2020 – Forum Archive

Cash Out Refinance Loan in California

November 26, 2020 George Risk No Comments

Loan in CA

Cash out refinance is a term that applies to the process of refinancing a mortgage on a house where the owner has accrued substantial equity. That has happened to tens of thousands of homeowners in California over the last five years due to the steep run-up in housing values. One of the ways of converting that equity into cash is to take out a second mortgage on the home. Another method is to take out a new loan in California with more attractive terms than the old one, and borrow more than you owe on the house.
That is the process of cash out refinancing. Refinancing any home is an expensive proposition, because you are paying all of the closing costs that you encountered on your mortgage the first time around. In addition, your first mortgage may have a prepayment penalty that adds to the cost. It is critical to carefully analyze the value of cash out refinancing – it can often be the case that you are paying dearly for the cash you are extracting from your equity.

It’s important to consider all of the costs involved in cash out refinancing. A new mortgage probably means a new thirty-year payoff period on your home, so you are extending the period of debt. It you are getting a better interest rate on your cash out refinance mortgage, that’s a positive step but it will reduce your tax deduction as a percentage of your mortgage payment. If your new interest rate isn’t quite as good as the rate on the old mortgage, you will be raising the level of your tax deduction – but you have to be in the right tax bracket to make that worthwhile.

Cash out refinancing that takes your debt on the house beyond 80% of valuation may lead to a new requirement of mortgage insurance. That’s going to add to your monthly payment as well. So it is important to chart the added expenses of a new mortgage in order to determine the true cost of the cash you are extracting from your equity.

The comparison most people make is between the choice of a cash out refinance – that is, a whole new mortgage – and the option of a second mortgage. Once again, the issues are current versus former interest rates, closing costs (much lower on a second mortgage) and extending the life of your primary mortgage. Finally, cash out refinancing is only going to make sense if you plan to remain in the home for the foreseeable future. The cost of a new mortgage does not make sense otherwise.…

3/1 Adjustable-Rate Mortgage

November 14, 2020November 19, 2020 George Risk No Comments

Mortgage

A 3/1 ARM is an adjustable rate mortgage that holds at a low monthly payment for three years and then adjusts to a higher interest rate based on two calculation values: the index and the margin. The index is a value taken from a well known money market product such as the one year Treasury bill. The margin is the number of percentage points (usually between two and three) that are tacked onto the index to produce the interest on your loan for the next twelve months. The source of the index and the margin number are both defined in the mortgage contract. The interest rate is adjusted annually.

The average introductory interest rate for 3/1 ARMs on this particular day in May of 2020 is 5.52%. That means the mortgage payments for the first three years of a $300,000 thirty year loan will be $1,707. We’ll assume that the index for this loan is the one year Treasury bill, which on the day this is being written has an interest rate of 4.9 percent. Our second assumption is that the margin for this 3/1 ARM is 2 ˝ %. That means that the interest rate on the thirty year loan will rise to 7.4 at the beginning of year four.

At that interest rate your monthly payment will rise to about $2,000 and will adjust annually, subject to an annual cap, which is usually a figure in the neighborhood of 7 or 8 percent per year. Seven percent of the year four interest rate (7.4%) is just over half a percentage point at .51%. So the worst case scenario for year five on this loan is an increase of 7.4% plus.51%, which equals 7.91%.

Most ARMs have a maximum cap for the interest rate, put in place in case some sort of turmoil develops in the economy and loan indexes shoot up. If the maximum interest rate on this particular 3/1 ARM is 12%, the most your payments can ever be is $2472.

Many people find themselves with adjustable rate mortgages because they don’t qualify for a fixed rate mortgage. Others see ARMs as a method to maximize their buying power by keeping their initial monthly debt low. Monthly debt service is a critical benchmark for most lenders; most won’t consider a mortgage if the mortgage payment drives debt service beyond 40% of household monthly income.

A 3/1 ARM is probably a good choice for home buyers that expect an increase in household income over the next few years or that need to spend a significant amount furnishing the house or landscaping it or remodeling some outmoded portion of the property. The year four increase is going to be about $300; that’s a figure that can be included in the household budget with careful planning and disciplined execution. The worst case scenario – an extremely unlikely occurrence – is still within range, even if household spending has to go into emergency mode. A 3/1 ARM can be the right choice for some buyers – especially young buyers – who have growing careers.…

3/1 Interest-only ARM

November 3, 2020November 19, 2020 George Risk No Comments

ARM, Interest

The interest only ARM is an ingenious bit of financial juggling that is designed to provide borrowers with an extremely low mortgage payment for the initial period of the loan – usually some number of years. The low payment allows borrowers to qualify for a larger loan than would be available to them under the terms of a standard ARM or a fixed rate mortgage. That in turn leads to the maximum in house value – and for the initial period of the loan, new homeowners making monthly payments on a house that they probably thought was beyond their reach.

A low payment schedule in the loan’s early years allows borrowers to meet the ceiling that lenders allow borrowers to maintain for total household debt service. Usually the acceptable maximum debt service for a potential borrower must be under 40% of the household’s total income. For the borrower, however, the real question that he/she must ask is “Can I afford the payments when the loan adjusts?”

A 3/1 interest only ARM is a loan that requires three years of monthly payments solely on the interest. It’s a good choice for someone who believes that the household income is going to rise substantially within the next few years, either through a new job or through the inclusion of additional breadwinners in the family.

People who bump the schedule to a 5/1 interest only ARM and pay mere interest for the first five years of the loan often intend to either sell the property or refinance it at five years. A three year period is probably too short for either of these choices to make sense, so the borrower who is contemplating taking a 3/1 interest only ARM needs to consider the consequences of paying on the fully adjusted mortgage.

The current interest rate today, (a May day in 2020) is 5.60% on a 3/1 interest only ARM. On a $300,000 loan, that will require a monthly mortgage payment of $1400. Make the assumption that your 3/1 has an index based on the one year Treasury bill and a margin of 2.5%. That means that beginning with the first month of year four in your mortgage, the monthly payment will be calculated by adding the interest rate on a one year T-bill for that particular day to your margin. Margins are usually two to three percent; we’ll assume that for this loan the margin is 2.5%. The T-bill interest rate today is 4.90%. If today was the adjustment day for your $300,000 loan the interest rate would jump to 7.4% and you would begin making payments on the loan principal as well. The result would be a monthly payment of $2142.

That’s an increase of over 50%. It’s the real number that you will have to deal with during 27 of the 30 years on the mortgage, and it is payments in that range that you should plan for. You’ve got three years to plan that new budget.…