INTEREST
RATES
Interest
rates are the name of the game when it comes to shopping for a home loan.
But it is not as simple as finding a mortgage company and getting a quote.
There are hundreds of programs and many options to these programs that
will affect your decision. Be sure to check the APR of your quoted rate,
which will calculate included fees.
INTEREST
RATE SAVINGS
The
most common reason to 'refi' is to lower your interest rate. Conventional
wisdom is to lower two points, but even one point can make it worthwhile.
Talk to some
lenders to determine the available rates and the costs associated with
refinancing. These costs include appraisals, attorney's fees, and points.
Then determine what your new payment would be if you refinanced. You can
estimate how long it will take to recover the costs of refinancing by
dividing your closing costs by the difference between your new and old
payments (your monthly savings). However, the ultimate amount you may save
depends on many factors, including your total refinancing costs, whether
you sell your home in the near future, and the effects of refinancing on
your taxes. The old rule of thumb used to be that you shouldn't refinance
unless the new interest rate is at least two percentage points lower.
However, many lenders are now offering zero point loans and low-cost
refinancing. Therefore, even if your rate change is less than one
percentage point, you may be able to save some money by refinancing.
ARMS
Adjustable Rate Mortgages
Most adjustable
rate loans (ARMs) have a low introductory rate or start rate, some times
as much as 5.0% below the current market rate of a fixed loan. This start
rate is usually good from 1 month to as long as 10 years. As a rule the
lower the start rate the shorter the time before the loan makes its first
adjustment.
INDEX
The index of an ARM is the financial instrument that the loan is
"tied" to, or adjusted to. The most common indices, or, indexes
are the 1-Year Treasury Security, LIBOR (London Interbank Offered Rate),
Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of
Funds (COFI). Each of these indices move up or down based on conditions of
the financial markets.
MARGIN
The margin is one of the most important aspects of ARMs because it is
added to the index to determine the interest rate that you pay. The margin
added to the index is known as the fully indexed rate. As an example if
the current index value is 5.50% and your loan has a margin of 2.5%, your
fully indexed rate is 8.00%. Margins on loans range from 1.75% to 3.5%
depending on the index and the amount financed in relation to the property
value.
INTERIM CAPS
All adjustable rate loans carry interim caps. Many ARMs have interest rate
caps of six-months or a year. There are loans that have interest rate caps
of three years. Interest rate caps are beneficial in rising interest rate
markets, but can also keep your interest rate higher than the fully
indexed rate if rates are falling rapidly.
PAYMENT CAPS
Some loans have payment caps instead of interest rate caps. These loans
reduce payment shock in a rising interest rate market, but can also lead
to deferred interest or "negative amortization". These loans
generally cap your annual payment increases to 7.5% of the previous
payment.
LIFETIME CAPS
Almost all ARMs have a maximum interest rate or lifetime interest rate
cap. The lifetime cap varies from lender to lender and loan to loan. Loans
with low lifetime caps usually have higher margins, and the reverse is
also true. Those loans that carry low margins often have higher lifetime
caps.
BUYDOWN
2-1 Annual
Buydowns:
The most common
buydown is the 2-1 buydown. In the past, for a buyer to secure a 2-1
buydown they would pay 3 points above current market points in order to
pay a below market interest rate during the first two years of the loan.
At the end of the two years they would then pay the old market rate for
the remaining term.
As an example,
if the current market rate for a conforming fixed rate loan is 8.5% at a
cost of 1.5 points, the buydown gives the borrower a first year rate of
6.50%, a second year rate of 7.50% and a third through 30th year rate of
8.50% and the cost would be 4.5 points. Buydown were usually paid for by a
transferring company because of the high points associated with them.
In today's
market lenders have designed variations of the old buydowns. Rather than
charge higher points to the buyer in the beginning they increase the note
rate to cover their yields in the later years.
As an example,
if the current rate for a conforming fixed rate loan is 8.50% at a cost of
1.5 points, the buydown would give the buyer a first year rate of 7.25%, a
second year rate of 8.25% and a third through 30th year rate of 9.25% , or
a three-quarter point higher note rate than the current market and the
cost would remain at 1.5 points.
3-2-1 and
Flex-Fixed Buydowns:
Another common
buydown is the 3-2-1 buydown which works much in the same ways as the 2-1
Buydown, with the exception of the starting interest rate being 3% below
the note rate. Another variation is the flex-fixed buydown programs that
increase at six month interval rather than annual intervals.
