Vail Daily column: Length of ownership key for mortgage choice
It has often been said that life is what happens to you while you’re busy making other plans, and in the case of owning property, changes in your life can certainly change your plans for how long you own a property.
How long you own a property can make a significant difference in how you should finance it.
If you’re quite certain that you will stay in a property for an extended period of time (say longer than seven years), then you probably will benefit from a fixed-rate mortgage. Also, if you’re pretty sure that you won’t want to refinance it to get cash out to start or expand your business or pay college tuition or consolidate bills, then definitely consider a fixed rate mortgage.
Benefits of Adjustable Mortgage
However, if there is a possibility that you will need to sell or refinance, then you may save thousands of dollars by going with some type of adjustable mortgage. The average American moves or refinances about every five years, and you can bet most of them never thought they’d do it that often. But life’s events are rarely predictable and career changes, business opportunities and major life changes do occur to most of us. I often tell clients who are contemplating a fixed or adjustable mortgage to ask themselves where they were five years ago, and did they envision themselves being where they are today in their lives back then. Almost every one of them resoundingly says “No way.” Many have had financial ups and downs, good years and bad, changes in lifestyles or location that they never dreamed would happen to them just five years ago.
Somewhat in response to this trend in our society lenders have recognized that a lot of people really don’t need the traditional 15- or 30-year fixed mortgage. The industry now offers consumers a variety of options to customize a loan to the consumers needs.
One-Year Adjustable Loan
At one time, a popular loan was the one-year adjustable, where the interest rate and payment adjusted annually. Also popular for a short while were loans that adjusted monthly. Consumers found that these loans were stressful as they never know what to expect and for the most part these loan programs have disappeared.
Popular now are loans that are fixed for the first five to seven years of the loan, and adjust annually thereafter. The loans have a 30-year amortization, and limits on rate adjustments.
There are three things to look at when considering an adjustable mortgage. The first are the adjustment caps. Every loan program can be different so check this out carefully. Typically, a loan might have what are called 5/2/5 caps. This means that if the underlying index plus the margin (or markup over the index) increases by 5 percent, then the loan interest rate could adjust up to 5 percent the first adjustment. If a $250,000 loan had a start rate of 3 percent with payments of $1,050, then the rate, in theory, could increase to 8 percent and a payment of $1,751. It is unlikely this would happen but it could. After the first adjustment, the rate can only go up 2 percent per year to the max of five points over the start rate.
The second thing is the index the adjustment is tied to. Generally this will be the one-year U.S. Treasury bill, but it could be the 11th District Cost of Funds Index (known as COFI) or the London International Base Offering Rate (known as the LIBOR). Ask your lender for a historic chart of the rate the index is tied to, as most lenders should be able to give you one.
The third and very crucial item to consider is the margin. A margin is the difference between the indexed rate (such as the yield on the one-year T-Bill) and your interest rate.
With adjustable rates starting about 1 percent lower than a fixed rate some homeowners can save a substantial amount if they only plan to need the loan for five to seven years.
To figure out what your rate might go to, look at the historic highs of your index and add the margin to it. If it seems within reason, then you might like the loan; if not, then look for a more reasonable margin and index.
Chris Neuswanger is a loan originator at Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers. His blog and a collection of his columns may be found at http://www.mtnmortgageguy.com.