How To Avoid The Adjustable Rate Mortgage Squeeze
Some key questions and important definitions for every homeowner’s financial arsenal.
In recent years new and “alternative” loan products have been making the dream of homeownership a reality for many Californians. Adjustable rate mortgages, 100 percent financing and interest only loans have given hope to consumers who thought that they would never be able to afford a home.
Now that interest rates are on the rise and many of the alternative loan products are poised to adjust to the current market, the California Association of Mortgage Brokers (CAMB) is encouraging all homeowners to take a refresher course and meet with their brokers, review their current mortgage status and come up with a financial game plan regardless of their situation.
While a majority of homeowners will be able to handle the increased rates, the Association is providing key questions every homeowner should ask about their mortgage to solicit real and factual answers about their financial situation.
Hybrid Fixed/Adjustable Rate Mortgages – This loan has an initial fixed rate period (typically for three, five, seven or 10 years) that rolls into an adjustable rate loan that adjusts either monthly or annually.
Key questions to ask:
• What are my options for a fixed rate period?
• Is the fixed rate period interest only or fully amortized?
• What is going to happen to my payments at the end of the fixed rate period?
• Is my total loan balance due at the end of my fixed rate period?
Interest-Only Mortgages – This allows borrowers to pay the interest without paying on the balanced owed on the loan. Once the interest-only period is over, the monthly payment resets to repay the loan over the remaining term. These products are available on both fixed rate loans and hybrid fixed/adjustable loans.
Key questions to ask:
• When will my loan reset to a higher payment?
• What is my payment going to be at the first adjustment based on interest rates today? If rates increase 1 percent?
• Can my interest rate change over the term of my loan? When? How often?
Option Adjustable Rate Mortgages (Option ARM) - This loan offers low introductory rates then the option of a minimum payment (at the low introductory rate typically for one year), interest-only, or a fully amortized mortgage payment.
Key questions to ask:
• Can my principal balance increase (negative amortization or deferred interest)?
• Is there a cap to how much my principal balance can increase and what happens if this cap is reached?
• What index is my loan tied to?
• What margin does my loan have?
• What is the actual interest rate being charged to me (index + margin = fully indexed)?
• Am I paying less than the interest charged to me?
• Am I borrowing every month if I make my minimum payment?
• Will I be penalized if I pay my loan off early?
To find the mortgage best for you, make sure to work with a mortgage broker who will clearly explain the benefits and risks involved with each loan option. CAMB is also urging consumers to learn the loan terms most commonly used in the popular alternative loan products. Common terms include:
1. Life Cap – the maximum interest rate allowed during the life of the loan.
2. Negative Amortization (Neg-Am) or Deferred Interest – an increase in the mortgage debt that occurs when the monthly payment is not large enough to cover the entire interest due.
3. Recast – to recalculate the monthly payment on a loan so that the loan will be fully paid off during the remaining term of the loan.
4. Amortize – to fully pay down the balance of a loan including the principal and interest over a specific period of time.
5. Margin – fixed percent interest paid over the index. This is also known as the “lenders markup” which is similar to purchasing a product at a store and paying the cost of service. The margin is combined with the index to determine the interest rate charged.
6. Index – the interest rate in adjustable rate mortgages (ARM’s) are based on various indices that may change as often as month to month. As they fluctuate, the payment on the mortgage also fluctuates. Homeowners with ARM’s should check their loan documents to see which index is tied to their loan.
Three commonly used indices:
COFI (11th District Cost of Funds Index) – represents the weighted-average cost of savings, borrowings, and advances of the 11th District members of the Federal Home Loan Bank of San Francisco.
MTA (12-Month Treasury Average Index) – based on preceding 12-month average of treasury yields. The treasury yields are published by the Federal Reserve Board on the first Tuesday of each month.
LIBOR (London Inter-Bank Offered Rate) – the rate London based banks offer each other for inter-bank deposits. It is also known as the rate at which a fellow London bank can borrow money from other banks.
This information will offer key clarifications for homeowners but it does not replace the value of sitting down with a broker to discuss their particular situation. The California Association of Mortgage Brokers offers a toll-free consumer information hotline, which puts consumers in touch with local mortgage brokers who can answer their questions. All CAMB brokers adhere to a strict code of ethics and are experts in their field. Consumers can go online to www.cambweb.org to find a member broker in their area.