Real Estate
The Mortgage Squeeze
Rates on ARMs become less attractive, and "exotic" mortgages lose their luster. For many buyers and refinancers, a 30-year, fixed-rate loan is a better, safer bet.
By Pat Mertz Esswein, Associate Editor
From Kiplinger's Personal Finance magazine, March 2006
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Interest-only niche
Some lenders claim that interest-only mortgages are useful tools for borrowers who educate themselves about what they're getting into. With an interest-only ARM for some period of time -- usually the first five or ten years of the loan -- you have the choice of paying your usual monthly payment of principal and interest or paying just the interest. On a $400,000 5/1 ARM with a rate of 5.8% and an interest-only option, you would pay $413 less than the principal-and-interest payment of $2,347.
Jay Fields, of Wells Fargo Home Mortgage in Las Vegas, says that is an attractive option for borrowers who have cyclical income, such as commissions and bonuses, and want to manage their cash flow in tight months. But he urges his clients to exercise discipline. "I tell borrowers that the money they're saving is for investment, retirement or college, not to go to the casino."
Belinda and Mark Lambrite, who recently moved from Las Vegas to Windermere, Fla., outside Orlando, are using an interest-only ARM to their advantage. Mark, 39, is a manufacturing-plant manager who relocates frequently, so the couple prefers hybrid ARMs because they're likely to move before the first rate adjustment. The Lambrites chose a 7/1 ARM with an interest-only option for their Florida home. They'll use the option until Belinda, 43, returns to work as a trauma nurse. When she does, they will make payments against the principal; if she doesn't, they won't be strapped.
Where might a market slowdown leave the Lambrites? They had a nice kitty to start with: the $335,000 they made when they sold their Las Vegas property. They put $300,000 of it down on their new, $650,000 home. If their home in Florida doesn't appreciate, and even if prices fall, they won't have a problem paying off the loan and covering real estate commissions when it's time to sell.
Another way to stretch your buying power is to take a mortgage with a longer term. For the privilege, you'll pay a slightly higher interest rate. At 6.5% on a $400,000 40-year mortgage, monthly payments would be $2,327, $122 less than with a 30-year term. Lenders are also considering mortgages with 50-year terms, which in this example would lower your monthly payment by $88.
Don't max out
As home prices rise, it's natural to want to buy the biggest house possible with the smallest down payment. That gives you a bigger return on your investment. But if you have a choice, taking on a bigger mortgage to buy a house that's more expensive may no longer make sense now that price hikes are slowing, says Peter Miller, author of The Common-Sense Mortgage. If you're selling during a cooling market, you could have a smaller pool of prospective buyers. "It's not always easy to sell the biggest house in town," says Miller.
Downsizing also helps ensure financial flexibility, even if you don't plan to sell anytime soon. Many homeowners have been tapping their rising home equity as a built-in emergency fund. If the equity isn't there to tap, or your home-equity-line payments soar, you could feel strapped. Says Miller: "When two working adults who are never at home buy a barnlike creation in the suburbs, it violates my first rule of real estate: Never buy a house you don't want to clean."