Mortgage Tips

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Perhaps one of the most confusing aspects of getting a mortgage is knowing who you actually pay once the thing funds. And to that end, when your first mortgage payment is due.

While Bank X may have closed your loan, an entirely different company could send you paperwork and a payment booklet. What gives?

Well, this highlights the difference between a mortgage lender and a mortgage servicer.

Mortgage Lender vs. Mortgage Servicer

loan servicer

  • The bank or mortgage lender processes and funds the home loan
  • Once it closes it may be sold off to a loan servicer or retained in portfolio
  • The job of a loan servicer is to collect monthly mortgage payments
  • And manage escrow accounts if your home loan has impounds

As noted, a mortgage loan servicer, also known simply as a loan servicer, is the company that collects your monthly mortgage payments.

They also manage your escrow account if your home loan has impounds, collecting a portion of property taxes and homeowners insurance each month, before making those payments on your behalf when due.

So really, there’s a good chance you’ll deal with your loan servicer a lot more than your mortgage lender, who may have only been in the picture for a month or so while your loan was originated.

You see, many mortgage lenders focus on loan origination as opposed to servicing, so they’re happy to fund your loan and quickly sell it off for a profit, then rinse and repeat.

The same goes for mortgage brokers, who fund your loan on behalf of a wholesale mortgage lender, which also may sell off the loan to a different servicing company shortly after it closes.

Further complicating all this is the fact that your mortgage lender could also be your loan servicer because some big banks and mortgage companies can profit from it.

One thing mortgage companies figured out in recent years was that keeping in touch with their past customers was a great way to generate repeat business.

But if they sell all their home loans off to other companies, they may lose out if mortgage rates fall and these customers are ripe for a mortgage refinance.

There are also mortgage subservicers, companies that perform loan servicing tasks on behalf of a lender, instead of completing those things in-house.

Anyway, without getting too convoluted here, it’s important to note this distinction between lender and servicer so you know who you’re dealing with.

And to ensure you’re sending monthly mortgage payments to the right place!

What Do Loan Servicers Do?

  • Collect monthly mortgage payments
  • Manage escrow accounts (property taxes and homeowners insurance)
  • Provide customer service if borrowers have any questions
  • Generate loan payoff statements
  • Perform loss mitigation (loan default, loan modifications, foreclosure, credit reporting)
  • Ensure compliance with federal, state, local regulations

The list above should give you a better idea of what loan servicers do, and why banks and lenders may choose to outsource these things.

If you have any questions regarding your home loan post-closing, it’s generally best to get in touch with your loan servicer as opposed to your mortgage broker or lender.

They should be able to answer any questions you have, whether it’s knowing where to send payments, how to make extra payments or biweekly mortgage payments, loan amortization questions, and so on.

Additionally, if having payment troubles in the future, your loan servicer should be the one to call to discuss options.

Remember, the lender is typically just there to help process and close your loan, then hands off the reins to a servicer from there.

Mortgage Servicing Transfers

  • Many home loans are transferred to loan servicing companies shortly after funding
  • You should receive a letter within 15 days of your loan being transferred
  • The new company’s contact information should be prominently displayed
  • It will also include the date when the old servicer will no longer accept payments
  • And the date when the new servicer will start accepting monthly payments

One of the most important things to do after your mortgage closes is to take note of who your loan servicer is.

Unfortunately, mortgage servicing rights are frequently transferred shortly after your loan funds, which can make it confusing to know who to pay.

Add in all the junk mail you might receive as a new homeowner (like mortgage protection insurance) and it could get really murky.

The good news is lenders and loan servicers must adhere to certain rules regarding the transfer of servicing rights.

After your mortgage funds, look out for a letter in the mail from the entity that closed your loan regarding a servicing transfer. You may also receive a letter from your new loan servicer as well.

It should clearly explain who will be processing your mortgage payments going forward, and is required to be sent 15 days prior to your loan’s servicing rights being transferred to the new servicer.

The letter should include all the relevant contact information you’ll need to ensure payments are sent to the right company at the right time.

Take note of when they’ll begin accepting payments, and when the old company will stop accepting payments.

In my opinion, it doesn’t hurt just to call the company and make sure everyone is on the same page before you send your payment, just to avoid a mess.

If you do make a payment mistake, there are some protections in place if it’s within 60 days of the servicing transfer, per the CFPB.

During this time, the new loan servicer can’t charge you a late fee or mark the payment as late if your payment was sent to your old servicer by its due date or within the grace period.

Who Are the Top Mortgage Servicers in the Country?

1. Quicken Loans
2. Regions Mortgage
3. Huntington National Bank
4. TD Bank
5. Chase
6. M&T Mortgage
7. SunTrust Mortgage (Truist)
8. Bank of America
9. Guild Mortgage
10. Citizens Mortgage

Quicken Loans was the highest-ranked mortgage servicer for the seventh consecutive year in 2020, per the latest U.S. Primary Mortgage Servicer Satisfaction Study from J.D. Power.

Both USAA and Navy Federal actually have higher rankings than all the companies listed above, but don’t meet the survey’s award criteria.

In other words, you should have a very good customer experience with those two companies as well.

Who Are the Largest Mortgage Servicers in the Country?

These are listed in alphabetical order since I don’t have figures available to rank them by total servicing volume. But they are some of the largest mortgage servicers in the country.

All of these companies service billions of dollars in home loans for customers, which they either originated themselves or acquired from other banks and mortgage lenders.

If you have a mortgage, there’s a good chance one of the companies on this list handles your loan servicing.

Tip: Always take the time to make sure you’re actually dealing with your loan servicer and not some phony entity.

Source: thetruthaboutmortgage.com

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Mortgage Q&A: “Why are refinance rates higher?”

If you’ve been comparing mortgage rates lately in an effort to save some money on your home loan, you may have noticed that refinance rates are higher than purchase loan rates.

This seems to be the case for a lot of big banks out there, including Chase, Citi, and Wells Fargo, which while enormous institutions aren’t necessarily the leaders in the mortgage biz anymore.

In fact, today Quicken Loans is #1, followed by United Wholesale Mortgage in the #2 spot, then a mix of these big banks and nonbanks, including loanDepot, Caliber Home Loans, and others.

So why is that some of the big guys list “purchase rates” and “refinance rates” separately, with different pricing, points, and APRs?

Well, for starters a home purchase is not the same as a mortgage refinance, though both processes are very similar, and the underlying loans themselves aren’t much different.

Ultimately, a home purchase loan is for someone who has yet to buy a property, whereas a mortgage refinance is for an existing homeowner who wants to redo their home loan.

We know they are different objectives, but if the underlying loans are both 30-year fixed mortgages with the same loan amounts, the same borrower credit scores, and the same property types, why should rates be any different?

Home Purchase Mortgages Default the Least

default rates

There are three main types of mortgages, including home purchase loans, rate and term refinances, and cash out refinances.

The first is self-explanatory and was already explained above, the second is simply redoing your current mortgage by obtaining a new interest rate and loan term, without changing the loan amount.

The third type results in a larger loan amount at closing because you’re pulling equity from your home, which a layman should assume would be the riskiest transaction.