As an example,
for a flex-fixed Jumbo buydown at a cost of 1.5 points, the first six
months rate would be 7.50%, the second six months the rate would be 8.00%,
the next six months rate would be 8.50%, the next six months rate would be
9.00%, the next six months the rate would be 9.50% and at the 37th month
the rate would reach the note rate of 9.875% and would remain there for
the remainder of the term. A comparable Jumbo 30 year fixed at 1.5 points
would be 8.875%.
COFI
Cost of Funds Index
The 11th
District Cost of Funds is more prevalent in the West and the 1-Year
Treasury Security is more prevalent in the East. Buyers prefer the slowly
moving 11th District Cost of Funds and investors prefer the 1-Year
Treasury Security.
The monthly
weighted average Eleventh District has been published by the Federal Home
Loan Bank of San Francisco since August 1981. Currently more than one half
of the savings institutions loans made in California are tied to the 11th
District Cost of Funds (COF) index.
The federal Home
Loan Banks 11th District is comprised of saving institutions in Arizona,
California and Nevada.
Few people who
use and follow the 11th District Cost of Funds understand exactly how it
is calculated, what it represents, how it moves and what factors affect
it.
The predecessor
to the 11th District Cost of Funds index was the District semiannual
weighted average cost of funds published for a six month period ending in
June and December. The San Francisco Bank was the first Federal Home Loan
Bank to publish a monthly cost of funds index.
The funds used
as a basis for the calculation of the 11th District Cost of Funds index
are the liabilities at the District savings institutions: money on deposit
at he institutions, money borrowed from a Federal Home Loan Bank (known as
advances) and all other money borrowed. The interest paid on these types
of funds is the cost of these funds.
The ratio of the
dollar amount paid in interest during the month to the average dollar
amount of the funds for that month constitutes the weighted average cost
of funds ratio for that month.
The average cost
of funds is said to be weighted because the three kinds of funds and their
costs are added together before a ratio is computed rather than
calculating averages individually for the three sources and using a simple
average of the three ratios. This gives the greatest weight to the
interest paid on deposits, and explains the delayed reaction of the index
to rising fixed-rate mortgages.
GPM
Graduated Payment Mortgage
The GPM is
another alternative to the conventional adjustable rate mortgage, and is
making a comeback as borrowers and lenders seek alternatives to assist in
qualify for home financing
Unlike an ARM,
GPMs have a fixed note rate and payment schedule. With a GPM the payments
are usually fixed for one year at a time. Each year for five years the
payments graduate at 7.5% - 12.5% of the previous years payment.
GPMs are
available in 30 year and 15 year amortization, and for both conforming and
jumbo loans. With the graduated payments and a fixed note rate, GPMs have
scheduled negative amortization of approximately 10% - 12% of the loan
amount depending on the note rate. The higher the note rate the larger
degree of negative amortization. This compares to the possible negative
amortization of an monthly adjusting ARM of 10% of the loan amount. Both
loans give the consumer the ability to pay the additional principal and
avoid the negative amortization. In contrast, the GPM has a fixed payment
schedule so the additional principal payments reduce the term of the loan.
The ARMs additional payments avoid the negative amortization and the
payments decrease while the term of the loan remains constant.
SCHEDULED NEGATIVE
AMORTIZATION
The scheduled
negative amortization on a GPM differs depending on the amortization
schedule, the note rate and the payment increases of the loan. GPM loans
with 7.5% annual payment increases offer the lowest qualifying rate but
the largest amount of negative amortization.
On a loan of
$150,000, with a 30 year amortization and a note rate of 10.50% with 12.5%
annual payment increases, the negative amortization continues for 60
months. The qualifying rate is 5.75% and the negative amortization is
11.34% (approximately $17,010).
HELP IN QUALIFYING
The note rate of
a GPM is traditionally .5% to .75% higher than the note rate of a straight
fixed rate mortgage. The higher note rate and scheduled negative
amortization of the GPM makes the cost of the mortgage more expensive to
the borrower in the long run. In addition, the borrowers monthly payment
can increase by as much as 50% by the final payment adjustment.
The lower
qualifying rate of the GPM can help borrowers maximize their purchasing
power, and can be useful in a market with rapid appreciation. In markets
where appreciation is moderate, and a borrower needs to move during the
scheduled negative amortization period they could create an unpleasant
situation.
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