Mortgage Structure Question

Discussion in 'After Hours Lounge (Off Topic)' started by Anthony_J, Dec 27, 2004.

  1. Anthony_J

    Anthony_J Stunt Coordinator

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    I need a little input from anybody well-versed in mortgage structuring...

    I recently signed up for an 80/10/10 mortgage. The 80% mortgage is a 5/1 ARM at 5.125%, my caps are 2% annually or 11% over the life of the loan. The second (10%) loan is a 15 year fixed at 6.95%.

    My mortgage guy recommended setting the 80% loan up as an interest only so I can take the difference between a fully amortized payment and the interest only payment and apply it against the second loan (to get rid of the higher-interest balance faster). There's no pre-payment penalty to do this.

    Note that monthly cash flow savings are not the driver for the interest only structure. In fact, I've never heard of interest only mortgages until the banker brought it up. In essence, my total monthly payment will be the same as if I had two fully amortizing payments, it's just a matter of the loan to which the payments are applied.

    This just seems terribly complex. Has anybody had any experience with this? What are the drawbacks, watch-outs, risks, etc. to do this? It seems that this may be a good plan of action provided that interest rates stay below the rate on the second loan (6.95%), but that I may lose money if rates go above 6.95% after five years, correct?

    Any thoughts would be appreciated.
     
  2. Scott Merryfield

    Scott Merryfield Executive Producer

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    My experience with ARM mortgages has not been good, so we avoid them completely now. Even when interest rates were stable, our rate was raised the maximum 2% after the first year, which immediately pushed it above the prevailing fixed rate. Do not be surprised if your rate goes up the maximum after the first year, too.
     
  3. Todd Hochard

    Todd Hochard Cinematographer

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    I'm about to do almost exactly what you're doing, with the purchase of a home in Northern VA.

    The drawback is that your first mortgage is variable-rate. The 80% 1st mortgage is fixed at the 5.125% for the first five years. After that, it's anyone's game, but expect that it will rise at least a couple of points.

    Another drawback to an interest-only product is that you aren't paying down the principal. That's pretty much irrelevant in a rising real-estate market, but becomes real important in a stagnant or deflating one.

    I intend to worry about that in five years.[​IMG] At that time, if rates are decent, you'll have the option of refinancing into whatever program you like, if the ARM is going to adjust too high. Worst case scenario- around year seven or eight of the mortgage, the payment becomes too uncomfortable, and you bail to a smaller/cheaper home.

    My 10% 2nd will be a variable-rate HELOC. I am intending to pay that off within the five years, so that when the first does begin adjusting, the 2nd will be all gone, and I'll have 20% (or greater, assuming appreciation) equity in the property.

    It is a slight risk, to be sure. I feel that I am essentially forced into this silly game, because too many people have opted this way before me, which, IMO, is a big factor in the ridiculous rate of rise in real estate prices right now.

    Todd
     
  4. ScottHH

    ScottHH Stunt Coordinator

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    What is the index your ARM sets off of? and what is the margin? It's probably something like 1 year T-bills +200bps. That's the rate you need to pay attention regarding where the ARM will price in 5 years, not current mortage rates.

    Most people refinance before their loans being to adjust. But that's because interest rates have basically only gone in one direction past 20 years--down.

    If you plan on selling the house before 5 years, you should pay the higher rate (the fixed rate loan) down first, like your banker suggested. And this is a good suggestion, because the average mortage is paid off within 7-years (house sold or mortgage refinanced).

    Otherwise,
    If you believe rates are going to go up, you should pay down the ARM first.
    If you believe rates will stay here or go lower, you should pay down the fixed rate loan first.

    At the beginning, most of the payment is interest, not principal pay down. So you'll pay down about $1,400 in principal for each $100,000 you've borrowed in the first year. The difference in interest on the ARM and the fixed side is less than $30 per year at the end of the first year. That difference will grow, but it's not big enough to lose sleep over! Is the rate on an interest only 5/1 the same as an amortizing 5/1? If it is higher, I'd be inclined to go for the amortizing loan.

    The difference between 5/1 ARM and fixed rate mortgages has narrowed significantly in recent months. Are you sure it's worth the risk to take the ARM? How much would they charge you to do the whole thing fixed rate? Especially if you think you're in this home for the long haul (7+ years), then you won't have the refinance risk in 5 years associated with the ARM.
     