After all, if a borrower now owes more debt, and maybe even has a higher monthly mortgage payment as a result, their default risk should rise.

Simply put, when you pull cash out of your home, you increase your outstanding loan balance, increase your loan-to-value ratio (LTV), and reduce your available home equity, that’s riskier.

This in theory should result in a higher mortgage rate to compensate for increased risk. And guess what – that is indeed the case. Cash out refinance rates are the highest, all else being equal, for basically all banks and lenders.

At least something makes sense around here…

A Rate and Term Refinance Sounds the Least Risky, Doesn’t It?

refinance rates

Now, a rate and term refinance should result in the least amount of default risk because the borrower is likely reducing their monthly payment in the process.

This happens via a lower interest rate and possibly a lower outstanding balance (paid down since origination) spread out over a brand-new loan term.

That leaves us with home purchase loans, which you’d think would be less risky than a cash out refinance, but not as risky as a rate and term refinance, since it’s ostensibly a first-time home buyer or someone in a new property.

If you were the bank, you’d probably want to give a new, cheaper loan to the seasoned homeowner who has been paying their mortgage for years as opposed to the first-time buyer or even a move-up buyer taking on more debt.

But for one reason or another, some banks and mortgage lenders offer the lowest mortgage rates on home purchase transactions.

The Lowest Mortgage Rates Are Offered on Home Purchase Loans

The reason boils down to DATA. Despite the fact that the actual loan characteristics (such as FICO score, LTV, and DTI) would indicate the lowest default rates on rate and term refinances, it is purchase loans that perform the best.

One possible reason why is because of faulty appraisals on refinances, which perhaps overvalue properties.

Regardless, purchase mortgages default the least, followed by rate and term refinances, and finally cash out refinances, the last of which actually makes sense.

Interestingly, the loan characteristics also indicate that cash out refis and purchase mortgages should default at about the same rate, yet they are priced the furthest apart.

And again, that’s because in real life, not expected default rates, purchase loans default the least and cash out refis default the most.

Lowest: Home purchase rates
Slightly Higher: Rate and term refinance rates
Highest: Cash out refinance rates

So when you compare mortgage lenders, you might often find that purchase rates are the cheapest, followed by rate and term refi rates, and finally cash out mortgage rates.

There’s no question cash out refinances cost the most – this is the norm amongst all banks and lenders to my knowledge.

But not all banks/lenders offer different rates for purchases and rate and term refis.

How Much More Expensive Are Refinance Rates?

  • Big banks tend to advertise higher refinance rates vs. purchase rates
  • Some lenders don’t differentiate between purchase rates and rate and term refi rates
  • Or simply charge slightly higher closing costs on refinance transactions
  • Rates may be .25% to .375% higher on refis but pay attention to points charged and loan assumptions

I looked around and found that Chase, Citi, and Wells Fargo offer lower home purchase rates, while Quicken Loans offers the same exact rates for purchases and rate and term refis.

Quicken even says this in their fine print: “Based on the purchase/refinance of a primary residence with no cash out at closing.”

In other words, a purchase or rate and term refi are priced the same.

Clearly this matters when shopping around for a mortgage, so take notice of who is charging more/less for certain transaction types and choose accordingly.

One last thing – pay attention to the assumptions lenders make when they list their rates. It could also be that you’re not comparing apples to apples, if there are different loan amounts, LTVs, credit scores, mortgage points, and so on.

But know refinance rates are higher because they default more than purchase loans, and that requires a higher price to compensate for heightened risk, plain and simple.

Source: thetruthaboutmortgage.com

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Everyone likes a discount, right, even if it’s on a small one-time purchase that equates to a nominal amount. For one reason or another, it just feels like a win.

It’s obviously even sweeter if you get a discount on a big-ticket item, as the savings will be much larger.

Better yet, how about a discount on something that you could be paying off for the next 360 months, like your home loan? Now we’re talking!

I did some research and came up with a list of mortgage lenders with the “best mortgage rates” to consider if you’re in the market to finance a new home purchase or refinance an existing mortgage.

There are literally thousands of mortgage lenders out there, so it’s easy to miss some along the way if comparison shopping.

Here are 10 that might offer a discount relative to other banks and lenders out there, not only because they seem to offer low mortgage rates, but also limited or no lender fees.

The one caveat here is no one mortgage lender can be the cheapest all of the time, for all borrowers.

So be sure to always take the time to shop around and get multiple quotes, even if it takes some additional legwork. Sure, it’s not fun but nor is spending more money.

Also, if you want the best mortgage rate, you’ve got to be a good borrower.

That means coming to the table with an excellent credit score, a decent down payment, and checking all the other boxes that affect mortgage rates.

You can’t expect the lender to do all the heavy lifting.

Better Mortgage

Aside from being a tech-savvy lender with a digital mortgage platform, Better Mortgage also prides themselves on not charging a loan origination fee. Or any lender fees or commissions for that matter.

Often, this fee can be 1% of the loan amount, so if you take out a $300,000, that’s $3,000 right there. Then there might also be additional fees for processing, underwriting, and so on.

They also openly advertise their daily mortgage rates right on their website, so they’re pretty transparent about their pricing as well.

In summary, you could get a discount and breeze through the home loan process thanks to their technology – they can fund 100%-digital loans without even a single phone call.

They’ve got a 4.6-star rating out of 5 on LendingTree with a 91% recommendation rating.

CIT Bank / OneWest Bank

If you choose to work with CIT Bank or OneWest Bank to get your home loan, they provide a number of discounts on top of their already low mortgage rates.

This includes a $525 cash back bonus if you have or open a CIT Bank or OneWest Bank deposit account before closing on your mortgage with them.

Additionally, they offer mortgage rate discounts if you make new deposits, including 0.10% off your rate with 10% of loan amount in new deposits, and 0.25% off if you can muster 25% of the loan amount in new deposits.

At last glance, they had a 4.5/5 on Zillow based solely on their home loans business, so they come highly rated as well.

Costco Mortgage

Folks looking for a deal often head to Costco, and you can actually shop your mortgage with the big-box retailer as well.

While not a direct mortgage lender, they have partnered with a variety of vetted lenders that have agreed to cap their lender fees.

For example, Gold star members pay lender fees of $650 or less, while Executive members only pay lender fees of $350 or less.

If the mortgage rates from their partner lenders are competitive, you might wind up with a low rate and limited fees, which is an excellent combination.

The Mortgage Program for Costco Members has a 4.8-star rating out of 5 based on Trustpilot, and the individual lenders involved have similarly-high ratings from past customers.

Intelliloan

I added Intelliloan to this list because they won’t stop talking about their mortgage rates. In fact, the first thing you’ll see if you visit their website is mortgage rates.

Their latest refinance rates match their APRs, which means they’re advertising their interest rates without any lender fees or discount points.

The company also offers a Rate Protection Promise where they’ll refinance you without lender fees if interest rates fall significantly within three years of your initial loan closing.

They’ve got excellent reviews across all the major ratings websites, including a 4.9-star rating out of 5 on LendingTree, with a 98% recommend score.

LoanFlight Lending

The holy grail for homeowners is a low mortgage rate with limited or no fees.

