Sunday, September 17, 2006

Do you really know what kind of Mortgage you have?

First off, this is not a slam on the mortgage industry as there are a lot of good people out there. This is simply to let potential home buyers know a little about what is out there.

With so many options out there today, so many people can 'afford' homes, or can they? Banks have introduced creative concepts with ARMS's, Interest Only loans, Home Equity (HELOC), and now some are even introducing 40-year mortgages..What? All of these options sounded great to a lot of cash-strapped people wanting to buy a house in the heated market.

Adjustable Rate Mortgage (ARM) - They are loans secured on a property whose interest rate, and monthly payment, vary over time. They are sometimes sold to unsophisticated buyers who are unlikely to repay the loan if the interest rate rises, which they are doing here in the US now.

On the flip side, if you can repay this loan, it might not be a bad idea...That is if you can pay it off in the time allotted and not face a "pre-payment penalty." Early payments of part of the principal will reduce the total cost of the loan (total interest paid), and will shorten the amount of time needed to pay off the loan. Early payoff of the entire loan amount (refinancing) is often done when interest rates drop significantly.

With all of these options out there, more and more people were buying property, thus continuing the market "bubble" for so long. One of the most most risky and most complicated loans, according to Business Week, is the Option ARM Loan. It brought in a whole new group of buyers in to the housing market. Basically, the option ARM's low payments are temporary. And the less you pay on it, the more is added back into the balance.

Option ARM - An "option ARM" is a loan where the borrower has the option of making either a specified minimum payment, an interest-only payment, or a 15-year or 30-year fixed rate in a given month. The minimum payment is less than an interest-only payment and therefore results in negative amortization, while the full payment is the fully-amortized share of interest and principal. Option ARM's are popular because they are usually offered with a very low initial interest rate (a so-called "teaser rate") and a low minimum payment, which permits borrowers to qualify for a much larger loan than would otherwise be possible.

As with regular ARM's, there can be benefits to these loans, but be careful. For instance, someone like who has sporadic income (Real Estate), self-employed, or in a seasonal market, might chose to do an Option ARM. For example, someone who makes the majority of their income around the winter holiday season, but who earns minimal income during the following few months may wish to pay the full payment during their busy season, but drop back to the interest-only payment or the minimum during a period of reduced earnings. With a fixed-payment loan, if they were unable to meet the payment during their lean season they would risk late fees or foreclosure.

These are just two options out there, so be careful. Did you know that mortgage brokers get more commission, the riskier the loan is? I didn't either until I read an article about it. In the same article from Business Week (September 11, 2006), it stated that, "Big banks love option ARM's because they can book all of the earnings up front even though the borrower may never pay in full...Banks are underwriting riskier loans to less creditworthy customers."

Oh yeah, did you know foreclosures are up to? According to, "For a homeowner with a 5/1 ARM (an adjustable rate loan with an initial fixed rate for five years that then adjusts annually) that's now resetting, the adjustment could add at least two percentage points to the interest rate. That could send the payment on a $200,000 loan up from about $950 a month closer to $1,200.

These exotic mortgages, which have been issued by lenders at much higher numbers the past few years, default at a higher rate than do fixed-rate mortgages. And sub-prime loans, which are much more common than in the past, have a higher default rate as well."

Now that you have some knowledge be careful about who you chose to do work with when financing your home. Be sure to ask the right questions, read the fine print, and stick to your guns!

As I've stated earlier, there are a lot of good lenders out there, so if you would like some names of the ones I recommend, shoot me an email and I'll let you know!


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