Thursday, January 17, 2008

ARMed (Mortgage types Explained)

We are getting down to the nitty gritty, getting everything in order to get everything in order to get this damn thing done.

One of the things still outstanding is the mortgage commitment letter. As I've stated before, getting this together is a project in itself, and we almost have everything except for one small detail, that being Amanda and I forgot to sign Page 1. that will happen tonight.

Last night as I read over the document I had noticed we were getting a 7 year ARM mortgage, which I was confused because I thought we'd go for a fixed. So i e-mailed my guy and asked him if he could explain the difference and why we would want over the other.

So i present to you what he told me, and in case you're wondering what type of loan you might want to get, here is what you need to consider going in:

1)How long you think you might live in your place (is it big enough that you would stay over 10 years and raise a family)?
2) Even if you don't think you'll live there for more than 5-7 years, do you think you might keep the property as an investment?

And here we go...

There are generally two types of loans. Fixed Rate, and an Adjustable Rate Mortgage, or (ARM), hence the title of this post.

1. A Fixed Rate Mortgage (FRM) has a rate and payment that will not change over the life (30 years) of the loan.

2. An Adjustable Rate Mortgage (ARM) has a fixed rate for a given period (3,5,7,or 10 years) and then adjusts within limits annually up or down based on Treasury Bill rates for the remainder of the term totaling 30 years.

3. The rate associated with a FRM is typically 0.5-0.75% higher than an ARM because the bank is guaranteeing the rate for a longer period and therefore assuming more risk and charges for that risk. (Imagine rates going astronomical and the bank is screwed because they can't adjust the rate).

The rule of thumb in deciding which way to go is to think about how long you will own the property. Assuming you will only live there between 5-10 years, you would be paying more over the life of your ownership with a FRM because you would really not be taking advantage of the benefit of the extended rate guarantee. If you expect to stay there more than 10 years then you should probably take the FRM.

Taking an FRM if you are going to stay less than 10 years, is sort of like buying more than you need, (and never using it). If you decide later that you want to stay longer, you can always refinance without penalty. Sometimes if the rate gets to a place that the banks are happy with, they may offer you a fixed rate later down the road.
For our purposes, we are going with the 7 year ARM. Basically, we spoke today and we realize that while we do want to have our children there and have them go to the school in the park slope school system, I can't imagine having w kids around the ages of 9 and say 6-7 all in our apartment. At some point in that time frame, we will probably look to move. (Look forward to

The next question is whether or not to opt for an Interest Only option. This is a variation on the ARM that permits you to pay only the interest with an option to make principal contributions whenever you wish.

The upside
: you control your cash flow better on a month to month basis and when you make any principal contribution, the loan will recast so that the interest charged in ensuing months will be calculated on the outstanding balance.

The downside: the rate is about 0.25% higher than a fully amortizing(Principal plus interest) loan, but the savings in interest based on the recast feature usually negates that.

A hugely positive thing about interest only loans: Your required monthly payments are lower and younger borrowers who are upwardly mobile (love that term) usually like the freedom of structuring their cash flow at the beginning of the loan and then make principal contributions as they acquire more liquidity. Win win.

OK, so what does it mean that we have a 7 year ARM?

It means that rate we lock in now is actually fixed for 7 years, and in the 8th year it adjusts annually based on the market differential from the initial rate. This way, if you don't plan on staying in your pad for more than 7 years, you most likely won't have to deal with this issue.

We asked our broker if he thought we should go for a 10 year ARM, and he told he didn't recommend because there isn't enough of a rate difference between that and the 30 yr fixed to be meaningful. If you're thinking about the 10 yr ARM then take the 30 yr fixed.

Finally, if you're wondering to yourself, 'well what if i stick around for more than 7 years, and my rate does change, how high or low can it go? The legal cap is 2% per year limited to a lifetime cap of 5% from the initial rate. So theoretically, if you start at a rate of 6% on a 7-year ARM, by year 10, it could go as high as 11%. can also factor in the amount you'll save during those first years against the increase. I know, it's kind of enough to make your head spin, but hopefully some of this makes sense. that that is done...all we gots to do is sign a piece of paper to get our mortgage commitment letter, then put the finishing touches on our application (still waiting on credit reports and some straggling W-2s, oh yeah plus we need to get them copies of ALL our bank statements from the PAST 2 YEARS, plus 6 months of 401Ks, this shit is ridiculous) and then we'll have a home soon.

FYI the average person in NYC lives in their initial home for about 5 years before upgrading or moving out of the city

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