And, if you don’t choose the right mortgage, you will be cheating yourself out of all benefits you should be getting by being in the best mortgage program. Be assured, there is a best program. Just as there is a worst program. Strangely, what is best for you might be worst for someone in different circumstances. There is also lots of room in between: good programs, maybe, but there are better ones if only you had known about those other program before you signed those mortgage docs.

Questions, simple questions, arise: should you do a 30-year fixed-rate purchase, or is it possible the dreaded adjustable rate mortgage might work better for you? When should you think of doing a shorter, or longer, term fixed mortgage—what are the advantages … and the disadvantages? You need money: should you do a personal loan—or should you do a 2^nd mortgage on your home? Or possibly do a new refinance on your home and take extra cash out of your equity? If you decided to do a cash-out second mortgage, should you apply for a fixed rate loan – or would a HELOC (home-equity-line –of-credit) work to your better advantage. Can you accomplish what you want to if your visible earnings leave you unqualified for a “full doc” loan? What are the disadvantages of a “stated” income loan? And the advantages. Can you qualify for a “light doc” loan if you are self-employed – or even unemployed or retired?

The questions you might ask your broker or lender—should ask—go on and on, depending on your own unique situation and financial goals. Because perhaps the most powerful tool you have to leverage those goals is your largest asset: your home. The right loan can be a financial coup; the wrong loan can sink you like the Titanic. Even if it not always that dramatic a choice, right or not-so-right can save you – or cost you big money. Smart borrowers will often tell you that they “live” on their house, as well as in it.

So, it can make as much as a six-figure difference to get to know a more about mortgages and the mortgage industry than you know now. Chances are that you will do at least one more mortgage, whether you buy a new house, a second home, an investment property, or even a commercial property. Most of you will do a number of mortgages in the refinance area to get better terms when they become available, to take out some of the equity you have acquired in the time we have lived in the property, or maybe just to refinance to better suit a new situation in life such as college-age kids, or retirement

FIXED RATE LOANS

First thing to consider is that there are fixed rate mortgages and adjustable rate mortgages (ARM’s). Neither is intrinsically better or worse than the other. But in your present circumstances one will probably work better for you than the other.

The fixed rate mortgages are pretty much those 30-year fixed rate loans most folks know something about because the majority of them now have such mortgages on their residences. Maybe they got them through VA loans if they were in the Armed Forces or FHA if they needed some government help in terms of down payment. But no matter where they got it – through a bank, a broker, a lender, or even an inheritance – it is basically the same animal. It comes in different sizes: 10-, 15-, 20-, and 40-year terms (and even 50 with a few lenders), but it is fixed because one pays the same monthly amount until the term has expired – and one owns the house, free and clear – formerly, the “American Dream”. There is also a price differential between Conforming (under $417,500) and Jumbo (over $417,500) loans. Jumbos charge a slightly higher rate.

Simple enough, but it doesn’t happen nearly as much as you might think that folks get a mortgage, pay it off, and live happily ever after. People move, or they refinance while the loan is in effect. They borrow on the equity. They put a second mortgage behind the first. In California, it has been estimated that 4 to 5 years in the same loan is the norm, not the exception.

With any loan, the longer the term, the smaller the monthly payment. The shorter the term, the higher the monthly payment. If owners stay till they pay off a shorter term mortgage, say a 15-year term rather than the more popular 30-year, they will save a huge amount of money; in many cases this savings will be well into six figures in California where homes are far from cheap. But in the meantime, they are paying considerably more each month. Which way to go? Work on it with your lender and financial advisor. It is important.

One of the best things that could be said about the fixed rate mortgage is that one always knows what the next month’s payment will be. It gives maximum security. Live up to the terms of the loan, and there are no surprises.

The other side of that coin is that if the borrower does not stay the course, he would have saved money in payments by choosing a different program. UNLESS YOU ARE SURE THAT YOU WILL BE IN YOUR RESDIENCE FOR THE FULL TERM OR THE FIXED-RATE LOAN, YOU SHOULD LOOK CAREFULLY AT ALTERNATIVES.

Adjustable rate loans

Adjustable rate loans (ARM’s) are less familiar to most homeowners. And many have been scared off by hearing of the “horrendous consequences” of getting a rate that goes up with the performance of something called “indices.” And then, they are told, “beware of the margin.” What is margin, we might ask ourselves?

ARM’s are not nearly so scary when we discover what they are, and that while there is an upward rate risk there is also the possible benefit of indices going down and with it the rate and our payment also going down. When the homeowner gets the ARM, the rate will be lower than the fixed-rate at that time. If not, there would be no reason for its existence. So even if the indices do go up, there is always that leeway before it catches up to the fixed rate at the time of the loan.

The indices are the published financial calculations of certain factors based on economic conditions: treasury notes (MTA), cost-of-funds-index (COFI), London-Indices-of-bank rates (LIBOR), and a few others such as Cost of Savings Index proprietary to the banks that use them. They go up and down along with economic factors such as inflation, unemployment, etc. When they go up, rates go up. When they go down, rates go down.

