Thursday, April 18, 2013

Common Mortgage Questions - Part 2

This is about a week later than I wanted, but I was able to implore the help of one of our newest colleagues- Sarah Stedman.  She is an up and coming LO and so her insight into questions from potential clients was greatly appreciated.  So without further ado - Part 2:

  1. What is the difference between an ARM and a Fixed Rate?
    • ARM (Adjustable Rate Mortgage) is a mortgage product that typically involves an introductory interest rate that in the future will adjust based on a variety of factors.  The most common ARM loans are 3/1, 5/1, 7/1, 10/1.  The first number means the introductory rate is fixed for the first 3, 5, 7, or 10 years respectively.  The second number following the "/" mean that every year after the introductory fixed period the rate could adjust based on the current market.  For example:  On a 3/1 ARM the introductory rate of 3.00% is fixed for the first three years and then every year after that for the next 27 years the rate could adjust.  Within the ARM program there are varying items that will affect the adjustment.  These include the Margin, Floor, Caps, Max Rate and whether it is based on the CMT or LIBOR.  We will explore these items in depth at a later time.

    • Fixed Rate is a mortgage product where the rate is fixed for the entire term of the loan.  The most common fixed rate options are the 30 YR Fixed Rate and the 15 YR Fixed Rate option (though you can choose varying terms, i.e. 20 YR, 25 YR etc.)  For example: On a Purchase or Refinance you lock the rate at 3.75%, it will never change or adjust until the full 30 years is up.  This means that the only items that will change on your payment could be a change to your homeowners insurance premium and/or if the county property tax rate changes for the property you own.  Your principal and interest payment will always be the same.
     2.  Is there a situation where an ARM loan a better option than a fixed rate loan?

    • That's a difficult question to answer.  Mostly because each borrower, situation and set of circumstances surrounding the purchase or refinance on a property are always different.  There is no "one size fits all" category to mortgage loans.  However, the duty of the Loan Originator is to provide the best options for the clients for their particular set of needs.  With that in mind, let's look at some key pros and cons to the differnt programs.
      • ARM Loans
        • PRO - Typically a Lower Interest Rate with the shorter term ARMS is evident.  A lower interest rate does lessen the interest cost that is paid to the bank during the introductory period and this reduces the principal balance faster.  Remember - less interest to the bank means more that can be applied to your principal balance.
        • CON - Rate may adjust higher in the future which means more money to the banks and less towards principal.
        • PRO - Borrower plans on selling within the timeframe on the loan.
        • CON - Life, circumstances and markets can change so they may not sell.
        • PRO - Lower payment could mean that a borrower could afford the payment
        • CON - Any changes in the market could render the home no longer affordable which could leave the borrower in a bad situation.
      • Fixed Loans
        • PRO - Certainty of the same payment every month.
        • CON - Rates are typically higher than the shorter ARMS so more interest is being paid to the banks and less towards your principal balance.
        • PRO - Most common Programs - allows the borrower to set a budget for home affordability
        • CON - Could limit your buying power because of the higher rates
        • PRO - Simple and Effective
        • CON - Most buyers don't keep their loans for 15 or 30 years.  The average homeowner refinance or moves every 5-7 years.  This means that more interest was paid out and less towards principal in the early stages of the loan.
Overall, the 15 and 30 YR Fixed rate options are the most common programs used today.  They allow certainty which, in this market, is great.  The rates are historically low so affordability shouldn't be a hinderance.  Plus, one should never switch to an ARM program to try and squeeze into the box so they can qualify.  This will inevitably lead to a bad situation. 

The best answer must come from each borrower individually.  Experts can predict the future, we can plan the future, but nobody really knows the future.  If you understand the loan program (whether it is Fixed or ARM) and you are comfortable with what the potential future holds with the loan you choose, then either option is valid.  I don't believe there is a specific situation where an ARM loan is "better" than a Fixed Rate loan.  I think they are different options to choose from and education is the key to making the best decision.


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