After all, a low rate that requires you to pay multiple discount points might not truly be low, but one that only requires a $1 in fees is usually as good as it looks.

LoanFlight Lending tends to advertise on Zillow a lot, and often features some of the lowest fixed rates listed, along with just $1 in lender fees.

That’s a tough combination to beat if you’re looking to save on your mortgage. They also have very good customer reviews to boot, with a 4.76-star rating on Zillow and a 4.7 on LendingTree with a 91% recommend rate.

The only downside appears to be the fact that they’re licensed in just 12 states.

Lower Mortgage

As I’ve said before, with a name like Lower Mortgage, you kind of have to offer low mortgage rates. Oh, and low lender fees too.

They say they do both, and the cherry on top is a Free Refi for Life deal, whereby you won’t be charged any lender fees on a future refinance with the company.

So if 30-year fixed rates do go down and they happen to be offering low rates relative to the other guys, you can get that new low rate sans fees.

The company also has great reviews, including a 4.9-star rating out of 5 based on LendingTree with a 99% recommendation rate.

Reali Loans

Formerly known as Lenda, Reali Loans, Inc. is the home of “no-nonsense home loans.” What that means is you won’t be charged traditional loan commissions or any lender fees.

In the past, I found that their interest rates were quite low when I played with the little rate slider on their website.

Like other fintech newcomers in the mortgage space, they lean heavily on technology to make the loan process less cumbersome and faster overall. That tech also allows them to offer more competitive rates to borrowers.

Reali Loans currently has a 4.57-star rating on Zillow and similarly excellent reviews on Trustpilot.

Redfin Mortgage

If you’re buying a home in certain states, one perhaps unexpected mortgage lender to consider is Redfin Mortgage.

Yes, the real estate brokerage also launched a home lending division and seems to have really competitive mortgage rates.

Additionally, they don’t charge lender fees, so the mortgage APR should be just as low as the mortgage rate.

The only downside is they don’t offer refinance loans, at least not at the moment. But that could change in the future.

On top of the low rates and lack of fees, they offer a $1,000 mortgage closing guarantee that promises to get you to the finish line in either 25 or 30 days (depending on the type of pre-approval) or you’ll receive a check.

Sebonic Financial

This so-called digital startup, which is actually the fintech arm of Cardinal Financial, a top-40 mortgage company nationally, often advertises mortgage rates with just $1 in lender fees.

In other words, you’re typically getting a no cost loan from Sebonic Financial, at least with regard to lender fees.

And they seem to still offer highly competitive refinance rates relative to other lenders, which often charge the usual fees that can amount to thousands of dollars due at closing.

They are also a highly-rated mortgage lender, with a 4.49-star rating out of 5 based on more than 3,000 customer reviews on Zillow.

Wyndham Capital Mortgage

Lastly, we’ve got Wyndham Capital Mortgage, which promises no hidden lender fees and competitive, below market mortgage interest rates

Aside from no hidden fees, they also don’t charge a loan origination fee. So if their mortgage and refinance rates are also low, that’s a pretty solid deal.

On top of that, they say they can offer discounts on costly things like title insurance because of their relationships with preferred settlement agents.

In terms of customer satisfaction, they’ve got a 4.8-star rating out of 5 on LendingTree from nearly 7,000 reviews, and 99% of customers would recommend them.

There are many more lenders out there, and you should certainly search locally as well as online to explore all of your options, including credit unions, local mortgage brokers, and more.

Remember, your monthly mortgage payment will stay with you for a long time, so putting in a few extra hours at the start can really pay dividends over the years.

Source: thetruthaboutmortgage.com

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Loyalty? Not in the mortgage business. That is, if you actually want to save money on your home loan.

A few years back, an HSBC survey revealed that 52% of U.S. homeowners “switched providers” (sorry, they’re British) when obtaining subsequent mortgages.

This was mainly driven (53%) by the desire to get a better deal, aka a lower mortgage rate with fewer closing costs.

That survey also found that 46% of consumers investigated a mortgage switcheroo, again either to save money or to lock in a new low rate due to rising interest rates.

Other reasons homeowners decided to go with another mortgage company were because they moved and purchased a new property.

Or due to their current mortgage deal was expiring. I think they mean an adjustable-rate mortgage resetting.

Is It Bad to Switch Mortgage Lenders?

mortgage retention

A new report from Black Knight claims that loan servicers retained just 18% of the estimated 2.8 million homeowners who refinanced a mortgage in the fourth quarter of 2020, the lowest share on record.

Interestingly, those who refinanced to improve their rate and/or term were retained at a higher rate (23%) versus those pulling cash out as part of the transaction (11%).

This could be due to cash out refinances being harder to come by lately, and thus offered by fewer lenders. Or it just feeling more complex to the homeowner.

But here’s the biggie – among higher-credit quality rate and term refinances, borrowers who switched mortgage lenders received more than an eighth of a percent lower rate than those who refinanced and remained with their current lender/servicer.

In other words, you might get a lower mortgage rate if you switch mortgage lenders, instead of remaining loyal.

So is it bad to switch mortgage lenders? Not if you want to save money! Of course, your old lender might not feel the same way.

Mortgages Are Mostly a Commodity

  • Home loans aren’t all that different from one another
  • This is why lenders are increasingly coming up with unique ways to sell you one
  • The vast majority are 30-year fixed products whose only difference might be the interest rate or fees involved
  • And the majority just follow the underwriting guidelines of Fannie Mae, Freddie Mac, or HUD

It’s really no surprise that a lot of consumers don’t stay with their original mortgage lenders and/or loan servicers.

Aside from some existing lenders sometimes talking borrowers out of a refinance, the product is mostly the same no matter where you get it.

That makes customer retention difficult, especially when other lenders are aggressively marketing to homeowners.

These days, the majority of home loans are backed by the agency guidelines of Fannie Mae, Freddie Mac, or the government via FHA loans and VA loans. I think it’s something like 90% of mortgages.

This means mortgage loans are pretty homogeneous, despite what channel they’re originated in, or which institution provides the financing.

You could get the same exact home loan from a local credit union, a big bank, an online mortgage banker, or a mortgage broker.

And who really cares where you get your mortgage as long as the company is competent enough to close the thing, and honest in terms of rate and fees?

It’s not like you’re going to walk around and brag about your cool mortgage from X bank after the fact. It’s certainly not a status symbol, or a conspicuous transaction.

I’m pretty sure I’ve never had a conversation about someone’s branded mortgage before.

And I doubt an “influencer” is going to post about theirs on Instagram. Well, I take that back, they might…because someone paid them.

Mortgage Advertising Is Following the Insurance Model

  • Like mortgages, most forms of insurance are similarly boring and unoriginal
  • But that doesn’t stop mega insurers like Geico from advertising to you 24/7
  • Other insurers create catchy new names for run-of-the-mill coverage that isn’t really unique
  • Mortgage lenders are beginning to do that too in a bid to separate themselves from the crowd

This is exactly why insurance companies use celebrity endorsements and smart marketing gimmicks to get you to switch, or conversely, to stick around.

Car insurance isn’t cool or exciting and never will be, nor are mortgages, as much as I want them to be.

