when they managed to get out from under their heavy mortgages through short sales and other transactions. The Mortgage Debt Relief Forgiveness Act exempts current homeowners from the hidden income taxes that are normally incurred when mortgage debt is forgiven. With this Forgiveness Act not in place the IRS will consider the mortgage debt wiped out without actually being paid back as income and tax it as such.
Struggling homeowners now have another reason to try and sell their homes in short sales and other sales before the end of the year. This could create the right opportunity for a buyer looking to move before the end of the year. Some short sale servicers are even expediting these transactions to get a short sale closed before year’s end.
In this market where many homes are still underwater and retiring seniors are relying on the profits from the sale of their home, as a buyer, you might stand to benefit from the inventory changes. Contact your local Crestico office today for more information.
