Tag Archives: index

Costly Mortgage Mistakes

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Ship on Rocks

Consumer Reports Money Adviser quoted me in Don’t Make This Costly Mortgage Mistake; How to Weigh Your Options Before Your Settle on a Deal (only available in Spanish without a subscription!) (UPDATE:  NOW IN ENGLISH TOO). It reads, in part (and in English),

As with anything you buy, scoring the best deal on a mortgage or refinancing involves shopping around. Yet 77 percent of borrowers applied for a loan with a single lender instead of checking out several to compare costs, according to a recent study by the Consumer Financial Protection Bureau. “People may well put more time and effort into shopping for smaller products such as appliances and televisions than they do in shopping for the right mortgage,” the bureau’s director, Richard Cordray, said in a statement. But the potential savings from doing your homework are significant. If you get a $250,000 30-year fixed-rate mortgage at 4 percent interest from a lender instead of paying 4.5 to another, you’ll save $26,345 over the life of the loan.

We know it can be difficult to find the right mortgage; the process can be intimidating. Following these steps will help you navigate better:

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2. Decide which type of mortgage is right for you

Before you shop, determine how much you want to borrow, which type of mortgage you want, and how long a term you need so that you can compare lenders’ products.

Most borrowers go with a fixed-rate mortgage, usually for a 30-year term, to spread out the cost of a home purchase over time while making predictable payments each month, says David Reiss, a professor who teaches real-estate finance law at Brooklyn Law School. Those loans make sense especially when rates are low and for buyers who intend to own their house for a long time.

But also consider an adjustable-rate mortgage (ARM), also called a variable-rate or floating-rate mortgage), Reiss says. It has an interest rate that’s fixed for an introductory period of time, then changes periodically, usually in relation to an index. The introductory rate is often lower than the rate on fixed-rate mortgages. For example, the average 30-year fixed-rate mortgage recently had an annual percentage rate (APR) of 3.5 percent, according to Bankrate.com; the average 5/1 ARM (which adjusts annually after five years) was 2.67 percent.

When the rate adjusts, it can sometimes result in a sizable increase in monthly mortgage payments. “ARMs are appropriate for people who anticipate relocating or paying off the loan before it adjusts,” Reiss says, “or for empty nesters who don’t plan to stay in a home for many years.”

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4. Push for a better deal

After you have found the best offer, try to negotiate even better terms. Ask the lender whether he will waive or reduce any of the fees he is charging or offer you an even lower interest rate (or fewer points). You are unlikely to get fees waived from third parties, like those for a title search, government processing fees, and appraiser fees, Reiss says. “But you may be able to cut the lender’s fees, like its underwriting, document processing, and document preparation costs,” he says.

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A Call to ARMs

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MainStreet.com quoted me in A Call to ARMs As Homeowners Opt for Lower Interest Rates. It opens,

Some homeowners are choosing adjustable rate mortgages instead of the traditional 30-year mortgages to take advantage of lower interest rates for several years.

The biggest benefit of an ARM is that they have lower interest rates than the more common 30-year fixed rate mortgage. Many ARMs are called a 5/1 or 7/1, which means that they are fixed at the introductory interest rate for five or seven years and then readjust every year after that, said David Reiss, a law professor at Brooklyn Law School. The new rate is based on an index, perhaps LIBOR, as well as a margin on top of that index.

The main disadvantage is that the rate is not fixed for as long as the interest rate of a 30-year fixed rate mortgage, but younger homeowners may not consider that a negative factor.

Younger Owners Should Consider ARMs

While many homeowners gravitate toward a 30-year mortgage, younger owners “should seriously consider getting an ARM if they think that they might move sooner rather than later,” he said. If you are single and buying a one-bedroom condo, it is likely you could enter into a long-term relationship and have kids.

The 30-year fixed mortgage rate is 3.50% as of April 7 while a 5/1 ARM is 2.83% as of April 7, according to Bankrate’s national survey of large lenders.

While ARMs expose the borrower to rising interest rates, they typically come with some protection. Interest rates often cannot rise more than a certain amount from year to year, and there is also typically a cap in the increase of interest rates over the life of the loan, said Reiss. During the height of the housing boom, lenders were originating 1/1 ARMs that reset after the first year, but now they reset frequently after the fifth and seventh year.

An ARM might have a two-point cap for one-year increases; that means, an introductory rate of 4% could only increase to 6% tops in the sixth year of a 5/1 ARM, Reiss said. That ARM might have a six-point cap over the life of the loan, which means a 4% introductory rate can go to no higher than 10% over the life of the loan.

Accurately Measuring Mortgage Availability

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The Urban Institute’s Housing Finance Policy Center has posted a research report, Measuring Mortgage Credit Availability Using Ex-Ante Probability of Default. This report tackles an important subject:

How to strike a balance between credit availability and risk to achieve a sustainable housing market is a much-debated topic today, but these discussions are not grounded in good measurements of credit availability and risk. We address this problem below with a new index that measures credit availability and risk simultaneously

The first section of the paper discusses the limitations of the existing measures. The second section describes our development of the new index, which distills borrower credit profiles, loan products and terms, and macro economic conditions into a measurement of the weighted average probability of default for mortgages originated at a given time. The third section illustrates the value of this measure by empirically exploring the varying risk appetites of the market as a whole, and of market segments, which directly aids evidence-based policymaking on how to open the tight credit box. The final section discusses the limitations of this new index. (1)
The report concludes,
Measuring a concept as complicated and varied as credit access is no easy task. Yet this is an important time to ensure that it is being measured accurately. As we seek to reform the housing finance system, Congress, the housing finance industry, advocacy groups, policymakers, and even the general public need to clearly understand how well the market is providing access to mortgage credit for borrowers. (18)
I say amen to that. There is a slim chance that housing finance reform may be back on the table in Washington, given the midterm election results. We need as much good data we can get in order to structure a system based on solid principles rather than on the views of special interests that typically dominate this debate.
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