Ultimately, we’re all being sold the same thing, it’s just that some companies try to differentiate themselves by slapping clever names onto their products.

For example, Quicken Loan’s Rocket Mortgage is about reinventing the mortgage process, not the mortgage itself.

You’re still probably going to get a 30-year fixed home loan or some other ordinary mortgage that you would get anywhere else.

It’s just the way you get it that might change. Instead of meeting face-to-face with a banker, you might upload documents on your smartphone and authorize the release of documents electronically.

This could make the experience a lot easier and more pleasant, but it doesn’t mean you’re necessarily getting anything different.

Because everyone is basically offering their customers same thing, it comes down to price, customer service, and now perhaps clever marketing.

The one exception is portfolio home loan programs, which are actually unique to the mortgage lender providing them. These are loans kept on the originating bank’s books that contain distinct underwriting guidelines.

We’re starting to see more of them, though most lenders remain fairly cautious with the mortgage crisis still a not-too-distant memory, despite taking place a decade ago.

For example, a lot of the zero down mortgages you see are unique to the companies offering them, the latest one I came across from Ideal Credit Union.

And some of the so-called fintech disruptors like SoFi Mortgage are actually providing unique offerings like a 5/1 ARM with an interest-only option and jumbo loans as high as $3 million with just 10% down.

Be Careful Not to Pay More for the Same Exact Mortgage

  • While it’s important to use a mortgage lender you can trust
  • Such as one that can actually close your home loan competently without major delays
  • It doesn’t really matter what “brand” the mortgage it is after it funds
  • And there’s a good chance it’ll be resold to a different company shortly after closing anyway

Those exceptions aside, many of us have very similar mortgages that are only unique in terms of where they originated from.

As noted, most of today’s mortgages are conforming loans, meaning they meet the guidelines of Fannie and Freddie. Or they’re simply backed by the government via the FHA, VA, or USDA.

And just about all of them are 30-year fixed-rate loans that function exactly the same.

That’s why you have to ask yourself – if the company isn’t offering anything different, why pay more?

Might as well bargain shop and find the best mortgage rate with the lowest closing costs, instead of simply going with a household name because of a funny commercial.

At the end of the day, as long as they get you to the finish line, you’ll probably never think about your mortgage company again. Just make sure they’re reputable first…

Chances are your mortgage will be sold off in a matter of months anyway, so the company you get it from likely won’t even service it.

In fact, your final correspondence might be a notice of your home loan changing hands…

(photo: lamdogjunkie)

Source: thetruthaboutmortgage.com

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Let’s talk mortgage basics: “What is the loan-to-value ratio?”

If you’re currently shopping for a home or already going through the mortgage loan process, chances are you’ve heard the phrase loan-to-value ratio get thrown around on more than one occasion.

You may have also encountered the acronym “LTV” while perusing mortgage advertisements or playing around on mortgage rate comparison websites.

Regardless of what’s going on in the housing market, you should know all about this very important term when applying for a home loan.

Why? Because it can greatly affect mortgage rate pricing, refinance options, and overall loan eligibility.

How to Calculate the Loan-to-Value Ratio (LTV)

loan to value ratio

  • It’s actually one of the easiest calculations you can make
  • Simply divide the loan amount by the appraised value or purchase price
  • And you’ll wind up with a percentage known as your LTV
  • The tricky part might be agreeing on a sales price and getting the home to appraise at value

Simply put, the loan-to-value ratio, or “LTV ratio” as it’s more commonly known in the industry, is the mortgage loan amount divided by the lower of the purchase price or appraised value of the property.

If we’re talking existing mortgages (in the case of refinance loans), it’s the outstanding loan balance divided by the appraised value.

When calculating it, you will wind up with a percentage. That number is your LTV. And the lower the better here folks!

It’s actually very easy to calculate (no algebra required) and takes just one step. You don’t even need a mortgage calculator. In fact, you might be able to run the numbers in your head. Honest!

Let’s calculate a typical LTV ratio:

Property value: $500,000
Loan amount: $350,000
Loan-to-value ratio (LTV): 70%

In the above example, we would divide $350,000 by $500,000 to come up with a loan-to-value ratio of 70%.

Using a basic household calculator, not a so-called “LTV calculator,” simply enter in 350,000, then hit the divide symbol, then enter 500,000. You should see “0.7,” which translates to 70% LTV. That’s it, all done!

This means our hypothetical borrower has a loan for 70 percent of the purchase price or appraised value, with the remaining 30 percent the home equity portion, or actual ownership in the property.

LTV ratios are extremely important when it comes to mortgage rate pricing because they represent how much skin you have in the game, which is a key risk factor used by lenders.

A Lower LTV Ratio Means More Ownership, Better Mortgage Rate

low LTV low rate

  • The lower your loan-to-value ratio the more home equity or down payment you have
  • Which is another way of saying ownership or skin in the game
  • A low LTV equates to a lower mortgage rate because you’re viewed as less risky
  • It means the bank is risking less since you are more invested in the underlying property

Essentially, the lower the loan-to-value ratio, the better, as it means you have more ownership (home equity) in the property.

Someone with more ownership is less likely to fall behind on payments or foreclose, seeing that they have a greater equity stake, aka financial interest to keep paying the mortgage each month.

They’ve also got more options if they do struggle with payments, as they could just sell the property without taking a loss (or the bank losing money).

Not only that, but banks and mortgage lenders also set up pricing adjustment tiers based solely on the LTV ratio.

Those with lower LTV ratios will enjoy the lowest interest rates available, while those with high LTVs will be subject to higher mortgage rates and/or closing costs.

For example, if you’re being “hit” by the lender for having a less-than-stellar credit score, that adjustment will grow larger as the loan-to-value ratio increases (higher LTV ratio = greater risk).

So if your mortgage rate is bumped a quarter percent higher for a loan-to-value ratio of 80%, that same pricing hit may be increased to a half percentage point if the LTV ratio is a higher 90%.

This can certainly raise your interest rate in a hurry, so you’ll want to look at all possible scenarios with regard to down payment and loan amount to keep your LTV ratio as low as possible.

More importantly, just maintain an excellent credit score and you’ll have plenty of loan options, regardless of your chosen down payment or available home equity.

80% LTV Is a Very Important Threshold!

80% LTV

  • Keep your mortgage at/below 80% LTV if you want to save money
  • You won’t have to pay private mortgage insurance (PMI)
  • And it should result in a lower mortgage interest rate with fewer pricing adjustments
  • You’ll also enjoy greater lender choice as most banks will lend up to 80% LTV

Most borrowers (who have the means) elect to put 20% down when buying a home, as it allows them to avoid mortgage insurance and the much higher pricing adjustments often associated with LTVs above 80%.

Fewer adjustments mean you can secure a lower interest rate on your mortgage. And if you can avoid PMI at the same time, it’s a win-win for your monthly housing payment!

You may also find it easier to get approved, as virtually all banks and mortgage lenders will accept LTVs of 80% or less.

But you don’t necessarily need to put 20% down to enjoy the benefits of a low-LTV mortgage.

Also Get to Know the Combined Loan-to-Value Ratio (CLTV)

Looking at the above example again, if you were to raise the first mortgage amount to $400,000 and add a second mortgage of $50,000, the combined loan-to-value ratio, or CLTV as its known, would be 90%.

