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Loan
Programs
Fixed Rate Mortgages
The most common type of mortgage program where your monthly payments for
interest and principal never change. Property taxes and homeowners insurance may
increase, but generally your monthly payments will be very stable.
Fixed-rate mortgages are available for 30 years, 20 years, 15 years and even
10 years. There are also "bi-weekly" mortgages, which shorten the loan by
calling for half the monthly payment every two weeks. (Since there are 52 weeks
in a year, you make 26 payments, or 13 "months" worth, every year.)
Fixed rate fully amortizing loans have two distinct features. First, the
interest rate remains fixed for the life of the loan. Secondly, the payments
remain level for the life of the loan and are structured to repay the loan at
the end of the loan term. The most common fixed rate loans are 15 year and 30
year mortgages.
During the early amortization period, a large percentage of the monthly
payment is used for paying the interest . As the loan is paid down, more of the
monthly payment is applied to principal . A typical 30 year fixed rate mortgage
takes 22.5 years of level payments to pay half of the original loan amount.
Adjustable Rate Mortgages (ARM)
These loans generally begin with an interest rate that is 2-3 percent below a
comparable fixed rate mortgage, and could allow you to buy a more expensive
home.
However, the interest rate changes at specified intervals (for example, every
year) depending on changing market conditions; if interest rates go up, your
monthly mortgage payment will go up, too. However, if rates go down, your
mortgage payment will drop also.
There are also mortgages that combine aspects of fixed and adjustable rate
mortgages - starting at a low fixed-rate for seven to ten years, for example,
then adjusting to market conditions. Ask your mortgage professional about these
and other special kinds of mortgages that fit your specific financial situation
Standard ARMS and the Differences
A few options are available to fit your individual needs and your risk
tolerance with the various market instruments.
ARMs with different indexes are available for both purchases and refinances.
Choosing an ARM with an index that reacts quickly lets you take full advantage
of falling interest rates. An index that lags behind the market lets you take
advantage of lower rates after market rates have started to adjust upward.
The interest rate and monthly payment can change based on adjustments to the
index rate.
6-Month Certificate of Deposit (CD) ARM
Has a maximum interest rate adjustment of 1% every six months. The 6-month
Certificate of Deposit (CD) index is generally considered to react quickly to
changes in the market.
1-Year Treasury Spot ARM
Has a maximum interest rate adjustment of 2% every 12 months. The 1-Year
Treasury Spot index generally reacts more slowly than the CD index, but more
quickly than the Treasury Average index.
6-Month Treasury Average ARM
Has a maximum interest rate adjustment of 1% every six months. The Treasury
Average index generally reacts more slowly in fluctuating markets so adjustments
in the ARM interest rate will lag behind some other market indicators.
12-Month Treasury Average ARM
Has a maximum interest rate adjustment of 2% every 12 months. The treasury
Average index generally reacts more slowly in fluctuating markets so adjustments
in the ARM interest rate will lag behind some other market indicators.
Introductory Rate ARM's
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 company to company 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.
London InterBank Offered Rate (LIBOR)
LIBOR is the rate on dollar-denominated deposits, also know as Eurodollars,
traded between banks in London. The index is quoted for one month, three months,
six months as well as one-year periods.
LIBOR is the base interest rate paid on deposits between banks in the
Eurodollar market. A Eurodollar is a dollar deposited in a bank in a country
where the currency is not the dollar. The Eurodollar market has been around for
over 40 years and is a major component of the International financial market.
London is the center of the Euromarket in terms of volume.
The LIBOR rate quoted in the Wall Street Journal is an average of rate quotes
from five major banks. Bank of America, Barclays, Bank of Tokyo, Deutsche Bank
and Swiss Bank.
The most common quote for mortgages is the 6-month quote. LIBOR's cost of
money is a widely monitored international interest rate indicator. LIBOR is
currently being used by both Fannie Mae and Freddie Mac as an index on the loans
they purchase.
LIBOR is quoted daily in the Wall Street Journal's Money Rates and compares
most closely to the 1-Year Treasury Security index.
Balloon Mortgages
Balloon loans are short term mortgages that have some features of a fixed
rate mortgage. The loans provide a level payment feature during the term of the
loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not
fully amortize over the original term. Balloon loans can have many types of
maturities, but most balloons that are first mortgages have a term of 5 to 7
years.
At the end of the loan term there is still a remaining principal loan balance
and the mortgage company generally requires that the loan be paid in full, which
can be accomplished by refinancing. Many companies have other options such as a
conversion feature at the end of the term. For example, the loan may convert to
a 30 year fixed loan at the thirty year market rate plus 3/8 of a percentage
point. Your conversion can be guaranteed based on certain criteria such as
having made your last 24 payments on time. The balloon mortgage program with the
conversion option is often called a 7/23 Convertible or 5/25 Convertible.
Interest Rate 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 costs were usually paid for by a
transferring company because of the high points associated with them.
In today's market, mortgage companies 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.
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%.
Cost of Funds Index (COFI)
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 Bank's 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 the 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.
Graduated Payment Mortgage (GPM)
The GPM is another alternative to the conventional adjustable rate mortgage,
and is making a comeback as borrowers and mortgage companies seek alternatives
to assist in qualifying 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 a
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.
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).
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.
Choosing A Mortgage Program
There isn't a single or simple answer to this question. The right type of
mortgage for you depends on many different factors:
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Your current financial picture.
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How you expect your finances to change.
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How long you intend to keep your house.
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How comfortable you are with your mortgage payment changing.
For example, a 15-year fixed-rate mortgage can save you many thousands of
dollars in interest payments over the life of the loan, but your monthly
payments will be higher. An adjustable rate mortgage may get you started with a
lower monthly payment than a fixed-rate mortgage -- but your payments could get
higher when the interest rate changes.
The best way to find the "right" answer is to discuss your finances, your
plans and financial prospects, and your preferences frankly with a mortgage
professional.
We’ll make
it easy! Call us at (951) 296-2280 so we can best assist you with your
with your lending needs.
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