TIP IF YOU WANT LESS VOLATILITY

Historically among the least volatile rates have been the cost of funds and the Libor index. However, as we move into new economic climates, that could change. Lenders should provide you with a chart showing changes in the index for your loan. Be sure you ask for a chart that includes the period of 1979 through 1981 and 1999 to 2003 so you can see how the index performed in both high-interest-rate and low-interest-rate economic conditions.

What Is the Margin? Each adjustable rate has a margin. This is a figure that is added to the index to give you your interest rate. For example, the margin might be 3 percent. Thus, if the index is at 5 percent, add the 3-percent margin and you have your effective mortgage interest rate of 8 percent.

TRAP IT’S NOT JUST THE INDEX Keep in mind that the index rate is not your interest rate. The lender’s margin is added to the index, and this can increase your effective interest rate substantially.

Plan Your Strategy If you’re going to live in the home only a short time and then resell, get the lowest teaser rate with the longest adjustment periods and shortest steps possible. For example, if you plan to live in the property for only three years, you might be able to find an ARM that gives you a below-market interest rate for the entire period of time! Also, most people aim for the most stable index. That way you have a better idea of your monthly payments. But if interest rates are

falling, you may want a more volatile index that will reflect falling rates in a more rapidly falling monthly payment. In addition, don’t compare just interest rates and points with ARMs. Sometimes an ARM with a higher interest rate and more points is a better deal, if it has a more favorable adjustment period, steps, margin, and so on.

Comparing Adjustable-Rate with Fixed-Rate Mortgages Now we’re at the stage of comparing apples with oranges. However, in truth, a direct one-to-one comparison isn’t usually very helpful. Rather, what’s more important to most borrowers is comparing the usefulness of each type. It’s sort of like saying, “Do I want to eat an orange now, or will an apple taste better?” Here are some guidelines that may prove helpful. When interest rates are low, get a fixed-rate mortgage to lock in the low rate. When interest rates are high, consider an adjustablerate mortgage with payments that will fall as interest rates come down. If you desperately want to buy a home but can’t qualify for a fixedrate mortgage, try an adjustable. The lower teaser rate should make qualifying a bit easier. (Currently lenders qualify not just on the basis of the teaser, but on an average between the market rate and the teaser, which is still probably lower than for a comparable fixedrate mortgage.) If you can’t afford to have fluctuations in your monthly payment, get a fixed-rate mortgage. You’ll at least know what your payments will be every month. If you plan to sell soon, get an ARM and take advantage of the low teaser rate. But beware, your plans could change unexpectedly! Sometimes ARMs have lower initial loan costs. If cash is a big consideration for you, look into them. Remember that with an ARM, if interest rates go up, so do your payments. (This may occur even after rates have peaked and started to come down. Because of your adjustment period, you may play “catch-up” for months after the falling, you may want a more volatile index that will reflect falling rates in a more rapidly falling monthly payment. In addition, don’t compare just interest rates and points with ARMs. Sometimes an ARM with a higher interest rate and more points is a better deal, if it has a more favorable adjustment period, steps, margin, and so on.

Comparing Adjustable-Rate with Fixed-Rate Mortgages Now we’re at the stage of comparing apples with oranges. However, in truth, a direct one-to-one comparison isn’t usually very helpful. Rather, what’s more important to most borrowers is comparing the usefulness of each type. It’s sort of like saying, “Do I want to eat an orange now, or will an apple taste better?” Here are some guidelines that may prove helpful. When interest rates are low, get a fixed-rate mortgage to lock in the low rate. When interest rates are high, consider an adjustablerate mortgage with payments that will fall as interest rates come down. If you desperately want to buy a home but can’t qualify for a fixedrate mortgage, try an adjustable. The lower teaser rate should make qualifying a bit easier. (Currently lenders qualify not just on the basis of the teaser, but on an average between the market rate and the teaser, which is still probably lower than for a comparable fixedrate mortgage.) If you can’t afford to have fluctuations in your monthly payment, get a fixed-rate mortgage. You’ll at least know what your payments will be every month. If you plan to sell soon, get an ARM and take advantage of the low teaser rate. But beware, your plans could change unexpectedly! Sometimes ARMs have lower initial loan costs. If cash is a big consideration for you, look into them. Remember that with an ARM, if interest rates go up, so do your payments. (This may occur even after rates have peaked and started to come down. Because of your adjustment period, you may play “catch-up” for months after the downturn.) You can’t call your lender later and say, “I can’t handle a $200 increase in my monthly payment!” Your lender isn’t going to be sympathetic and will threaten you with foreclosure if you don’t pay. The time to consider a big monthly increase is before you get that adjustable-rate mortgage, not afterward.