Banks and mortgage lenders have both LTV and CLTV limits, meaning they won’t allow homeowners to borrow more than say 80, 90, or 100 percent of the property value.

These limits came down after the Great Recession but are creeping back up again…

Let’s do the math here; again, no mortgage calculator required!

Simple math: $400,000 + $50,000 = $450,000 / $500,000 = 90% CLTV

You would have a first mortgage at 80% LTV, and a second mortgage for an additional 10% LTV, making the CLTV 90%. Simply add up both numbers.

Sometimes borrowers elect to break up home loans into a first and second mortgage, known as combo mortgages.

This keeps the loan-to-value ratio below key levels, thereby reducing the interest rate and/or helping the homeowner avoid private mortgage insurance.

Tip: The undrawn portion of a home equity line of credit (HELOC) typically isn’t included in the CLTV calculation.

Max LTV by Home Loan Type

max LTV

  • FHA loans go as high as 96.5% LTV (3.5% down payment)
  • Conforming loans (Fannie/Freddie) go as high as 97% LTV (3% down)
  • USDA and VA loans go to a full 100% LTV (zero down)
  • Jumbos, cash-out refis, and investment properties are much more restrictive
  • And there is no maximum LTV in many cases for streamline refinances

There are certain LTV limits based on home loan type, with conventional loans (non-government) typically being more restrictive than government loans.

And mortgage refinance programs often less accommodating than home purchase loans.

At the moment, you can get an FHA loan as high as 96.5% LTV, which is just 3.5% down payment.

You can get a conventional loan as high as 97% LTV, which at just 3% down is higher than it used to be.

In recent history, the maximum was 95% LTV, but now Fannie Mae and Freddie Mac are competing directly with the FHA.

[See FHA vs. conventional for more on that.]

You can get either a VA loan or USDA loan at 100% LTV (which represents no money down).

These are the most flexible loan programs LTV-wise, but they are also only available to veterans or those living in rural areas, respectively. So not everyone will qualify for these types of mortgage loans.

There are also proprietary home buying programs from various private mortgage lenders that allow for 100% LTV financing if you take the time to shop around.

If it’s a jumbo home loan, a cash-out refinance, or an investment property, the loan-to-value will be a lot more limited, potentially capped at just 70-80% LTV, depending on all the attributes.

And finally, those underwater or upside down borrowers you hear about; they owe more on their mortgage than the property is currently worth.

This can happen due to negative amortization and/or home price depreciation.

A quick underwater loan-to-value ratio example:

Property value: $400,000
Loan amount: $500,000
Loan-to-value ratio (LTV): 125%

As you can see, the underwater borrower has a LTV ratio greater than 100% (this equates to negative equity), which is a major issue from a risk standpoint.

For the record, you get 1.25 by dividing 500 by 400.

The problem with homeowners in these situations is that they have little incentive to stick around, even with a modified mortgage payment, as they’re so far in the red that there’s little hope of recouping home value losses.

However, the popular Home Affordable Refinance Program (HARP) allowed millions of underwater homeowners to refinance to lower rates with no LTV limit. And many of these folks are probably now back in the black.

Today, this type of program still exists, but is a permanent option known as a high-LTV refinance, or HIRO for short.

So there are options to refinance and get a lower interest rate, as long as your loan is owned by Fannie Mae or Freddie Mac, no matter the mortgage balance relative to the property value.

Same goes for FHA loans and VA mortgages thanks to the FHA streamline refinance and the VA IRRRL option.

Despite being far behind new homeowners entering the market in terms of building home equity, many of these formerly-underwater borrowers now have lots of equity thanks to rising home prices and several years of paying down their mortgages.

That’s why you have to consider the long-game in real estate and never give up, even when times get tough. This also illustrates why home buying shouldn’t be a quick or hasty decision.

A Lower Loan-to-Value Can Save You Money!

  • A lower LTV generally results in a better interest rate
  • Which means cheaper monthly mortgage payments
  • It puts more of your hard-earned dollars toward the principal balance each month
  • Potentially saving you thousands of dollars over the life of the loan!

As noted, a lower LTV will likely result in big savings thanks to a lower interest rate.

Additionally, you may be able to avoid costly private mortgage insurance, enjoy expanded loan program eligibility, and have an easier time getting approved for a mortgage.

If your LTV is higher than you’d like it to be, there are some creative options to lower it.

Borrowers Can Reduce Their LTV in a Variety of Ways

  • Come in with a larger down payment if it’s a home purchase loan
  • Ask for gift funds to increase your down payment
  • Or break your mortgage up into two separate loans (combo loan)
  • Make extra payments or a lump sum payment for a refinance to get the LTV down before you apply
  • Or simply wait for natural amortization and home price appreciation to lower your LTV over time

If we’re talking about a home purchase, simply bring in more down payment money and the LTV will be lower. Easier said than done, sure, but possible for some.

Perhaps someone will gift you the money or act as a co-borrower?

Alternatively, you can look into breaking up your financing into two loans, with both a first and second mortgage.

If it’s a mortgage refinance, simply pay down the mortgage balance a bit more before you apply, whether on schedule or by making extra mortgage payments.

This can be especially helpful if you’re super close to a certain LTV threshold, or just above the conforming loan limit.

Speaking of, pay close attention to your LTV – if it’s just above 80% or some other meaningful tier, think about adjusting your loan amount down (your loan officer should advise you here!).

Lastly, there’s another way existing homeowners can get their LTV down and it requires no effort whatsoever.

You don’t have to do anything except sit back and watch your property value increase over time, thereby lowering your LTV in the process. Of course, the opposite can happen too if home values drop!

But as noted, real estate should be treated with a long time horizon, so be sure you have the ability to ride the ups and downs and make moves when it’s most favorable to you.

Read more: 10 ways to build home equity.

Source: thetruthaboutmortgage.com

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While perhaps the most advantageous reason to use a mortgage broker is their ability to shop your rate with multiple lenders, you still need to put in the time to comparison shop.

There are three main reasons I can think of offhand to explain this argument. And while you’re at it, don’t forget to compare banks vs. brokers too if you want to truly exhaust all your options.

Remember, gathering several mortgage quotes is a proven method to land a lower interest rate on your home loan, backed up by real studies.

Yes, it takes more time, but the return on investment can be enormous when you look at the fraction of time involved to the potential money saved.

Different Skill Sets and Personalities

  • Mortgage brokers are individuals just like real estate agents
  • This means they can have various experience levels and unique personalities
  • You’ll want to choose one that is both competent and easy to work with
  • Who takes the time to explain how everything works and answers your questions

First off, mortgage brokers are often just individuals, though larger shops exist as well.

This means they may have various personalities and hold different skill sets, with some more experienced than others.

You might find one broker that’s been working in the mortgage industry for two years, and another that’s been at it for 30 years or longer.

Chances are you’re going to favor the veteran if faced with a decision between the two, but if you don’t even put in the time to check out more than one, you’re doing yourself a disservice.

This isn’t much different than only obtaining a single mortgage rate quote from a retail mortgage lender.

