In Mortgage Finance

Raising a family and managing all the financial decisions related to food, shelter, clothing, healthcare, tuition fees, and additional living expenses in the already inflated counties and cities in high-tax California is not a pretty sight for most households.  Let’s face it; you have to pay to play in California.  In fact, there is common saying that once you leave California you cannot afford to come back.  Housing is another matter that has been out of control for years and it is not getting better it is getting worse.  The cost of housing is skyrocketing, and the last opportunity to get into the rising cost of California real estate will soon be gone as interest rates continue to rise.

Janet Yellen, the chairwoman of the Federal Reserve, announced that the federal discount rate  must increase in order to keep inflation under control.  This increase will negatively impact mortgage interest rates, and this will make choosing the right mortgage more difficult as you look for the lowest rate and payment possible, especially with all the options that are available today.  So what is the best mortgage on the planet that everyone should have?  If you do not know, then take my advice.  I have been a witness and a participant in the craziness of the mortgage business for the last thirty years. I have seen it all and I can help you.

So here is it – the best mortgage on the planet:  The 30 or 40-year fixed rate.

The 30-year fixed rate is the best and only option as far as I am concerned that a buyer has available, and it does not matter if you are a first time homebuyer or an experienced investor.  The 40 year is available but I believe the term is too long.   Do not apply for anything less or more than a 30-year fixed mortgage. This option is definitely the most popular mortgage in the United States. A 30-year fixed rate mortgage is a loan from a financial institution that must be paid off in thirty years. The long term allows for smaller monthly payments and the down payments can be as low as 3%.  A 30-year fixed rate mortgage also allows the buyer to borrow up to three million dollars depending on their credit, overall qualifications, and cash reserves. This mortgage option provides peace of mind and a clear path to paying off the mortgage with lowest possible payments as they work to achieve homeownership, which is the American Dream realized. Keep in mind that obtaining a mortgage to buy your home is just the beginning of the American Dream to own your own home. You must make all of the payments to pay it off to achieve the American Reality of Homeownership.  For many, the dream becomes a nightmare when they lose the home they were financing, because they received bad advice and were victims of predatory lenders and real estate agents.

There are, however, a few problems with the 30-year fixed mortgage. One is that you have no idea what your life is going to be like in thirty years. Perhaps you will have children to send off to college, retirement, or health problems to sort out. Dealing with the mortgage on top of life can be difficult but you have to have somewhere to live, so you have to ask yourself  the question: do you want a mortgage for 30 years?   Also, the mortgage interest on a home adds up quickly. For example, if you were to obtain a  mortgage of $500,000 dollars over thirty years at an interest rate of 4%, then the total interest paid after the thirty years will be approximately $359,349 dollars, which is a substantial amount of money that is added to the price of the home. This does not include the cost and fees associated with the mortgage, which is reflected in your annual percentage rate (APR).  $359,349 is just the interest you will pay in addition to the principle.

A risky alternative is a 15-year fixed mortgage. A 15-year fixed mortgage is the same as a 30-year fixed mortgage, but you pay for fifteen years instead of thirty. A benefit to this plan is that the amount of interest you have to pay is cut in half to approximately $165,719 and this is because you are paying the loan off in one half the time.  You will no longer need to worry about shelling out a large check to the bank every month even during your retirement. . Instead, that money becomes income to live your life.

The problem with a 15-year fixed mortgage is that the monthly payments are significantly higher than a 30-year fixed mortgage.  Many borrowers opt out of the 15-year fixed mortgage simply because the payments are not affordable and it may put them at risk of  defaulting on their loan. You may also not qualify for the mortgage because of the higher payment and may have to settle  for a smaller home, smaller mortgage, or higher down payment to meet the debt ratio requirements for the lender.  Buying a smaller home with a 15-year mortgage is something you should only consider if you are in your late 30s or early 40s.  Do you really want a mortgage when you are ready to retire or are getting close to retirement?

Another option for a homebuyer is an intermediate adjustable rate mortgage (ARM). An intermediate ARM has a below market initial interest rate that is fixed and lasts a set period of time of three, five, seven, or ten years.  The rate will adjusts annually after the fixed period for the remaining term of the thirty year loan.  The increase in the rate is limited to an annual rate cap and lifetime rate cap that is disclosed at the time of the application, so that you are completely aware of the rate risk.  The rate caps prevent the interest rate from increasing too high and too fast.  For example: at the end of the initial fixed period your interest rate and mortgage payment will most likely increase based on the combination of the index rate and margin value at the time of the cap.  The increase of your interest rate is limited to the interest rate cap of 2% annually and 5% over the lifetime of the loan. So if your initial rate is 3% at the end of your fixed period, your interest rate will be 5% until the next adjustment. No one can predict the future, so it is in your best interest to know what your payments could be if the interest rate increased to annual cap each year or achieve the interest rate equal to the life cap over the life of the loan.

