Understand new mortgages
The ever-changing real estate market goes through time periods where certain trends are eaten up by less experienced investors. We are currently in the “exotic” or new mortgage trend.
These new mortgages are very beneficial for certain people with certain needs, but if you do not fully understand their implications and terms, you may get burned.
New mortgages are designed with specific people’s needs in mind. If you do not fit the characteristics, then you should stay with more traditional mortgage options.
Tara Siegel Bernard’s article, “Know the Real Price of New Mortgages,” which is posted on move.com, explains the finances and qualifications of certain new loans, to help you determine if you fit their mold.
As interest rates gradually climb and home prices continue to rise in many parts of the country, loans that offer affordable payments and advertise tantalizing introductory rates can be a way to purchase the home of your dreams that was otherwise out of reach.
“But these mortgages come with a cost that isn't always immediately apparent. With many of these products, home buyers won't make a dent in their principal balance for several years. And buyers who take out large mortgages could wind up in a deep financial hole if real-estate prices fall.”
There are a variety of these new mortgages available. The most demanded product, especially in areas where home prices exceed national averages, allows borrowers to make interest-only payments for several years. People seem to not mind that these payments will not knock down their principal balance at all.
Another popular product is the hybrid adjustable-rate mortgage (ARM), which allows borrowers to pay a fixed rate for a specific amount of time, usually several years, before switching to an adjustable rate.
There are many variations of hybrid ARMs available. But most of them have a basic financial formula.
“Case in point: a $300,000, 30-year fixed-rate mortgage with an interest rate of 5.5% would cost $1,703.37 monthly. Compare that with a 5/1 interest-only ARM with a 4.5% rate (5/1 means the initial rate is fixed for five years, then adjusted annually). This loan costs $1,125 a month, and saves borrowers $578.37 each month for those first five years.”
But be careful borrowing an interest-only ARM. When the five-year interest-only period expires, if the rate rises two points from 4.5 percent to 6.5 percent, the monthly payments will escalate more than $900 to $2,025.62. That would be tough for anyone to adjust to, especially someone who took out this mortgage because of its low monthly payments.
Lenders agree that most people expect to move after the fixed-rate period is up, with hopes that their home has value has appreciated, or they will refinance. But there are still a couple of risks. Borrowers may need to stay in their house longer than anticipated and rates could rise higher.
“Meanwhile, a traditional 5/1 ARM on the same $300,000 mortgage with a 4.5% interest rate would cost $1,520.06 monthly -- considerably more than with the interest-only version. But after the five-year fixed period, more than $26,500 in principal would have been paid off. Then if rates have risen to 6.5%, payments would increase to $1,846.51 -- nearly $200 a month less than the interest-only version.”
As previously mentioned, these new loans are designed to allow people with certain financial situations the ability to purchase a home.
But you will most likely save money over the entire life of the loan going with a traditional mortgage, if you have the necessary finances.