Sure, the broker has the advantage of shopping your loan scenario with multiple lenders on your behalf, thereby providing you with several quotes, but it’s still not an exhaustive search.

Obviously, you want to choose a broker that is competent enough to get your loan to the finish line, especially if it’s an important, time-sensitive home purchase.

And you’ll also want to work with someone who is honest, trustworthy, and perhaps friendly and available if and when you have questions.

Similar to a real estate agent, it can be worth your time to speak to a few different brokers to feel them out before proceeding to work with one.

Sure, referrals are great, but make sure you like the person as well, and vet them yourself to ensure they’re a good fit.

Distinct Wholesale Lender Partners

  • Brokers can work with an unlimited number of wholesale lenders
  • Some may be approved with a ton of different companies, while others only work with a few
  • Their mortgage rates and available loan programs will be dictated by who they choose to partner with
  • This means you might have more options and/or lower rates with one broker versus another

That brings us to reason number two why you need to compare mortgage brokers. They may have different wholesale lender partners.

Remember, one of the main reasons to use a mortgage broker is their ability to shop your loan with several lenders.

As opposed to a retail bank, which just has one set of loan programs, rates, and fees, a broker can explore their entire rolodex to find a good home for your loan.

However, this search really depends on who that particular broker is partnered with, or if they take the time to present you with a full range of options.

Not all brokers are approved to work with the same wholesale lenders. For example, some may work with United Wholesale Mortgage (UWM), while others may work with Quicken Loans’ Rocket Pro TPO.

As such, the broker you choose may only be able to quote you mortgage rates from one of these companies.

Along those same lines, one broker may be approved with a dozen wholesale lenders, while another only two or three.

Additionally, they may just have a preferred wholesale lender that they send most of their loans to, and you might not get to see all there is to offer.

Ultimately, you want choice when using a broker, otherwise it’s kind of a waste of time, even if they provide exceptional service and are highly competent.

Varying Compensation Levels

  • Brokers get to choose their lender-paid compensation plans with each company they partner with
  • Two different brokers can select completely different plans with the same exact lender
  • This means one broker could earn double that of another while offering the same loan from the same company
  • The result could be a higher or lower mortgage rate depending on which broker you wind up working with

I saved the best for last – brokers get to choose their compensation levels with their wholesale partners.

They might get the choice to earn one, two, or even three points on every mortgage they close, along with numbers in between like 1.75% or 2.50%.

While what they earn is totally their prerogative, it does mean you could partner with a broker that earns double or even triple that of another who is working with the same exact lender, and providing the same exact loan.

For example, let’s say you’ve got a $400,000 loan amount and the broker you decided to work with has a compensation plan of 2.50% with Lender A.

This means they’ll earn $11,000 in lender-paid compensation for your loan, which is paid directly by the wholesaler to the broker.

While it doesn’t come out of your pocket directly, higher commission equates to a higher mortgage rate.

Now imagine a different broker who works with that same lender chose a compensation plan of just 1% per loan, in order to snag more business (increased volume, smaller margins).

They’d only be paid $4,000 on our hypothetical loan, which means you’ll probably get a lower interest rate as a result.

And remember, it’s the same exact loan from the same exact lender. The only difference would be the individual who is handling your loan.

Again, that can matter, as not all brokers are created equal, as mentioned above, but this does illustrate the importance of comparing mortgage brokers, just as you would banks and direct lenders.

(photo: Tom Shockey)

Source: thetruthaboutmortgage.com

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In your endless search to find the lowest mortgage rates on the planet, you may be wondering which route will lead to the biggest savings.

Should you go to your local bank, try your luck with an online mortgage lender, visit a credit union, or consult with an independent mortgage broker/banker?

You’ve Got a Lot of Options When It Comes to a Mortgage

  • There are many avenues you can take to obtain a home loan
  • Including local brick-and-mortar banks and credit unions you may already know and work with
  • Or direct mortgage lenders (both online and offline) you may have never heard of that promise low rates
  • Lastly don’t forget to consider an independent mortgage broker as well

You may have heard that mortgage brokers offer the lowest interest rates thanks to their wholesale partners.

And as we all know (or should know), wholesale prices tend to be cheaper than retail prices, the latter of which rise as operating costs are passed along.

So does this mean brokers will automatically offer better rates than the competition?

To be blunt, there’s no easy answer here. Actually, there is, but it’s not without its legwork.

I’d argue to call/visit all of the above to see who offers the best interest rate and closing cost combination.

Yes, I know it’s a pain, but if you don’t do it, you’ll never really know what could have been. And consider the return on your investment for those few extra hours you put in.

Of course, you’ll need to be firm with each company you call, as they’ll be selling you as hard as humanly possible, and making promises to best everyone else, whether true or not.

Assuming you survive the endless sales pitches, you’ll need to determine if the company offering the “best deal” can be trusted to actually get the deal done. After all, a mortgage offer is of no value if it doesn’t actually close.

This requires doing some research on the company and/or individual involved, asking for references, and so forth.

Oh, and going over the rate and cost of the loan more than once to ensure everyone is on the same page.

That’s right, not every mortgage company is reputable, and if you pick one that can’t deliver, you’ll waste a lot of time and potentially miss your window to snag a low interest rate.

Again, it sounds like a lot of work, but if you consider the money involved (potential savings every month for the next 30 years), it’s really not a whole lot of effort.

Extreme couponers who spend hours saving a few bucks, I’m looking in your direction…

A Mortgage Broker Might Be Able to Offer a Shortcut

  • There’s one little shortcut you can take to make the mortgage shopping part easier
  • If you use a mortgage broker they can compare rates from multiple lenders on your behalf
  • They have lots of wholesale lending partners at their disposal which can save you time and money
  • This is actually a key part of their job – to find you the lowest rate possible from their many partners

One “shortcut” you can take is by consulting with a mortgage broker, who act as middlemen between wholesale banks/lenders and the borrower.

Instead of calling 25 different retail banks to inquire about rates, costs, turn times, eligibility and so on, you can ask a mortgage broker to do all of that for you.

A mortgage broker is basically your own personal shopper, and they will have access to loan programs from numerous banks and lenders.

They’re kind of like independent insurance agents, who can get quotes from a bunch of different insurers, without you having to fill out a quote form 100 times.

Similarly, brokers simply gather your information once and then determine which mortgage lender they work with will offer you the best rate, based on your unique loan scenario.

After THEY shop around, they’ll come back to you with their best rate in the hopes of earning your business.

And if you tell them that a retail bank is offering something lower, you may hear an even better deal out of their mouth.

[Are mortgage rates negotiable?]

Can Mortgage Brokers Get You a Better Rate?

mortgage broker rates

  • This is a difficult question to answer universally because many factors are at play
  • It depends on the wholesale lender(s) the broker does business with
  • If these lenders offer low rates and the broker doesn’t take a large commission
  • They may offer an unbeatable deal, but still always shop around and negotiate!

At any given moment, retail banks and direct lenders may offer lower or higher mortgage rates than brokers and independent mortgage bankers.

They may not always be lower, and they may not always be higher, which is why you should consider all avenues before deciding on any one company or individual.

