Posts Tagged ‘ARM’

Adjustable Rate Mortgages

December 9, 2014

blog-author-clayjeffreys3

Continuing the educational video series. Last time we discussed different loan options. Now let’s focus on the interest rate and amortization – you can get fixed rate loans with terms between 10 and 30 years. Or you can get an adjustable rate mortgage, which are commonly referred to as an ARM.

To contact any of us at Dunwoody Mortgage Services, click here!

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Government Shudtown impacting lending

October 1, 2013

blog-author-clayjeffreys3

UPDATE – As of 10/07/2013 – most of the lenders I use are allowing loans to close for W2 salaried borrowers as long as their employer completes a full Verification of Employment. Since the government (and IRS) is still shut down, this is great news for some. Those who are self employed or make most of their money from commission/bonuses will not be able to close until a tax transcript can be provided from the IRS.

With the government shutdown (which is still on as of this post) in full swing, most people assume they will still be able to close their home loan if it isn’t a government loan such as an FHA, VA or USDA loan.

The truth is the shutdown could literally shutdown closings regardless of the type or purpose (purchase or refinance). Why? The government shut down also closed the IRS. That wouldn’t be a huge deal a few years ago, but it is today.

Why?

The reforms in the mortgage industry and underwriting brought the IRS into the middle of the loan process. In order to close on a loan, the IRS must supply tax return transcripts from the previous two tax filing years. It doesn’t matter if you are a W2 salaried employee, self employed, 100% commission, etc… if you are applying for a home loan, tax transcripts are required.

Until the government is up and running again, the IRS won’t process the tax transcript requests. As of today, requests are piling up. The longer this goes on in DC, the larger the pile of requests will get. Eventually this will begin delaying closings, rate locks could expire, emotions will run high… fun times.

Fortunately, government shutdowns only last a few days. I’m sure DC will figure this out soon (fingers crossed!).

In the meantime, juts realize the shutdown could impact your home loan even if it isn’t a government loan.

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Beware if your Adjustable Rate Mortgage is LIBOR Based!

May 26, 2010

Everyone has read it in the newspapers and heard it on the television, the debt and banking problems of Greece, Spain and Europe. Everyone wonders how it will affect the United States or more importantly, me! The affect has been positive on the United States mortgage rates because everyone is moving their money to US debt since it looks to be much more stable than European debt.

If you are a homeowner and enjoyed the wonderful low rate of an adjustable rate mortgage, be very careful. If your ARM is a LIBOR arm, all indications is your rate will be increasing very soon. The LIBOR is Europe’s equivalent of the Treasury. As the European banking system continues to struggle, the LIBOR will continue to increase to take into account the risk associated with the potential of default of debt. In the short-term, borrowing costs are climbing faster for European banks than American and the cost of insuring against default on debt issued by European financial firms is climbing.

The possibility exists this event could have significant upward pressure on the LIBOR rates which will result in you LIBOR based ARM to increase in the next adjustment period. If we have a catastrophic event occur in Europe’s banking system, it will significantly affect your LIBOR based ARM. Do miss out on the opportunity to refinance your home on a fixed rate mortgage while rates are low. A storm looks to be brewing in Europe that could affect your payment.

If you have an ARM, what do you do?

February 24, 2010

 

So, you have an adjustable rate mortgage, what to do, what to do?

A lot of consumers took advantage of low mortgage rates five years ago by taking out an adjustable rate mortgage.  These mortgage loans, generally fixed for 3 years or 5 years, 7 years or 10 years, allowed consumers to save thousands of dollars in interest by having an interest rate below the rate of a fixed rate mortgage.

For example, on a $300,000 mortgage, in November of 2004, you could get a 5/1 ARM (principle and interest payments) at 4.5%.  The comparable 30 year fixed rate loan at the time was around 5.375%, giving the adjustable rate mortgage a monthly savings of $159 per month . . . or $9,540 over the first 60 months (5 years fixed term).  Saving $10,000 is good, not toxic, or exotic, or evil as the media has vilified ARMs; a $10,000 savings is a good thing.   In fact, in 2004, Alan Greenspan agreed that savings thousands of dollars is a good thing, stating that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.” (source: usaToday.com here). 

My prediction — the NEXT big headline against the mortgage industry (give it 12 to 24 months to materialize) will deal with consumers with ARM’s NOT refinancing to fixed rate mortgage when rates were at an all time historic low (ala, now).  The media will likely talk about how confused consumers, not fully understanding the terms of their risky exotic mortgage  . . . (breathe, 1, 2, 3 . . . more on that next time).

So, for any consumer who HAS recently refinanced their ARM in to a fixed rate mortgage, EVEN if you spent $6,000 in closing costs to refinance, you have still saved $3,540 when compared to the 5.375% fixed rate mortgage you could have started with.  And, in addition to that savings, you now have a rate in the high 4’s, where if you would have still have had the 5.375%, you may have just kept it, because the difference between the two is probably not enough to warrant the refinance (an additional $115 in savings per month). 

