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Interest rates on mortgages are
continuing to hold at historically low levels. These low levels combined
with the tremendous variety of lenders and loan products available to the
consumer, provide an opportunity that has never existed before. The smart
borrower can put together financing packages that his parents never would
have even dreamed of. This article touches on a few ways consumers can use
current low rates and new loan programs to save money. Since a home
mortgage is usually the single largest outstanding item of debt on a
personal balance sheet, managing this debt wisely can reap substantial
benefits to almost every homeowner. Some useful techniques include the
following:
·No Closing Cost Loans
·Hybrid Loans - Shorter Fixed Periods
·Using ARM Teaser Rates in Your Debt
Strategy
·Eliminating Mortgage Insurance
No Closing Cost Loans
Any loan where the broker or lender pays
all of your closing costs is commonly referred to as a ``no closing cost''
loan. These closing costs would include title & escrow fees,
appraisal, lender's fees, credit report fees, and other expenses which are
non-recurring over the life of the loan. Lender's use the term
non-recurring to refer to only those expenses which are one time, and to
exclude items such as interest, insurance, and property taxes, which are
considered recurring closing costs because they will continue to be
expenses every month. Recurring costs are not covered expenses in a no
closing cost loan.
In the mortgage market, there are a
variety of interest rate and point combinations available to the borrower
at any point in time for the same product or loan type. As an example, for
a loan amount of $200,000 a borrower can be quoted 6.75 percent with .875
percent points, 7.0 percent with zero points, or 7.25 percent with no
closing costs. All three of these quotes are for a 30 year fixed rate
mortgage. The lender allows the borrower to choose amongst rate and point
combinations since some people prefer a lower rate immediately, while
others prefer minimizing how much they pay out of pocket upfront. Thus,
the borrower can select the combination which feels most comfortable to
their personal situation. For some borrowers, the no closing cost option
of 7.25 percent, while providing a slightly higher rate, still requires
the least investment upfront and therefore is the best option.
No closing cost loans can be used for
either a refinance or a purchase transaction, although they are most
commonly associated with a refinance. A no cost refinance is the quickest
way to generate immediate interest rate and payment savings with no
upfront investment in closing costs. To continue with our example, let's
assume that a borrower is currently at 7.5 percent on a 30 year fixed rate
loan and is interested in refinancing now that interest rates are
declining. But what is the best time to finally ``bite the bullet'' and
lock in a rate? If the person chooses to refinance using the no closing
cost method, it doesn't matter when they lock in, so long as they are
immediately saving money by refinancing. By choosing the 7.25 percent no
closing cost loan, their payment would decrease right away, with no
upfront investment to refinance. Should interest rates continue to
decline, the borrower can simply refinance again to obtain additional
savings.
In a purchase situation a no closing
cost option can work extremely well when the borrower has limited funds
available for closing or when the rate market is declining and the
borrower may want to refinance quickly. While most people associate a
purchase with paying points just to obtain tax deductibility of the
points, this is too simplistic a view. While the tax deductibility is an
important factor, it is only one consideration for a borrower. Paying
points upfront to secure a low rate, in a steadily declining interest rate
market, may be simply throwing money away.
With a true no closing cost loan, you
can refinance for any incremental drop in your interest rate. Because
there is absolutely no investment in upfront costs, the savings of
refinancing are immediate. In a market where you believe rates may
continue to fall, it makes sense to refinance at no cost. Should interest
rates decline further, you can refinance again without having to recoup
the closing costs. Many borrowers refinance every year or less at no cost,
while keeping their initial teaser rate in an Adjustable Rate Mortgage!
Hybrid Loans - Shorter Fixed
Periods
If you want the security of a fixed rate
mortgage but like the lower payments of an adjustable rate mortgage (ARM),
a hybrid loan may be the product for you. A hybrid loan is one of the many
loans currently available that is fixed for a shorter time than the
traditional 30 or 15 years.
Hybrid loans can be found with fixed
rate periods of 3, 5, 7, and 10 years. All of these loans are still
amortized over 30 years so there is no need to worry about the monthly
payment being too high. And at the end of the fixed period, these loans
automatically roll into another ARM, so there is no balloon payment to
anticipate. By matching up how long you plan on keeping your loan with the
closest fixed term you can minimize your interest rate, since a 30 year
fixed mortgage is a much more expensive option.
The advantage of a hybrid loan is the
lower rate of interest that they require. It is important to point out
that in the above example, the 30 year fixed rate is actually lower than
the 10 year fixed/ARM. In a perfect market, the shorter the fixed term the
lower the rate, however this isn't always the case. Market inefficiencies
do exist and while this may not make economic sense (the longer fixed term
being priced lower than the shorter term), it is one of the current
inefficiencies in the mortgage market. Also, because fewer lenders offer
10 Year fixed products than 30 year fixed rates, there is less competition
to drive down the prices of the 10 year loans. It is important to not only
track one specific product but to view several in a search to find such
inefficiencies and exploit them when possible.
Using ARM Teaser Rates in Your
Debt Strategy
Many lenders offer low introductory
rates on mortgages which then adjust after some period of time, typically
six months or one year. These Adjustable Rate Mortgages with low teaser
rates can be used successfully to minimize mortgage payments and interest
costs. While this type of loan may seem risky, it can be the perfect loan
in a stable or declining rate environment to use while interest rates hold
steady or continue to fall. This type of approach relies on using no
closing cost or low point loan choices, versus paying upfront points and
costs. Any borrower can take advantage of the teaser rate options, however
the strategy of refinancing frequently to replace the teaser with another
teaser rate works best when the borrower's loan balance is at least
$200,000. This is because below this amount it is difficult to obtain a no
closing cost loan. The higher the loan balance, the better this strategy
works. When the ARM is about ready to adjust up again, the borrower can
refinance again for no cost at another low teaser rate.
Many borrowers have been successful in
averaging their interest rates below 7 percent for the better part of the
last four years. With the advent of Web mortgage sources it is now easier
to obtain rate information and follow the market closely for such
opportunities. Risks to this strategy include facing an unfavorable
interest market when the time comes to refinance. However, the market does
not move overnight and it is possible to lock in a rate quickly when
movements upward are detected. Alternatively, when you consider all of the
savings on the front end, a slightly higher than expected rate on the back
end may still leave you ahead of the game.
Eliminating Mortgage Insurance
(MI)
If you purchased your home with less
than 20 percent down, chances are you have a loan that is insured by
``Mortgage Insurance'' (MI). Most borrowers are aware that they are paying
it on a monthly basis, but you can check your statement to be sure. As
your home appreciates or your loan balance decreases (or a combination of
the two), your equity in the home will exceed 20 percent. At that time a
favored method of eliminating the MI tied to the loan is to refinance. The
savings on the MI alone can often warrant the refinance.
Be aware that mortgage lenders value
your property at what the comparable homes have sold for in the last 6
months, not what they are currently listed for. If you are close to that
20 percent mark, ask your mortgage source to give you a ``compel search''
figure which will tell you what the lenders will see your home's value as.
To summarize, there are many ways to
approach your home financing that can save you thousands of dollars over
the life of your home ownership. Since most people have mortgage balances
that are substantially greater than their total assets, the limited time
spent in creatively viewing your financing can save you substantial
interest costs. Times have changed and the choices for mortgage loans have
grown so investigate your options and enjoy the benefits of lower
interest.
Hal Schupp, CRS, GRI, Designated Broker for Vail Realty, has been
a Tucson, Arizona, Licensed Real Estate Broker since 1987 and has created
100s and 100s of sales of Tucson properties.
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