Back to the “margin”: the margin is fixed; it is the index that fluctuates. You add that fixed margin to the fluctuating index and you have the pay-rate. It is re-calculated periodically. Margin is calculated by a number of factors, which lessen or increase the risk to the lender. If one opts to take a pre-pay (penalty for getting out of the loan before the pre-pay period has concluded), for example, the bank is covered for that period of pre-pay, so the margin is lower. If credit is excellent, the margin is lower. If the margin is say 2.5, and the index is 4.5, then the rate would be 7%; if the margin is 2.5 and the index falls to 3.8, rate then goes to 6.3%. It “adjusts” with the index.

One further fact: during the past 20 years, adjustable rate loans (used to be called “variables”) have performed consistently better than fixed rate loans.

When should you consider an ARM? When you might get better terms than you could with a fixed-rate loan because of more lenient guidelines. Perhaps when you know you will be moving along with your job, or retiring. When you think there will be a more advantageous time to get a fixed-rate loan in the relatively near future. And a variety of other considerations, which would indicate that you will not be in the loan for the full term.

In short, it very much depends on your situation as to considering an ARM rather than a fixed-rate mortgage

HYBRID MORTAGES

An in-between alternative to fixed-rate or ARM mortgage is what has been called the “hybrid” mortgage. This offers a fixed rate for a certain period (from one-year to ten years) before transitioning to the prevailing adjustable rate for the remainder of the 30-year term.

This is a loan that offers the borrower fixed-rate security with lower payments than the full 30-year fixed loan and a lot more flexibility if there is a good chance that they will not be staying in the loan for 30 years. It is a good option to not taking the risk of an ARM going up in rate. Folks who move as part of a career path or intend to retire within the fixed rate time usually can do well with these loans.

PAY-OPTION ARM’S

Last, but certainly not least, is the Pay-Option ARM. This has become extraordinarily popular since rates have ratcheted up from the low 4’s in the early 2000’s. Essentially, it is a loan that allows the borrower to borrow from himself by paying less than the interest-only amount (interest-only would keep the original loan principal amount in equilibrium.) The difference between that interest-only and a lesser payment is added to the principal amount of the loan.

It is called an “option” program because each month there is an option to pay at the minimum rate of 1% ($242 per $100,000 of the loan), at the interest-only rate, or the fully amortized rate – or any other amount as long as it is more than the minimum option. In effect, you put the difference between the minimum payment and the interest-only payment in your pocket.

What are the advantages of doing this? When it initially emerged as a powerful financial tool, it was called the “investors’ loan.” This was because it freed up capital for borrowers to “invest.” As long as property is appreciating, little or no value is lost, and payments are dramatically lower than any other loan at present market rates. On a million-dollar mortgage, a borrower could opt to pay $2,420 reach month for the first year and add only 7.5% to the payment in the subsequent four years of the 5-year window for minimum payment option.

The true investor might (and has) taken up to the limit (usually 80% of the appraised value of the property) available to him in cash, which he invests in a something that pays out better than he would get if he paid the fully amortized amount of the loan for the full term of the loan. Some others take it to keep payments as low as possible in the residence they intend to “grow into” because of improving earning capacities.

A number of retirees find this works better for them better than the mysterious “Reverse Mortgage” even if they invest the investment capital that is available to them relatively conservatively. Case in point: retiree refinances his free-and-clear house for 80% of its $625,000 value. He invests the $500,000 at 6%, yielding him $2,500 a month. He gets $2,000 from Social Security. He can pay the minimum payment of $1,210 and live on the rest. His property taxes are low because he has been in the property that has appreciated 4 times its purchase price and his home owner’s insurance is reasonable. He is living “on” his home as well as in it.

There are a number of considerations to look at before you opt for this loan, and your broker or lender can go over all of them before you make this choice. As in every other case, “it depends on your circumstances.”

Sometimes it makes sense to do a new 2^nd mortgage rather than refinance your first to get some cash-out. Usually this is the case when you have a very good 1^st mortgage, well below the market rate at that time, so you want to keep that loan. Or you might do it because you don’t have enough equity in the first to get the cash-out without having to take “mortgage Insurance,” which has a number of things against it, not the least of which trying to get rid of it by proving the enhanced value to someone who wants to keep getting his insurance payments.

The next decision is to do a fixed-rate 2^nd or a Home Equity Line of Credit (HELOC). The payment is lower on the HELOC because you are obligated only to pay interest-only, but it is an ARM, so you have the risk of rates going up. The fixed rate will stay at that rate for the life of the loan, unless you choose a 30-year term due in 15 years or a similar loan that requires a balloon payment.

Again, your circumstances should guide your choice. Talk to your broker or lender about your options and the pros and cons of each.

HELP IS AVAILABLE

We at American Family Loan can give you chapter and verse on any and all of the programs you might be considering, starting with: “should I do something NOW?” Even if you are not planning to purchase or refinance right now, we will be happy to answer any questions you might have. Phone or e-mail us and an experienced, licensed Loan Officer with 10 years or more of financial background will answer your questions and get you started on a new mortgage that will meet your goals.