So why are consumers NOT refinancing out of their ARMs in to historically low fixed rate mortgages??  For some it is because they can not refinance their mortgage (low appraised values, loss of income, 2nd mortgage unwilling to subordinate).  But for others, it is because their interest rate has actually gone DOWN.

Continuing with the example above, with a start rate at 4.5% in November of 2004 (lets also assume the ARM in the example is based on the LIBOR index with a 2.25% margin) . . . in November of 2009 at the time of adjustment, the LIBOR index was around 1.95%, which means that the interest rate would adjust to (index + margin), 1.95% + 2.25% = 4.25%.   Assuming this loan is a standard conventional principal and interest ARM, the rate of 4.25% would now be fixed for 12 months, and the payment would go down by $45 per month . . . even more savings!  If your interest rate were to adjust today (February 2010), because the LIBOR index is even lower, the rate would adjust down to 3.25%!

And WHY IN THE WORLD would anyone pay $6,000 in closing costs to refinance out of a 3.25% interest rate??

Here’s why:

1 — Historically low rates will (will) [will] (will) come to an end.  Economist agree that interest rates WILL go up — how quickly and how high is certainly up for discussion.  The Feds program to purchase mortgage -backed securities (MBS)  is ending March 2010 (next month) and supply and demand tells us that rates will go up.  The Feds are providing the demand for purchasing MBS, with them stepping out, the demand will go down, prices will go down, and when prices go down, mortgage rates go UP.

The Feds announced their MBS purchase program in November 2008 and look what happened to rates immediately.

2 — Your next adjustment will be UP (very likely).

Most people assume that when the Feds “raise rates” that mortgage interest rates go up.  While this is sometimes true, the Feds actually move an internal banking rate known as the Federal Funding rate.  While the Fed’s Fund rate is not tied directly to mortgage rates, it does track with the LIBOR index.  And as the Feds “raise rates” the LIBOR index will follow.  The 5 year average for the 12 month LIBOR index is 3.9.  Using this as an assumption of where it might stand a year from now, 3.9% index + 2.25% margin = 6.15%.  Taking the scenario above, and your payment from 3.25% to 6.125% just went UP more than $500 per month! 

3 — Refinancing now is better than refinancing later (likely).

Instead of an increase of $500 per month (3.25% to 6.125%), that $300,000 mortgage could be refinanced at 4.75% = an increase in payment of $260 per month from 3.25%, but a savings of $257 when compared to 6.125%.  Assuming the closing costs are $6,000 to refinance now, and assuming that the following year (2011) the ARM would stay around the 6.125% (which may be the BEST case scenario), the closing costs on a new refinance would take 23 months to recoup.  Which means, assuming that you are going to stay in your current home for more than 2 years from today, you should refinance . . . you should refinance, now . . . unless you think interest rates will go lower . . . which they aren’t . . . so you shouldn’t think . . . so you should . . . refinance. 

You’ll be glad you did . . . wishing I knew the emoticon for “call me.”  🙂

Finally, the truth about MTA loans.

January 15, 2007

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Amazingly, there is still a lot of interest about MTA loans.  These loans are usually one-month adjustable rate mortgages based on the MTA index (an index based on a 12 month average of actively traded treasury securities).  These loans give customers the “option” (very big air-quotes) of paying a minimum payment, an interest-only payment, or a principle and interest payment.  In cases where the minimum payment does not cover the interest for the month, the interest is added back to the loan amount creating a negative amortizing loan.  Negative AM sounds so harsh and ugly, though, huh?  So, mortgage brokers and investors call these loan Pay-Select loans or Pay-Flex loans, as if to say, “Sure, pay what you want . . . you choose . . . really, we’re fine either way, no big.” 

To read my previous post on MTA loans, click here

The reason that I am writing on this again is twofold:

One, the number one search terms that land people on ‘the Mortgage Blog’ are searches for MTA, or MTA loan or MTA index.

Two, I finally found out the truth about this loan.    

Here is the thing . . . there are companies (wholesale investors as well as retail mortgage brokers) that sell the heck out of this loan.  There is one company who claimed to have 80% of their mortgages originated into this product.  Although they have boasted of increased buying power, consumer flexibility and wiser cash-flow management, I have always (for good reason) been suspicious. 

My simple question . . . why would a consumer take on a one-month adjustable rate mortgage that is not nearly as good as what they could get in a 5 year interest-only ARM?

Here is the math:  the MTA index currently sits at 4.933.  If you were take an MTA loan today, the start rate would be 1%.  After the first month, the interest rate would adjust based on the MTA index and the margin.  For this example, lets say the margin is a friendly 2.5% (accepting a higher margin = more commission for the loan originator).  Fast-forward 30 days, and now your interest rate has gone up to 4.933 + 2.5% = 7.433%.  So why the 1% start rate?  Well, your ‘minimum payment’ (which may not be enough to cover the interest) is based off of your start rate and is usually guaranteed to go up no more than x% per year.  And, for your first payment, in the example above, the minimum payment will come no-where-close to paying for the interest at 7.433%, and the difference will be added to your loan balance.  Ouch.

