THE VIRGINIAN-PILOT
Copyright (c) 1995, Landmark Communications, Inc.
DATE: Saturday, October 14, 1995 TAG: 9510130433
SECTION: REAL ESTATE WEEKLY PAGE: 20 EDITION: FINAL
COLUMN: ABOUT THE OUTER BANKS
SOURCE: Chris Kidder
LENGTH: Medium: 97 lines
For the last month I've been shopping for construction financing and a permanent mortgage. The ordeal has reminded me of one of my grandmother's favorite sayings: ``There's more than one way to skin a cat.''
She meant it figuratively, of course, and probably didn't have mortgage banking in mind. But let me tell you, she was right.
You might assume that because the banking industry is heavily regulated by the federal government that one mortgage company is the same as any other. You might assume that their products and rates are, for all intents and purposes, the same.
Those assumptions could cost you thousands of dollars. They could discourage you before you start. I've sat across the desk from lenders who said, ``No way,'' while other lenders told me what I wanted was possible.
I say this tongue-in-cheek, but mortgage bankers want you to suffer. They don't want you to comparison shop. Each lender will tell you they're the apple in a barrel of oranges. Don't believe it without checking the numbers for yourself.
Every lender uses a ``prime rate,'' the interest rate they charge their creditworthy customers. This prime rate set by each lender. It varies from lender to lender, usually by one-half percent or less. All lenders base their rates on the interest rate (called the discount rate) the Federal Reserve Board charges its member banks for money. What lenders do with that rate would amaze even my 93-year-old grandmother.
Grandma, still one sharp cookie, lives comfortably on her own property, bought and paid for at a time when mortgage lending was a lot simpler. In those days, there was no talk of ARMs, lock-ins, balloons, jumbos and no-docs. The lender had one rate to discuss with the average customer. Most mortgages were written for 25 or 30 years.
Today, wading through the financial implications of a 7/1 adjustable rate mortgage versus a 15-year fixed rate requires major mathematic skills and the intuition of a gambler.
Do you want an ARM?
The ARM was created in response to inflation in the 1970s that had both lenders and borrowers nervous. Lenders, already saddled with millions of dollars worth of pre-inflation mortgages that wouldn't mature for years, needed an influx of cash that wouldn't be tied up at below-market rates.
On the other hand, borrowers were reluctant to commit to inflated rates but they were optimistic that rates would fall. The ARM offered a chance to beat the bank when that happened. The ARM was a win-win product for its time.
ARMs aren't as attractive in a the present market where interest rates are low and somewhat stable. Lenders, as uncertain about what will happen with the money market over the long term as consumers, have closed the gap between 30-year fixed mortgages and shorter-termed ARMs, forcing consumers who want to gamble on rates going down to pay for the privilege.
Typically, a borrower can save one-half of a percent or less by choosing a 3, 5, 7 or 10 year ARM over a fixed-rate 30-year mortgage right now.
Unless you feel confident that you can predict the price of money three to 10 years down the road, there are only two reasons that I know for going that route.
The first good reason is to save money in the short term. The most popular ARMs on today's market call for a one-time adjustment at the end of 3, 5, 7 or 10 years, with an automatic roll-over to a conventional fixed-rate loan. Roll-overs don't entail another loan closing and borrowers are not required to re-qualify.
This kind of an ARM makes good sense for buyers who expect to sell their property before the loan rolls over.
The second reason to choose an ARM is to meet lender expense-to-income ratios by choosing a mortgage product that has the lowest possible monthly payment. Because the rate difference is so small right now, this approach to financing doesn't offer much on the plus or minus side.
Using an ARM in this way has its pitfall: A buyer may not be able to afford the adjusted payment if rates go up.
How much should you borrow?
A mortgage loan is based on appraised property value, not on the amount you have agreed to pay for the property. It would be misleading to say that a lender doesn't care what you're actually paying - in most cases, they do - but that has little bearing on what they will allow you to borrow.
It's easy to think you should borrow as much as you can get: After all, a mortgage is cheaper money than using your Visa card. It's possible to borrow 90, 95, sometimes even 100 percent of the property's appraised value.
But if you borrow 80 percent or more of a property's value you will be required to buy private mortgage insurance to protect the lender against your default. That can add as much as $50 a month to the payment on a $100,000 loan.
When the loan-to-value ratio is lower, lenders waive PMI. The more equity borrowers have in property, the less likely they are to default. And, if the lender should be forced to foreclose, that equity should cover their losses.
Next week, we'll look at more than one way to use loan-to-value numbers to qualify for a mortgage along with other mortgage tricks of the trade that consumers might or might not want to use. MEMO: Send comments and questions to Chris Kidder at P.O. Box 10, Nags Head,
N.C. 27959.
by CNB