What determines how much your rate will increase is the index rate at the time of the adjustment and the margin value. The index rate is a variable rate tied to a publicly traded security. The margin value is fixed throughout the lifetime of the loan and represents the profit that the lender makes on the loan and is negotiable. The index rate is tied to variable interest rates that are published regularly and available publicly. Typical index rates that are associated with ARMs are LIBOR (London Interbank Offered Rate), COFI (11 District Cost of Funds), T-Bill (U.S. Treasury Bill), and CMT (Constant Maturity Treasury).  To determine your interest rate on an ARM, add to your index rate to the margin value and the result is the fully indexed rate for an adjustable-rate mortgage.  This rate determines your mortgage payment until the next adjustment period in six months or one year depending on the program you choose.   For example, If your index rate is 2% and your margin is 2.75% , then your fully indexed interest rate would be 4.75% percent at the adjustment period; however, the rate cannot exceed the annual or lifetime rate cap and its corresponding payment.

The initial interest rates for ARMs are normally lower than a fixed rate, which in turn means your monthly payment is lower temporarily. Many people choose this plan, because they are sold on the dream or hope of making more money in the future, selling the home at a higher value, or the hope that something great will happen to prepare them for the future when the interest rates adjust. Unfortunately, bad things happen to good people all the time and your great plans may not come to pass. The ARM loan is just a trick in the mortgage industry to help you buy more house than you can afford, so do not fall for it.  It sounds great, but it is not.  It is like car dealers who have one car price below market and they advertise it to get in to sell you another car at or above the market price.  Unfortunately, if you take the bait with the ARM you may be stuck when the honeymoon of the low initial start rate is over. After this happens you have to face the reality of paying the real mortgage payment for the home of your dreams instead of the home you can really afford. One of the reason many people choose ARMs over a 30-year fixed rate mortgages is because they have champagne tastes and beer budgets.  In other words, they are buying more house they can afford.  It is like the person who buys a 60k car with payments equal to or in some cases higher than their rent, and they have yet to purchase a home.  In fact, they cannot purchase a home now because of the car payment.  If they had purchased a home first ,they would not have purchased the car.

ARMs are generally considered high risk loans, because your interest rate will go up after the initial fixed-rate period ends. Most people who can afford to buy a home and have prepared themselves to buy do not take this mortgage. The benefits are temporary and may result in higher cost, because you are forced to refinance or even sell the property because you can no longer afford the mortgage payments after the adjustment.  To make matters worse, you may not be able to sell if the property value decreases and there is not enough equity to sell or refinance. In my opinion there are no advantages associated with any ARM that is worth the risk of the mortgage payments being too high to pay. The value of your home may increase or decrease, but as long as you can afford the payment you will be okay.

The market is changing, California real estate is going nowhere but up, and it is the same everywhere. Interest rates are rising and we will see a market correction in real estate and the stock market. The baby boomers are downsizing and as a result we will see inventory increasing and prices dropping in larger homes, and we will see increase prices on smaller homes, townhouses, and condos where the homes are most affordable.  Do not be surprised to see many people downsizing because they are ready to retire. The baby boomers and senior citizens represent the fastest growing population in the US that are headed to retirement, and they do not want a mortgage. The millennials would rather not be burden with a mortgage so small, and affordable is their focus. The demand for homes in $200k to $400k is going to increase significantly in California for sure.  Every state has their affordability range.

Choosing the right mortgage when you are ready to buy imperative.  Stay away from the adjustable-rate mortgage loan as interest continues to rise and choose a 30-year fixed.  If you cannot afford the payment, then buy a smaller home.

Want to know more? Go to www.thepowerisnow.com and join the buyer’s and seller’s club for free to get  free support, consultation and information from me and my team. You have the power to change your life now because The Power Is Now.

 

Eric Lawrence Frazier MBA

President and CEO

 

Reference

Register on Real Estate Blog: Orange County Register: 30-year mortgage rates drop slightly. Retrieved August 3, 2015.

30-year mortgage rate drops to 4.04%. Retrieved August 3, 2015.

Register on Real Estate Blog: Orange County Register – The Orange County Register. Retrieved August 3, 2015.

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