Some Should Consider an ARM

Adjustable-rate mortgages are not the right choice for many homeowners especially, if they plan to own the home for a long time.  Less than 3% of buyers choose an adjustable-rate mortgage according to NAR's 2021 Profile of Home Buyers and Sellers.  With fixed-rate mortgages hovering in the mid 4.00% range, it's understandable that people select a rate that will not change over the term.

The buyers who know they're only going to be in the home a few years should, at least, investigate an adjustable-rate mortgage.  Compare the cost and evaluate the risk of an ARM instead of a fixed-rate mortgage.

The payment on the ARM in the example is $223.25 less than that of the FRM.  The rate is locked in for the initial period which is five years on a 5/1 ARM.  This will save a buyer $13,395 in the first 60 months.

The lower interest for the initial period is an obvious advantage to create savings but another dynamic that takes place is that lower interest rate loans amortize faster than higher interest rate loans.  In the example shown, the unpaid balance on the ARM is $6,165 less than the fixed-rate mortgage creating a total savings of close to $20,000 for the ARM in the first five year period.

  

This comparison estimates the breakeven point on this example to be 7 years and 1 months.  That is when the savings during the initial period will be exhausted based on interest rate adjusting the maximum allowed at each succeeding period. This is a worst-case scenario because ARMs are adjusted according to an independent index that the lender has no control.  The payment can adjust downward just as it can adjust upward.

Even if a person knows they are not going to be in a home for five years or less, their tolerance to risk may cause them to choose a fixed-rate mortgage.  With the difference in rates being so close, some people might think the fixed rate is safer in case their plans change and they end up living in the home a longer period.  Still, for the person who feels comfortable with the uncertainty of changing payment, the ARM may save them money.

For an estimate of what it could save you based on your price range, use this ARM Comparison and you can see the current FreddieMac rates on fixed and adjustable loans.  Call me at (616) 402-3535 for a recommendation of a trusted mortgage professional.

Waiting Will Cost More

Mortgage rates have been kept artificially low by the Federal Reserve since the Great Recession in 2010.  There is a whole generation of people who have never known what might be called normal mortgage rates.  And then, most of the rest of the adults in America have forgotten what average rates were in the 60's, 70's, and especially, in the 80's when they hit 18.45%.

The bottom of the market was February 2021 with 30-year fixed rates were 2.73%.  Current rates, as of February 10^th, according to Freddie Mac, are at 3.69%.  Earlier predictions by NAR, FNMA, Freddie Mac, and MBA were that rates would go as high as 4.00% by the end of the year.

Those estimates may be considered low now based on concerns about inflation and the federal government's efforts to keep it under control.  The Fed has announced a series of policy rate increases for the balance of the year.  Mortgage lenders, in anticipation of the rate hikes, have already started raising their rates as evidenced in the rates since January 3, 2022.

It is possible that a year from now, 30-year fixed rates could be at 5% or above.  This could make a significant difference in a buyer's payments especially compounded with rising prices.

A $450,000 purchase price today with a 90% fixed-rate 30-year mortgage at 3.69% has a principal and interest payment of $1,862 a month.  If things continue to heat up and the mortgage rate goes up by one percent while the price increases by ten percent, a year from now, the home will cost $495,000 and the payment would be $446 higher each month for the term of the mortgage.

Use the cost of waiting to buy to make projections on the price home you want to buy based on your own estimate of what interest rate and appreciation will do in the next year.

Acting now causes the payment to get locked in at the lower rate and the increase in value belongs to the buyer as equity build-up.  Unfortunately, with the current state of supply and demand on housing inventory, waiting to purchase moves the bar higher and higher until some buyers will not qualify.

For more information, download the Buyers Guide.

Why a Home Should Be Your First Investment

Real estate has been described as the basis of all wealth.  Without considering income or investment property, buying a home to live in is an incredibly powerful way to build wealth or financial net worth.

A home is an asset measured by the size of the equity.  Equity is simply the difference between the value of the home and the amount owed.  There are two powerful dynamics at work to increase the equity which include appreciation and amortization.

Appreciation occurs when the fair market of the home increases.  The shortage of available inventory coupled with high demand has contributed to an 18% increase in value in the past year on average for homeowners in the U.S.