In some cases, your loan scenario may not be attractive to the bank offering the lowest rates for one reason or another. Simply put, your loan may not fit their product niche.

And some retail banks just offer higher rates than others because mortgages aren’t their strong suit, or only business, so if you happen to be with that more expensive bank, a broker may have a better rate for you.

If this is the case, knowing who does “like” your type of loan is paramount. With a broker/banker, you don’t need to search around to find that “right” bank. They’ll do it for you.

So it is possible to get a better deal with a broker/banker, depending on the circumstances.

Why Do Some Brokers Have Better Mortgage Rates Than Others?

  • Mortgage rates can vary among brokers just like they do with retail lenders
  • This is because they work with various wholesale lenders and may select different compensation packages that can affect the rate you receive
  • Be sure to shop and compare individual brokers just like you would banks
  • Some may charge more than others and/or not be approved with the banks offering the lowest rates

As noted, mortgage brokers work with lots of different lender partners, which means interest rates can vary from lender to lender. This partially has to do with their compensation.

Say one broker decides to get paid 2% on all the loans they originate with a certain bank, while another only charges 1% with that same bank.

That could result in an interest rate of say 3.125% versus 2.875% on the same loan thanks to the difference in commission.

If you only speak to the broker charging 2%, you won’t know that another broker out there can do better because they’re willing to earn less per loan.

The same may be true of the lenders they’re partnered up with. For example, one broker may work with a low-cost lender that the other doesn’t happen to work with.

So while a broker has the ability to shop your rate with multiple lenders, you might want to shop with multiple mortgage brokers to see what’s out there.

You may discover that one broker can beat another broker’s pricing thanks to the lenders they work with and/or their compensation levels.

Lastly, be sure to compare multiple brokers/bankers as well to weed out the bad players.

And as alluded to earlier, a good deal is only worth its salt if it actually funds.

If a broker/banker can get a tricky deal done for you, there’s a lot of value there, even if the rate is slightly higher.

If a big bank drags their feet and isn’t able to get it done in a reasonable amount of time (or at all), their seemingly better deal essentially becomes worthless.

Read more: What mortgage rate can I expect to receive?

Source: thetruthaboutmortgage.com

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Mongoose vs. Cobra. Coyote vs. Roadrunner. Pirate vs. Ninja?

And finally, “fixed-rate mortgage vs. adjustable-rate mortgage.”  Yes, we’re talking about the greatest rivalries of all time.

Okay, maybe this one isn’t as interesting as those others mentioned above, but it can be if you’re buying a home or refinancing an existing mortgage.

So what’s better, the boring old fixed-rate mortgage or the more provocative and often controversial adjustable-rate mortgage (ARM)?

Let’s discuss both and come up with some conclusions, which can vary based on individual preferences and circumstances.

Fixed-Rate Mortgage vs. Adjustable-Rate Mortgage

ARM_vs_fixed

During the housing boom in the early 2000s, homeowners often chose adjustable-rate mortgages as a means to qualify for a home they probably wouldn’t be able to afford with a traditional fixed mortgage.

Back then, you could qualify a borrower at the ARM’s lower start rate, even though the loan would eventually adjust much higher.

Even if they could afford a fixed-rate loan, homeowners were happy to take the lowest interest rate possible, which typically came with the ARM.

But times have changed, and adjustable-rate mortgages have now fallen out of fashion with fixed-rate mortgage rates hitting all-time record lows. Rates have since risen quite a bit but the trend is the same.

In fact, fixed-rate mortgages account for more than 90% of the purchase money mortgages and refinance loans being originated nowadays.

Sure, fixed mortgages are definitely more popular, but that doesn’t mean they’re any better, or always the right choice.

It’s just a matter of preference for most.  And as homes become less and less affordable, the popularity of ARMs will rise once more.

Fixed-Rate Mortgages Like the 30-Year Are the Default Option

fixed

  • Most homeowners opt for fixed-rate mortgages when buying a home or refinancing an existing loan
  • We’re talking 90% or more of all home loans are 30-year or 15-year fixed mortgages
  • ARMs were very popular prior to the mortgage crisis because of their relative affordability
  • But now have less than 5% market share (that could change as home prices continue to rise)

When taking out a mortgage, most people tend to choose a fixed-rate mortgage, making it the default option.

The most popular of the fixed mortgages is the 30-year fixed, seeing that the payment is fixed for the entire term of the loan, and the long amortization period keeps monthly payments low.

The 15-year fixed-rate mortgage is also pretty popular, but because the entire balance must be paid off in half the amount of time, monthly payments are much higher.

That means fewer borrowers are willing or able to choose one due to affordability concerns.

Start with a 30-Year Fixed, Refinance to a 15-Year Fixed?

Typically, a homeowner will start with a 30-year fixed, then when it comes time to refinance, they’ll go with a 15-year fixed to stay on track and avoid resetting the clock.

This allows a homeowner to save money and stay on track in terms of paying off their loan. If they take out another 30-year loan they’d delay their payoff.

There are also adjustable-rate mortgages, which most borrowers tend to avoid unless they are extremely savvy investor-types, ultra-rich, or instructed to do so by their mortgage broker or loan officer.

I say savvy because some folks will take a chance on the initial interest rate discount offered on ARMs despite the associated risk of a higher interest rate in the future.

So you need to know what you’re doing when selecting an ARM, and most importantly, have the capacity to absorb any interest rate adjustments in the future.

As mentioned, there were also those borrowers who had to take out an adjustable-rate mortgage to qualify because the interest rate was lower.

This was a routine practice before the mortgage crisis, with the ARM option typically floated by the real estate agent, broker, or loan officer whether it was in the borrower’s best interest or not.

This isn’t as common nowadays because it’s not necessarily easier to qualify for an ARM since you often need to qualify at the fully-indexed rate.

What Type of Adjustable-Rate Mortgage Are We Talking About?

most ARMs

  • Today’s ARMs are usually hybrids with a fixed and adjustable period
  • They feature a fixed interest rate at the beginning of the loan term for X number of years
  • Followed by an adjustable-rate period for the remainder of the loan term
  • This makes them a little bit safer, but not as cheap as they otherwise would be

The big question when debating the fixed vs. ARM decision is what type of adjustable-rate mortgage are we dealing with?

These days, it’s quite common to take out an ARM with an initial fixed-rate period, such as a 5/1 ARM or a 7/1 ARM.

The above examples are fixed for the first five and seven years, respectively, before becoming annually adjustable for the remainder of the term. They’re known as hybrid ARMs for that reason.

There’s even an option that is fixed for 10 years before its first adjustment, making it relatively low-risk.

This means you’ve got some breathing room before the interest rate adjusts up or down. That’s right, your mortgage interest rate can move up or down if it’s an ARM.

And all of these ARMs are amortized over a 30-year period, meaning they will take 30 years to pay off, assuming you hold them until maturity (which most borrowers don’t).

So they are the same as a fixed-rate mortgage in terms of length, and if you only keep them for five or seven years, they act no differently regarding how much principal and interest is paid.

Actually, you’d likely pay off more of your principal balance and pay less interest due to the lower interest rate on the ARM.

