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Debunking the allure of the 30-year fixed mortgage

 

(INMAN NEWS) Adjustable-rate loans, especially those with an interest-only component, recently have been shunned and criticized, hammered and nailed. If you are looking for sympathy in your daily life, simply mention at your kid’s weekend basketball game that you have an adjustable-rate mortgage (ARM) set to adjust in May.

Ever since the mortgage mess began to unravel, consumers have raced to fixed-rate loans, reportedly with a newly found “pay-it-off” mindset. While this appears to be great news, it does not ensure that these same folks will not dip into their home’s equity when the housing market eventually returns. That sort of discipline has yet to be proven among the baby boomers that have showed a tendency to refinance or take out a home equity loan for cars, vacations or a hot stock tip.

In reality, refinancing to a 30-year, fixed-rate loan may not be the best strategy for a homeowner looking for lower payments while hoping to reduce the principal.

For example, let’s assume a working couple has a five-year, interest-only ARM with an interest rate of 6 percent. When an ARM adjusts, the index and margin are added to arrive at the new interest rate. The index for the loan (the financial gauge that determines the loan’s interest after it adjusts) is the one-year LIBOR, 2.12 percent at press time. The margin (the amount added to the index to ensure a lender’s profit and cover costs) is 2.25. Combine the two numbers and the couple’s new interest rate is 4.37, lower than their initial interest rate. The couple could take the amount saved each month and apply it to the loan’s principal, thereby creating a fully amortized loan.

Loan advisor Tom Lasswell clarifies that allowing an ARM to adjust may be the best avenue for borrowers, especially if they are planning to remain in the home for only a short period of time. According to Lasswell, borrowers too often are swayed by the “flavor-of-the-month” loan, which may or may not be the best loan for them.

And, many consumers are also unaware that they can make extra principal payments every month on their interest-only loan. Most borrowers, even those with significant prepayment penalties, can make lump-sum payments to their principal balance as long as the lump sum is not greater than 20 percent of the current mortgage balance. For example, if a borrower had a $300,000 loan with a prepayment penalty, most of the time the borrower could pay $60,000 directly toward principal without triggering the penalty.

In a recent column, we discussed the case of a young woman with excellent credit and a decent job who bought a home four years ago. She was dinged with a new “risked-based” premium when she attempted to refinance due to a late credit-card payment on a company card she had had her name on at a previous job.

Why not just let her ARM adjust, make the new payment after the adjustment, and then refinance to a fixed-rate loan when her credit issues were resolved? The gamble would be the possibility of a higher fixed-rate loan environment down the road. Rates now are at historic lows, and loan officers and “the media” have been eager to promote the benefits of fully amortizing loans rather than the “just renting” element attached to interest-only mortgages.

Let’s look at the young woman’s situation again from a different angle:

After four years of perfect mortgage payments plus a move to a better job, the woman began the process to refinance to a fixed-rate loan. To her surprise, her credit scores had dropped considerably, due to a late credit-card payment. While her name was on the card, it was company business (custom printing, copying) and not her personal use. Before the card was transferred to her successor, a payment was missed.

After the missed payment, the woman’s credit scores from the three bureaus were 696, 706 and 756. Since most lenders take the middle score when it comes to mortgage qualifying, she was assigned a score of 706 on her loan documents, which then cost her an additional $2,364. Here’s why:

A 706 credit score had a “risk-based” markup of 0.75 points based on her estimated home value of $420,000. (If the value had appraised at $425,000 or more, the add-on would have been only 0.5 points because her loan-to-value ratio would have been below 75 percent). If the middle credit score was 740 or higher, there would be no add-on at all.

If the woman added the risk-based markup ($2,364) to the 1.675 percent loan fee ($7,035) the total ($9,399) would equal an amount slightly greater than the first two years of the principal portion ($9,233) on a $420,000 fixed-rate loan at 6 percent.

If you are considering a refinance from an ARM to a fixed-rate loan, first ask yourself how long you see yourself staying in the home. It could be very worthwhile to take all the fees you would pay for a refinance and pay down your present principal. If you have credit issues that need to work out to avoid paying higher fees, it may be worth staying put until your credit is repaired.

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Mortgages take priority by the order in which they are recorded in the county records. This priority is basically the order in which they would be repaid in case of a problem – ie: in the case of a foreclosure, collection, judgments, etc.

When you refinance and pay off the 1st mortgage, the current 2nd mortgage shifts into “1st position”, and any new mortgage would become a secondary lien. In order for this not to happen, permission is needed from the 2nd mortgagee to allow a 1st mortgage to get replaced through a refinance, and for them to remain in second position, where it is now.

The act or request for which we go through this process is called a Request for “Subordination of Mortgage”.

Does it affect them in anyway? Not really.

Are they obligated to do it? Absolutely not. 

Why would they subordinate? Because they are really loosing nothing. They may try to contact you to convince you to refinance the 1st mortgage with them, but ultimately if you are lowering the payment on the 1st mortgage, their mortgage is still safe, and you are only in a better financial position because your payments are lower. 

Why wouldn’t they subordinate? Frankly because they don’t have to, they might not want to. More so, because 2nd mortgages in the marketplace have lost so much value because home prices have gone down, and more people are delinquent on second mortgages, some banks are using this as leverage to say “no” to subordinations, in the hopes that you are forced to pay them off in full through a cash-out refinance.

What are the issues with subordinations?  It takes time to get a response from these banks as everyone is backed up for weeks. This will likely affect the interest rate lock-in or the ability to lock for a short period of time.

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