Most mortgage loans are amortized with monthly payments that include the interest that is owed for the previous month and an increasing amount that is paid toward the principal loan amount so that if all the payments are made, the loan would be repaid by the end of the term.

A 30-year mortgage at 3.5% interest on a $400,000 loan amount would have a principal and interest payment of $1,796.18 every month for 30 years.  After the interest is applied from the first payment, $629.51 would reduce the loan amount, thereby, increasing the owners' equity.

Each succeeding payment would have an increasingly larger amount applied to the principal and a decreasingly lower amount applied to interest.

Recently, CoreLogic reported that homeowners with mortgages have seen their equity increase 29.3% since the second quarter of 2020.  Equity rich is defined as when combined loans secured by a property are no more than 50% of estimated market value.  ATTOM reported that 42% of mortgaged homes in the U.S. are considered equity rich as of the fourth quarter of 2021.

Another advantage of this powerful asset is that borrowing money against the equity of your home is a non-taxable event. Regardless of whether it is a refinance or a home equity loan, the borrowed money is not income and not taxable.

A homeowner could stay in the home for years and as the home increases in value due to appreciation, they could borrow against their equity as many times as the value will justify.  They could continue to pull money out of their home for decades and under the current tax law, they could die and will the home to their heirs who would receive a step up in basis and the taxes would never have to be recognized.

Lastly, let's consider the home as an investment by looking at the rate of return.  Obviously, it is a personal asset that the homeowner will be able to live in, enjoy, raise a family, and share with their friends.  In calculating the rate of return, we consider a $375,000 home with a 3.00% 30-year FHA mortgage with a 3.5% down payment.  Using an annual appreciation of 3% and normal amortization, the $13,125 down payment in this home turns into a $148,062 equity in seven years.  The rate of return calculated is over 40% per year for the seven-year holding period.

Even if you discounted the ROI by half for all the unforeseen other expenses that may affect the real equity, it is still a 20% return on investment which could easily justify why purchasing a home should be your first investment.

It is challenging, particularly in some markets with low inventory, multiple offers, rising prices and increasing interest rates, but the advantages of owning a home are significant.  Would-be homeowners need the facts about their market and how to get into a home.  Start with downloading the Buyers Guide and make an appointment with a trusted real estate professional.

Paying Points to Lower the Rate

Two commonly known ways to lower your mortgage payments are to make a larger down payment especially if it eliminates private mortgage insurance and improve your credit score before applying for a mortgage.

Another way to lower your payment would be to buy down the interest rate for the life of the mortgage with discount points.  A discount point is one percent of the mortgage borrowed.  Lenders collect this fee up-front to increase the yield on the note in exchange for a lower interest rate.

A permanent buy down on a fixed-rate mortgage is available to borrowers who are willing to pay discount points at the time of closing.

Let's look at two options on a $315,000 mortgage for 30 years at 4% interest with no points compared to a 3.75% interest rate with one-point.  The principal and interest payment on the 4% loan would be $1,503.86 compared to $1,458.81 on the 3.75% loan. 

The $45.04 savings is available because the buyer is willing to pay $3,150 in points.  By dividing the monthly savings into the points paid, you can determine the breakeven point.  In this example, if the buyer is planning to stay in this home for at least 70 months, they would recapture the cost of the points and each month after that would be savings.

Another interesting thing to consider is that lower interest rate loans amortize faster; in other words, they build equity faster by paying off the loan sooner.  If the buyer stayed in the home for 10 years, their unpaid balance in this same example would be $2,117.38 lower than the 4% mortgage.  Combine that with the $2,259.29 in savings from the breakeven point to the end of 10 years and the buyer, in this situation, is $4,372.67 better off buying down the mortgage by paying the additional points. 

For a person buying a home, it may be difficult to come up with the extra amount for the points but one benefit is that the points paid are considered interest by IRS and can be deducted in the year paid.

A rule of thumb commonly used is that one discount point lowers the quoted mortgage rate by ¼% or 25 basis points.  A lender may quote X% + .6 points for a mortgage.  Using this scenario, to lower the mortgage rate by .25%, the buyer would need to pay 1.6 points. It is important to note that each lender determines the pricing of points for the loans they make. 

It may be beneficial to a buyer to pay points depending on how long they plan on being in that home.  To help you determine whether paying points should be considered, use this Will Points Make a Difference and download the Buyers Guide