Fixed- or Variable-Rate Mortgage? You should get a fixed-rate mortgage:   If you can lock in a low-interest rate   If you plan on keeping the property a long time   If you want a fixed mortgage payment (does not go up or down) You should get a variable rate mortgage:   If interest rates are high and you can get a long-term, low initial (teaser) rate   If you plan on selling or refinancing soon   If you can handle flexible mortgage payments (that can rise during the life of the loan)

There are a whole bunch of hybrids out there, any one of which may be better for your situation than a straight fixed or ARM mortgage.

What Is a Convertible Mortgage? Some ARMs may be “convertible” to a fixed rate, or vice versa. Many allow a conversion at a set date three or seven years, for example in the future. Just be sure the conversion is guaranteed at the lowest interest rate at the time of conversion. There are literally hundreds of types of convertible mortgages available. Some lenders will even create one just to suit your financial situation. Be sure to ask.

What About Short-Term Fixed,

Amortized over 30 Years? The whole point behind an ARM, from a lender’s perspective, is to give a loan that can respond to interest rate fluctuations. Another way of accomplishing this is to give a shorter-term fixedrate mortgage. Currently lenders are offering short-term fixed-rate mortgages in the following time lengths, all amortized over 30 years, 15 years, 10 years, 7 years, 5 years, or 3 years. The shorter the term, the better the interest rate is. What this means is that after the initial period, you have a “balloon,” a single large payment where the remaining balance is due. For example, you can get an interest rate reduction if you agree to get a loan with a balloon in 15 years (see the following). You might get an even bigger reduction if you agree to a balloon in 10 years instead of 15. If you agree to a balloon in 3, you might get the interest rate reduced the most. (Note: The monthly payments can still be spread out amortized on the basis of 30 years. It’s just that you have a shorter due date, or balloon payment at the end.)

On short-term fixed-rate mortgages, if it turns out that you can’t sell or refinance as you planned at the end of the term, you could lose the property to foreclosure! You’re gambling a lower interest rate on future market and personal financial conditions. Therefore, make sure a shorter-term mortgage includes an automatic refinancing option at the end. Usually this is an ugly adjustable, but at least if worse comes to worst, you won’t be without a loan.

Some people simply want a shorter mortgage. As opposed to the hybrids just discussed, in a fully amortized shorter-term mortgage, the payments are higher so it can be fully paid off at the end of, say 15 years. (With a hybrid, you have lower payments, but a balloon at the end here the mortgage is paid completely.) The advantage here is much less interest over time. With a 30-year amortized mortgage the total interest is more than twice as much at the same interest rate than with a 15-year fully amortized mortgage! Of course, you may be saying to yourself that this is all well and good yes, you save more than half the interest. But you probably more than double your payments. Not quite. The difference in payments between the same 15-year and 30-year mortgages is only about 20 percent. You’ll end up paying only about 20 percent more monthly. (Yes, it really does work out that way. It’s all in the way mortgages are calculated.)

Many people like the idea of saving interest and, since they currently have enough income, jump to a 15-year mortgage. The problem is the higher monthly payment. What if at some point during the time you’re paying back the mortgage, you get ill or lose your job? It’s a lot harder to repay a higher monthly payment than a lower one. The solution is to get a 30-year mortgage with no prepayment penalty. (Most modern mortgages don’t have penalties for early repayment.) No prepayment penalty means that you can pay a higher monthly payment at any time you want. Thus, you can pay the equivalent of the monthly payment to turn a 30-year loan into a 15. However, if the loan was originally set up as a 30 year, then at any time making that higher payment becomes a hardship, you can drop back to the lower 30- year payment. When things get better, you again pay more. Here, you get the advantage of being able to pay off the mortgage in a short time if you choose, but also have the safety of a lower payment if hard times hit.

Popular a few years ago, some biweekly mortgages are still around. Here, instead of paying your mortgage each month, you pay half the monthly amount every other week. The result is that you actually pay an extra month each year. (There are 12 months, but 52 weeks in a year, meaning you would make 26 biweekly payments which equals 13 months.) Over the long haul, that extra month means you end up paying more in principal each year, which means much less interest down the road. This works for either a 30-year or a 15-year mortgage. With a 30-year mortgage, going biweekly can mean paying it off in around 23 years. The problem with biweekly mortgages is that you can be forever writing checks. Therefore, the only realistic way of handling them is to have the money taken out of your account automatically every two weeks. You can easily set this up yourself at your bank, or for a hefty fee, there are service companies that will do it for you. Keep in mind, however, that the biweekly mortgage is not for someone who is self-employed and gets paid irregularly. An unstable cash flow can cause real problems when you have a mortgage payment due every other week.