  5. todbnla

    todbnla Screenwriter

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    Just wondering for anyone who wants to answer, anyone using QUICKEN for their Mortgage? Some of this sounds like them?
    PLMK
     
  6. Anthony_J

    Anthony_J Stunt Coordinator

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    The ARM is adustable based on LIBOR plus 2.5%. I've heard that this is pretty standard.

    My mortgage place will give me 5.8% on a 30 year fixed as opposed to a 5.125% 5 year ARM. In terms of monthly payments (fully amortizing), the fixed rate will cost me about $5,500 over the 5 years that I could have been locked at 5.125%. Even if I were to get hit with 2% increases in subsequent periods, it would still take about 2 years before a 30 year fixed mortgage would provide savings. By that time, I'll be 7 years into the house and probably ready to move anyway.

    I have seen 5.5% offered on the internet, which would make it worth going with a fixed rate mortgage. However, I've been told that some of those internet trollers are shady - like they'll hit me with ridiculous closing costs in return.
     
  7. Denward

    Denward Supporting Actor

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    FYI, here's historical LIBOR info:
    http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=141&a=627

    You should know which LIBOR they're talking about. I'd bet they're talking about USD LIBOR, but there's 1 week, 2 week, 1 month, 2 months, ..., 12 months.

    As far as this being a "standard" index, I'd say it's one of several acceptable indexes. You just want something that's well-defined, reflective of interest rates in general, and unlikely to become extinct. LIBOR is becoming (or already has become) the most universally accepted short term interest rate index. US treasuries used to be the most accepted, but short term treasuries are subject to distortion because large investors often buy them in large quantities as cash proxies, thus driving down the interest rates.
     
  8. Todd Hochard

    Todd Hochard Cinematographer

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    I put in a request to quickenloans.com, and someone from Rock Financial called me back. She offered a 3/1 int-only at 5.5%. She was all about the high-pressure NOW NOW NOW thing, too. When I told her that her rates weren't very good, she accused the broker I ultimately went with (a local Virginia broker, with a Chase Manhattan loan) of flat-out lying about the rates. I told her that perhaps she'd have better luck with someone less educated, and to have a nice Christmas.[​IMG]

    My line of work is such that I don't think I'll be in the same place/city in seven years, which is why I convinced myself to go with the 5/1 ARM.

    Todd
     
  9. todbnla

    todbnla Screenwriter

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    Todd:
    When I called, man were they high pressure [​IMG] She even tried to give me a $500.00 "credit" to do it that day. I told here no and to call me the next working day which was Monday, she never did...[​IMG] and she said almost the same thing about another bank I was quoting. [​IMG]

    Still Looking into Country Wide but My mother-in-law works in our county's tax department and she says that they have more problems with C/W paying the property taxes correctly (read not enough at times) out of all of the companies out there.
     
  10. Scott Merryfield

    Scott Merryfield Executive Producer

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    That's interesting regarding the high-pressure sales from Quicken/Rock. We did not have that experience, but we only talked with them when we were ready to refinance, so they did not have to "sell" us.

    Our two current mortgages are with Countrywide (brokeraged through Rock Financial). We have not experienced any issues, but we pay our own property taxes on both properties.
     
  11. Brian Perry

    Brian Perry Cinematographer

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    Keep in mind, some of that $5,500 might be reduced by tax savings (if you haven't figured that in to the number yet).

    I've never heard of an 11% cap (unless the 11% refers to the actual max interest rate). Most caps are at 6%. Of course, hopefully you won't be in the loan anymore at that point...
     
  12. Anthony_J

    Anthony_J Stunt Coordinator

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    Thanks for the info, all.

    They're using the USD 12 month LIBOR as the basis for the ARM.

    I haven't calculated the cash flow effect of a fixed vs. ARM net of tax, but my gut tells me that it'll work out about the same because I'll also get an increased tax deduction when the ARM starts to float (and I'll hopefully be in a higher tax bracket).

    The oddest thing is that I'm a CPA. I understand all of the terms, etc. but I still can't help feeling like I'm being taking to the cleaners (even though I like my mortgage people). The mortgage industry is a totally different world - I can see how easy it is to get lost in all of the complexities.
     

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