With today’s rising interest rates and unpredictable economy, it’s no wonder people don’t have a clue what to do with their current mortgage rates. I began my finance career at the age of 15 when I interned at JP Morgan on Wall Street in New York City. Over the years I have seen rates decrease from 18% down to 3.5% in 2003 and rise back to 8% in 2006. The average 30 year fixed rate is hovering between 6.125% to 7.50% depending on your credit standing. Although I have been in finance for 20 years, I knew very little about interest only loans until about 5 years ago.
In my twenties, I purchased my first home and because of my finance training and education I had some reasonable knowledge of the market, so I shopped around for a good interest rate. During the time of my first home purchase, interest rates were between 7 and 8%. I locked my rate in at 7% with 0 points, so I felt pretty good about my decision. After living in my home for nearly 8 years, I relocated to Georgia where I purchased my second home and interest rates were between 6 and 7%, so I was thinking about locking my loan in at 7% again until my broker asked me why I was set on a fixed rate mortgage and I thought that, what a silly question, so I responded, “to be safe of course”. The broker went on to tell me about the latest interest only ARM products. As soon as he mentioned “interest only”, I refused to even hear what he had to say because it was something foreign to me and the truth of the matter was; I was afraid of the unknown.
As a woman of faith, I know better than to have fear of anything, but for some reason, I just did not understand how these interest only loans worked. My limited understanding of them; was it was like renting instead of purchasing. Needless to say I went on to purchase the new home at a 7% fixed interest rate. The payment was good, so I felt good about my purchase; that was until I was asked to attend a rally, where my company was to launch a brand new product. No one had a clue as to what the product was until we reached our destination and low and behold; there it was a sign bigger than life “INTEREST ONLY ARM”! I thought, wow, I just can’t get away from this interest only product, so I decided to listen intently to the facilitator to see what all the hoopla was about. The event lasted about two hours and at the end of the session I was so upset about what I had heard. When the facilitator gave examples, statistics and other data outlining how many thousands of dollars you can save from having an interest only loan, I was ill. Although the facilitator gave some great information I had to check it out myself, so I immediately went back to my office and crunched the numbers and he was absolutely accurate with the information he shared about the costs and the savings.
I have now purchased my 4th home here in Georgia and this time I chose an interest only ARM loan and I am elated! I don’t plan to live in this home more than 5 years, so it just didn’t make sense for me to pay 1 to 2% more to get a fixed rate. My current interest rate is 5.60% and I am pleased. I am not suggesting that everyone should run out and get an ARM, but I am suggesting that you be informed forever making a decision. Most people don’t realize that an ARM is a 30 or 40 year mortgage just like a fixed rate mortgage and you can choose to keep it for as long as you want, however the difference is the fact that at some point the interest rate you have on your ARM will adjust, thus the name, Adjustable Rate Mortgage. Also, most lenders offer a 10 or 15 year interest only option on 30 or 40 year fixed rate mortgages. This is a phenomenal feature, because if you run a 30 year Amortization schedule, you’ll see for yourself that for the first 8-10 years of your having a fixed rate loan you will be paying mostly interest, so why not get an interest only option which also gives you the option to pay additional principal as well. In order to give you some guidance in your decision, I want to give you some brief information on how to decide if a fixed rate or interest only ARM rate would be the best rate for you:
Fixed Rate Mortgages: Target audiences for these loans are typically people in one of two categories; good or poor credit. I will separate the categories and give you the benefits within each of these categories:
1. Excellent/Good (credit scores 680 and above) Benefits:
a. Rates – People within this category are good candidates for a fixed rate mortgage because they will most likely be able to qualify for a prime market rate which today is between 6.25 and 6.30% which means that if you’re willing to pay a point you could possibly buy your rate down between 5.50 and 5.75%.
b. Closing Costs – Their closing costs will be lower due to the fact that they don’t have to buy down their rate with points.
c. Full Nesters – If they are raising a family and you plan to live in your home for 7 or more years, your payments will remain fairly consistent.
2. Poor (credit scores lower than 580) Benefits:
a. Rates – If you meet certain guidelines, you may qualify for an FHA loan and since FHA is not credit score driven, your rates are more likely to be close to if not the same as the prime market rates for customer with excellent credit.
b. Closing Costs – You closing cost will be reasonable because you’re only required to pay a 3% down payment and in some cases if you qualify for other Government programs, your loan might go from 97% to 100% which would require you to only pay closing costs.
Adjustable Rate Mortgages/Interest Only Loans: Target audience for these loans are typically people in two categories good and fair credit:
1. Good credit (credit scores 660 and above) Benefits:
a. Rates – People within this category are good candidates for an ARM/interest only mortgage because they will most likely quality for a Libor or MTA index with very little margin. Therefore they could end up with a rate between 5.00 – 5.50%.
b. Closing Cost – Their closing cost will be lower due to the fact that they don’t have to buy down their rate with points.
c. Payments – Due to the interest only option, payments will be low.
d. Empty Nesters – These are folks that have owned their homes between 18 and 25 years and have quite a bit of equity available to them for that vacation they always wanted or to help with college expenses.
2. Fair credit (credit scores between 580-650) Benefits:
a. Payments – Due to the interest only options payments will be low.
b. Rebuild credit – The quickest way to add more points to your credit score is to purchase a home or automobile and make payments on time for the next 12 -24 months.
I would never recommend to someone with poor credit to obtain an ARM because the interest rate would be outrageous! Bottom line; do your homework before your next home refinance or purchase. There is so much information on this subject that I could go on and on, so please email me your comments or contact information and I’ll be happy to answer your questions.