So my question has always been, why not take a 5 year interest-only ARM at 5.75% (based on today’s rates)??

And, until a few days ago, I have NEVER been able to get a straight answer.

I was talking with a new wholesale lender account rep (they call on mortgage brokers like me, hoping that I will send loans to them for underwriting, funding, etc).  He told me that their MTA loan was by far the most popular product that they were closing . . . like hot-cakes.  So, I asked him the same question that I ask everyone who mentions that loan to me . . . “Why wouldn’t I sell the customer a 5 year interest-only ARM instead?  Why is the MTA loan better than a 5/1 ARM?  Can you even tell me one situation where an MTA loan would be better than any interest-only type mortgage?”

“Well Jeffrey,” he said, “I guess it’s the perfect loan for the customer who wants to buy more house than they can afford.”

And he’s right.  Lasso of truth will get you every time.

an MTA loan, (sing) “More than meets the eye.”

September 8, 2006

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What if I told you could get a $200,000 mortgage at a 1% interest rate, with a minimum monthly payment of $643 per month!? And your payment would only adjust by about $50 per year no matter what the market does! Sound familiar? Too good to be true? (recall mother’s advice: “If it sounds too good to be true . . . it probably is.”)

If you have heard or read this before, most likely they are talking about an MTA loan. Here is why this loan is anything but “Optimus” for your home financing. The loan and monthly payments start out well-and-good but quickly ‘transform’ into something very different. Kind of reminds me of that time when Megatron was leading the Decepticons in their villainous plight to take over . . . (sorry, I have taken the Transformers analogy MUCH too far!! nerd alert!! nerd alert!!)

MTA stands for Monthly Treasury Index. This type of loan (generally named an MTA loan, a Pay-Flex loan or a Pay-Select loan) is a one month adjustable rate mortgage based on the MTA index. The MTA index is an index calculated based on the twelve month average of annual yields on actively traded US Treasury Securities — the Monthly Treasury Average Index. Because this index is an average of the previous twelve months, it is a much slower moving index than all other adjustable rate mortgage indices. For more information on adjustable rate mortgages (ARMs) and how they adjust, check out my previous post.

This loan does in fact have a rate of 1% . . . a “start-rate” of 1%. Based on the example above, the first month’s payment (of principle and interest) would be $643 per month. However, after the introduction period (usually a 1 month or 3 month period), the interest rate adjusts to the “real” interest rate = the MTA index plus a margin. The margin on this type of loan can vary between programs, but for the sake of this post, I’ll use 2.75%. With the MTA index currently sitting at 4.664 (as of September 9th), the “real” or fully-indexed rate would be 7.414%. Ouch! And to make matters worse, unlike most ARMs, this loan usually does not have a cap on adjustment (although it may have a life-time cap of 10% or so). Ouch again!

So what about the payment only going up $50 per year?

Here is where the loan gets even more confusing. The loan is called a “Pay-Flex” loan because it is sold to consumers with the idea that you have the flexibility to make one of four payments. You can make the minimum payment, an interest-only payment, a 30 year amortization payment or a 15 year amortization payment (the last two options are laughable at best). The consumer can select (hence the name “Pay-Select loan”) which option they want to pay. What a friendly loan!?? Just make whichever payment you like, no problem . . . not a problem if you like paying more interest of course.

In the example above, the payment (the minimum payment) will only increase by 7.5% per year. So if the first year’s payment (minimum payment) is $643 per month, the second year’s payment (minimum payment) will be $691. However, because the interest rate has adjusted up, the difference between the minimum monthly payment and the interest for the month . . . read carefully . . . will be added to the loan balance. So, for a $200,000 mortgage balance, now at a rate of 7.414%, the interest for one month would equate to $1,253. The minimum payment would be $592 TOO LOW even to cover the interest on the loan and that amount would be added to the loan balance (called negative amortization). Next month’s interest payment would be calculated on a new loan balance of $200,592. This cycle of adding to the loan balance would continue until the loan value had maxed-out at 115% of the original appraised value.

Bottom line, compared to an intermediate adjustable rate mortgage (a loan that is fixed for a set number of months or years like 3, 5, 7 or 10, and then converting to a 1 year ARM with caps on adjustment), now available — and extremely popular — with an interest-only payment, the usefulness of an MTA loan is pretty slim.

There may be one small argument that would say that because this loan adjusts as the market adjusts, a consumer will reap the benefit of falling interest rates (and a falling MTA index) automatically without the hassle and expense of refinancing, but it would be a pretty tough argument to make. If you looked at the average of the MTA index over the past 10 years (3.973 — which would equal a mortgage rate of 6.73%) and over the past 5 years (2.503, which would equal a mortgage rate of 5.25%), someone might make a mildly convincing argument.

But, if somone made the argument so compelling to you (especially at the beginning of 2004 when the MTA index was at it’s lowest point and the adjusted rate was 3.975%) now that things have transformed for the worse and the rate has gone up to 7.375%, and your interest-payment has gone from $662 per month to $1,229 per month, you might just wish you had a 30 year fixed rate loan at 5.25%.