The major difference is that the 30-year fixed is, ahem, fixed, while the ARMs are, you guessed it, adjustable. By adjustable, I mean your mortgage rate can move up, down, or sideways.

This obviously presents some serious risk, assuming mortgage rates rocket higher during the few short years you hold the loan.

ARMs Can Go Up and Down (But Typically Only Rise)

FRM vs ARM

  • ARMs can adjust higher or lower over time depending on the associated mortgage index
  • In that sense they don’t necessarily need to be refinanced
  • Whereas if mortgage rates drop significantly after you obtain your loan
  • You may need to refinance your fixed-rate mortgage to take advantage of lower market rates

While it’s possible that mortgage rates could move lower in the future, they’re no longer at record lows and may just stay put over the next few years in the 5-6% range.

And mortgage indexes tied to ARMs have risen with all other interest rates and likely won’t fall anytime soon.

So an ARM you obtain today will probably reset higher upon its first adjustment, meaning your monthly mortgage payment will go up.

If you can’t handle that hypothetical higher mortgage payment, you may want to stick with the 30-year fixed, even if it’s slightly higher today.

But will you stay in the home for 5-7 years, or will you move. And will you refinance before that time?

If there’s a good chance you will do either, an ARM could make more sense than a fixed-rate mortgage, assuming the interest rate is a lot lower.

Also note that both fixed-rate mortgages and ARMs require active participation. Just because your loan has a fixed rate doesn’t mean you don’t have to keep an eye on rates.

If rates move lower, you may lose out if you don’t refinance your fixed-rate mortgage. So it’s not as set-it-and-forget-it as it appears.

Keep the ARM for the Fixed-Rate Period Only

If you are buying your first home, but plan to move or upgrade to a better home as you start a family, an adjustable-rate mortgage might be the best option short-term.

And the money saved during those few years can be used for a down payment on the next home. Additionally, the lower interest rate increases affordability during the months it’s held.

At the same time, it hasn’t been uncommon lately for homeowners to choose a 30-year fixed, then refinance into another 30-year fixed shortly after once rates improved.

This is mainly because the initial discount on ARMs hasn’t been great relative to fixed-rate alternatives.

If the spread between the two isn’t wide, it may not be worth the risk.

And chances are someone who elects to go with an ARM will likely suffer long-term if they keep it.

Most will probably have to refinance or sell before the first rate adjustment.

This is why short-term ARMs are typically reserved for the very wealthy, who have the option to refinance or pay off the loan whenever they choose.

If you go with an ARM and don’t have the option to pay it off or refinance, you could be stuck with a rising payment, which could put your mortgage (and property) in jeopardy.

Tip: Never choose an adjustable-rate mortgage just to qualify for a loan. If you can’t qualify for a loan at the fixed mortgage rate, consider holding off and renting for a while or buying a cheaper property.

Does the Initial Discount of an ARM Justify the Risk?

worth risk

  • Make sure the ARM discount is worth the risk of a potentially higher rate later
  • Also consider how long you’ll keep your home loan and the property
  • You might not keep it long enough to ever worry about a rate reset
  • It could be a much better deal than the more expensive fixed loan you won’t take full advantage of

Be sure you’re getting a good discount on the ARM in exchange for the uncertainty and risk of it rising in the future.

Currently, 30-year fixed mortgage rates are hovering around 6%, while the 5/1 ARM is pricing pretty similarly, depending on the lender.

The spread between products isn’t great at the moment, meaning ARMs aren’t too favorable right now.

At other times, the difference in pricing might be 1.5%, making an ARM a serious contender.

Risk appetite, age (retirement), job status, investment strategy, and downright stress will also come into play, so be sure to do plenty of math and compare different scenarios before deciding on anything!

Simply put, you’re taking a risk when choosing an ARM (hence the discount), so take a hard look at the numbers compared to fixed rate options.

While an adjustable-rate mortgage typically provides financing at a discount, it comes with much more uncertainty, especially in today’s market.

And if it’s a goal to pay off your mortgage, a fixed mortgage is generally the best option for most.

Tip: If you buy an owner-occupied property that you intend to later rent out for the long-term, a fixed-rate mortgage might be a good pick because you’ll probably keep the loan for a long period of time.

And chances are you won’t want to refinance the loan since financing is more expensive on investment properties.

When Is an Adjustable-Rate Mortgage Is a Good Idea?

  • You are buying a starter home and plan to sell in a few years
  • You expect mortgage rates to improve in the near future and will likely refinance
  • You have marginal credit and expect to improve it, thereby opening the door to better financing
  • You didn’t get great terms in general and think you can do better once those issues are resolved
  • You’re wealthy and can pay off your loan in full whenever you wish
  • There’s a large spread between ARMs and fixed interest rates

When a Fixed-Rate Mortgage Might Be the Better Call

  • Rates are super low (or at/near record lows) and aren’t expected to get any better
  • When interest rates are expected to rise substantially in the near future
  • If you have trouble refinancing and don’t want to take any chances
  • You bought a home you wish to rent out in the future and don’t want to have to refinance it as a non-owner occupied property
  • You want to pay off your home loan in full by a certain date (e.g. retirement) and want that certainty
  • If the spread between fixed and ARM rates is marginal

Pros of Fixed-Rate Mortgages

  • The interest rate will NEVER change
  • Your monthly payment won’t fluctuate
  • Easier to manage your finances/budget
  • Rates on fixed-rate mortgages are very low at the moment
  • No stress about what rates are doing (you can sleep at night)
  • No need to refinance unless rates drop dramatically (but you still can if need be)
  • Easy to wrap your head around, no surprises

Cons of Fixed-Rate Mortgages

  • Interest rates are typically more expensive
  • Your monthly payment will be higher
  • You’ll pay more interest over the loan term
  • It could be harder to qualify for a mortgage with a higher rate
  • You’ll pay your mortgage off more slowly
  • You’ll build equity at a slower rate
  • You may choose not refinance for fear of losing your low, fixed rate

Pros of Adjustable-Rate Mortgages

  • Lower mortgage rate (at least initially)
  • Lower monthly payment
  • You’ll pay less interest in the early years
  • Build equity faster while interest rate is lower
  • Most ARMs are fixed for a certain amount of time
  • Caps and ceilings limit interest rate movement
  • You might sell/move before the interest rate even adjusts
  • You can always refinance if rates rise and you qualify
  • Interest rates can actually drop over time!
  • You’ll have extra cash on hand for other expenses or investments

Cons of Adjustable-Rate Mortgages

  • Interest rates can rise substantially in a short period of time
  • You may not be able to afford the higher monthly payment post-adjustment
  • You could lose your home to foreclosure if you can’t keep up with payments
  • You may refinance over and over and never actually pay off your mortgage
  • Refinancing can be quite costly versus holding your original fixed-rate loan
  • You might be stuck with your high-rate loan if you don’t qualify for a refinance
  • ARMs often feature floors that limit if you interest rate can actually drop
  • You need to actively keep track of mortgage rates
  • You will likely be a lot more stressed
  • Your interest rate may dictate whether you move or stay put
  • More difficult to budget accurately
  • Time moves faster than you may think

(photo: eckes/bernd)

Source: thetruthaboutmortgage.com