Question

What is your opinion of Adjustable Rate Mortgages and down payment assistance programs, and what are the advantages and disadvantages of both?

Answer 1

1. ADJUSTABLE RATE MORTGAGE:

An adjustable rate mortgage is a loan that bases its interest rate on an index. The index is typically the Libor rate, the fed funds rate, or the one-year Treasury bill. An ARM is also known as an adjustable rate loan, variable rate mortgage, or variable rate loan.

Each lender decides how many points it will add to the index rate. It's typically several percentage points. For example, if the Libor rate is 0.5 percent, the ARM rate could be anywhere from 2.5 percent to 3.5 percent.

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Most lenders will keep the rate at that advertised rate for a certain period. Then the rate rises at regular intervals. This is known as a reset. It depends on the terms of the loan. It can occur monthly, quarterly, annually, every three years or five years, depending on the type of loan you get. You've got to read the small print carefully to determine if you will be able to pay the higher interest rate.

After the reset, the rate will increase as Libor does. That means your money payment could suddenly skyrocket after the initial five-year period is up. If Libor rose to 2.5 percent during that time, then your new interest rate would rise to 4.5 percent or 5.0 percent. The historical Libor rate reveals that Libor increased in 2006 and 2007. It triggered many mortgage defaults that led to the subprime mortgage crisis.

That means you've got to pay attention to changes in the fed funds rate and short-term Treasury bill yields.

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That's because Libor typically changes in lockstep with it. Treasury yields rise when demand for the bonds fall.

Pros

The advantage of adjustable rate mortgages is that the rate is lower than for fixed rate mortgages. Those rates are tied to the 10-year Treasury note. That means you can buy a bigger house for less.

That's particularly attractive to first-time homebuyers and others with moderate incomes.

Cons

The big disadvantage is that your monthly payment can skyrocket if interest rates rise. Many people are surprised when the interest rate resets, even though it's in the contract. If your income hasn't gone up, then you may no longer be able to afford your home, and could lose it.

Adjustable rate mortgages became popular in 2004. That's when the Federal Reserve began raising the fed funds rate. Demand for conventional loans fell as interest rates rose. Banks created adjustable rate mortgages to make monthly payments lower.

2. DOWN PAYMENT ASSISTANCE PROGRAMS:

Down payment assistance programs help low-to-moderate income borrowers make a down payment when they buy a home. Saving money for a down payment can be one of the biggest obstacles to buying a home so these programs can be very helpful to home buyers. Additionally, the larger the down payment you make, the smaller the mortgage you need to buy a home. By potentially reducing your mortgage amount and monthly payment, down payment assistance programs can make home ownership more attainable. Making a larger down payment may also enable you to afford more home. Depending on how they are structured, these programs can increase the equity you own in your home on day one when your mortgage closes and over time. Finally, while the primary purpose of down payment assistance programs is to help home buyers make their down payments on a home, in some cases the funds may also be used to pay for closing costs and limited property repairs.

Let’s take a quick glance at some of your options and the pros and cons of each.

Conventional 3%

This program only requires a minimum down payment of 3% of the purchase price. This is a great program for any home buyer that is looking for a small down payment option. The con is as a result of your lower down payment your Private Mortgage Insurance (PMI) is higher. Overall, great for any buyer with a small down payment and a good credit score. Grants are available with this type of structure currently.

Conventional 20%

This program is just like any conventional mortgage program, except you are putting 20% of the purchase price down. You start with a good amount of equity in the property, you are not required to pay PMI and your closing costs are typically lower. The con is that a larger down payment can be hard to save up for. Overall, this is the most popular program.

FHA Mortgage Program

The Federal Housing Administration (FHA) offers several different programs, essentially offering the homebuyer lower down payments and lower interest rates in correlation with your credit score. The FHA offers flexible terms for loan repayment with only 3.5% down, your down payment can be gifted from a family member, taken from your 401k, or a client can utilize a down payment assistance program. The con is it carries a Mortgage Insurance Premium (MIP), a percentage of your loan in addition to your closing costs and your PMI will be higher. Overall, this option might be best for someone has a small down payment, not perfect credit, or someone who is recovering from a major credit event like bankruptcy, short sale, or foreclosure recently.

There are two additional loan programs available, come back to learn more detailed information on these two programs:

• 100% Financing Options such as the USDA Rural Housing Program
• VA Mortgage Program