ARMs or adjustable rate mortgages is making some what of a comeback. While ARMs took a beating the past few years for getting borrowers into loans with low initial teaser rates that promoted unsustainable low monthly payments. Eventually this caused borrowers financial problems who were unprepared when the adjustment period kicked in and increased the monthly payments caused defaults on loan. The key word was for unprepared borrowers, but if you know how to use an ARM it does have its advantages for certain borrowers.
Rates for 5/1 ARM are very attractive right now, as low as 4% with no points and can be even lower with some points for loans up to $729,750.
To know if should you take an adjustable rate mortgage you need to understand what exactly is an ARM. An adjustable rate mortgage have several components; some generic to the industry some specific to the loan. The generic components are:
Starting rate, this is the rate your initial monthly payments are based on. It can be as low as 1% in the past, most of those loans is no longer around.
Adjustment period, this is when the monthly payment will change based on market rate changes, for example if it is a 5/1 ARM with a starting rate of 4%, it means you will have your first payment change after 5 years.
An index, a published rate based on some industry recognized source. The most common indexes are United States treasuries and LIBOR, which stand for London interbank offering rate. Many home equity loans are based on WSJ (Wall Street Journal) prime.
A margin is what each lender adds on to the index to calculate your new monthly payment. Most margins are between 2.25% to 2.75%, each loan will have its own stated margin and the margin will be constant and never change. Today most margin are 2.25%, so in five years after the initial period has expired, your new payment will be based on whatever the index is at the time plus the margin. Many of the ARMs are using the LIBOR index. Today the 1 years LIBOR index is 1.32% assuming five tears from now the index rises to 3.32% which means rates increased by 2%, your new payment will be calculated base on 3.32% plus 2.25% for a new rate of 5.57%, not a prediction just an example. And the loan will have that rate for 1 year, the following year the same calculation is done again.
For protecting against unexpected large rate increases, ARMs have built-in rate caps. Today the most common rate caps are 5/2/5. This mean for the first adjustment period the rate can increase by no more that 5% higher than you initial rate; each year after it can increase no more than 2% higher than the previous year and for the lifetime of the loan no more than 5% of the initial rate. To be clear, if your first adjustment is 5% higher then you have capped out and it can never increase. Any future adjustments can only be lower than the 5% cap.
Shopping for ARMs is much less confusing today. The margin and index are fairly standard and the days of the past when loans with artificial low teaser rates and complicated payment options allowing borrowers to pay less than what the actual payments should be are gone. While conservative borrowers may still fear the ARMs, if your individual situation fits the parameter of an ARM, you should consider it.
The clearest example of a candidate for ARMs is someone who intends to move on to a new home after 3 or 5 or 7 years. In this case the ARM certainly offers a lower rate than the traditional fixed rate mortgages. All the variety of ARMs offered in the past probably had some feature that can benefit some borrowers, but many of the borrowers who took out the fancy ARMs did not fully understand the loans to truly benefit from them.
I am a conservative borrower and stayed away from the ARMs, but as it turned out because the rates have been so low for so long, one of my mortgages based on LIBOR have been the best loan I have had for the past 5 years.
Thursday, August 20, 2009
Thursday, August 13, 2009
Subordination: What is it & why should I care?
Guest-blogging today is Alex Nunemaker, a Loan Consultant with Borrow123.com. He can be reached at alex@borrow123.com with any specific questions or comments.
You have a mortgage that you’d like to refinance – but you also have a home equity line or other 2nd trust on the property. While this situation is fairly common, the market has made getting these 2nd trusts “subordinated” more difficult.
To begin with resubordination (or just subordination) is required when you have more than one lien on the property. More than likely, your smaller 2nd trust (such as the case if you have an old 80-10-10 loan) or a Home Equity line is in the second lien position. Anytime you refinance your primary or first mortgage you have to get a Subordination Agreement from you 2nd trust holder. This agreement will state that your 2nd trust holder has reviewed the new terms and conditions and they agree to stay in the 2nd lien position. Otherwise the new mortgage you are refinancing into would go into the 2nd position, and your Home Equity Line would bump into the first lien position (which almost all lenders will not agree to).
While it’s not important that you as a borrower now everything that goes on this process, there are a few reasons why you as a borrower may be effected, and they all stem from two facts: 1) home values are dropping and 2) interest rates are low and 2nd trust lender have received a lot of requests for subordinations. As a result lenders are taking longer to subordinate loans and are rejecting more subordination requests.
Let’s look at an example:
You have a first mortgage of $250,000; a HELOC with no balance but a total line up to $100,000. Your current market value is $350,000, but when you received the HELOC it was $450,000. When you send in a subordination request they will calculate your CLTV based upon your first mortgage + the total line (not just your balance – since you can draw upon the entire line). This would make your CLTV 100% since your value is $350,000. Most lenders will not approve this – traditionally what we see is lenders approving loans between 85-90% CLTV as a maximum. To proceed with the loan you would likely need to reduce your total HELOC amount or reduce your 1st mortgage loan amount.
Before even locking in a rate, it is also imperative to contact your 2nd trust lender to see how long their turn-times are for subordinations. While in the past in only took a couple of days, we now routinely see them take 2-8 weeks which will effect your lock-in period.
Many times, it makes more sense (especially if you have a HELOC with no balance) to close the loan and reopen another HELOC after refinancing. Just make sure you won’t have any unexpected early closure penalties. With any loan these days it’s important to contact your 2nd trust lender to see how long they would take, and if they have any special guidelines to make your refinance as smooth as possible.
You have a mortgage that you’d like to refinance – but you also have a home equity line or other 2nd trust on the property. While this situation is fairly common, the market has made getting these 2nd trusts “subordinated” more difficult.
To begin with resubordination (or just subordination) is required when you have more than one lien on the property. More than likely, your smaller 2nd trust (such as the case if you have an old 80-10-10 loan) or a Home Equity line is in the second lien position. Anytime you refinance your primary or first mortgage you have to get a Subordination Agreement from you 2nd trust holder. This agreement will state that your 2nd trust holder has reviewed the new terms and conditions and they agree to stay in the 2nd lien position. Otherwise the new mortgage you are refinancing into would go into the 2nd position, and your Home Equity Line would bump into the first lien position (which almost all lenders will not agree to).
While it’s not important that you as a borrower now everything that goes on this process, there are a few reasons why you as a borrower may be effected, and they all stem from two facts: 1) home values are dropping and 2) interest rates are low and 2nd trust lender have received a lot of requests for subordinations. As a result lenders are taking longer to subordinate loans and are rejecting more subordination requests.
Let’s look at an example:
You have a first mortgage of $250,000; a HELOC with no balance but a total line up to $100,000. Your current market value is $350,000, but when you received the HELOC it was $450,000. When you send in a subordination request they will calculate your CLTV based upon your first mortgage + the total line (not just your balance – since you can draw upon the entire line). This would make your CLTV 100% since your value is $350,000. Most lenders will not approve this – traditionally what we see is lenders approving loans between 85-90% CLTV as a maximum. To proceed with the loan you would likely need to reduce your total HELOC amount or reduce your 1st mortgage loan amount.
Before even locking in a rate, it is also imperative to contact your 2nd trust lender to see how long their turn-times are for subordinations. While in the past in only took a couple of days, we now routinely see them take 2-8 weeks which will effect your lock-in period.
Many times, it makes more sense (especially if you have a HELOC with no balance) to close the loan and reopen another HELOC after refinancing. Just make sure you won’t have any unexpected early closure penalties. With any loan these days it’s important to contact your 2nd trust lender to see how long they would take, and if they have any special guidelines to make your refinance as smooth as possible.
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