Major retailers, including GAP, Inc., Target Corporation and Limited Brands Incorporated (owner of Macy’s and retail chains) all reported retail sales increases for February 2012. Despite rising fuel prices, sales of automobiles were also up during February, with the projected annual sales rate on pace for the best year since 2008. Additionally, the U.S. unemployment rate dropped for the fifth straight month in January to 8.3%; a rate not seen since February 2009.
Is the recession finally over? Not according to Federal Reserve Chairman Ben Bernanke, whose recent remarks to congress summarized the recovery as “uneven” and “modest.” However, speaking about the housing market, Bernanke was relatively upbeat about the options available to potential buyers. Due to the decline in house prices over the past five years and historically low mortgage interest rates, housing is dramatically more affordable today than it has been in some time.
No one can predict the future, and home prices could continue to fall, but a large number of people have entered the U.S. housing market. Assuming you’re one of them, or considering becoming one of them, it might be useful to review your financing options for a traditional single-family home.
Fixed Rate Mortgage
The fixed rate mortgage is the most straightforward of the conventional mortgage products. These loans are comprised of a notional balance (otherwise known as the “face” of the loan), a fixed interest rate (hence the term), the frequency of compounding interest (daily, monthly, etc.) and the loan term.
The interest rate on a fixed rate mortgage was originally derived from the yield-curve of United States’ Treasury notes, which still factors in, but it has expanded to include the large population of mortgage-backed securities that have been generated since the 1980′s.
Yield-curves are generally upward sloping, which means that short-term interest rates are lower than long-term interest rates. This is principally due to inflation, which is normally expected over time. The longer you lend a dollar, the less it is worth when you get it back. Therefore, the interest charged on the arrangement needs to be higher than with a shorter termed loan.
Fixed rate mortgages are most common offered over 15 or 30-year terms, but other durations are available from certain lenders. In contrast to a balloon-payment mortgage, where money is borrowed with little principal repayment until the expiration of the term, fixed rate mortgages pay off principal over time. Therefore, a portion of your monthly payment is for interest and the rest goes to pay down the principal.
As time progresses, an ever-increasing percentage of the payment is applied against the principal, since the periodic interest owed diminishes as the principal balance is repaid.
In today’s low interest environment, it is clear that most borrowers believe that a fixed rate mortgage is the financing product to use (see discussion about Freddie Mac’s adjustable rate market shared in the adjustable rate section below). Inflation, economic recovery and other factors could all lead to a sharp increase in mortgage rates. Locking in a fixed rate at these historic lows could prove to be an exceptionally wise move.
Are Adjustable Rate Mortgages Still Popular?
The housing boom of the past couple of decades generated a broad array of adjustable rate mortgage (ARM) products. There was incredible diversity with these products, a sampling of which include: Graduated margins (1% in the first year, 2% in the second, etc.), hybrid ARMs (fixed interest rate for a period of time, followed by an adjustable rate) and straight-forward adjustable rate mortgages (usually a margin + an indexed interest rate).
To some, these instruments were a godsend, allowing them to purchase a home with a financing instrument that met their specific needs; for others, these products were instruments of evil and allowed them to buy a home beyond their financial capabilities.
While the “moral hazard” of these products can be debated until the cows come home, the fact is that these products continue to exist and you should educate yourself about them in order to determine whether one of them is right for you.
Keep in mind that while many of the terms for these loans are standardized, variations exist and while mortgages need to meet specific guidelines to qualify for certain government programs (e.g. conforming to Fannie Mae and Freddie Mac standards), not all loans need to qualify for government programs. Banks can offer products that don’t meet the government institution requirements if they don’t intend to sell them to those institutions. Be sure to understand the exact terms of the borrowing agreement you are entering into before you sign.
“Plain vanilla” ARMs are the most straightforward of these products; they operate virtually identically to the fixed rate products described above, except for the fact that the interest rate is tied to a published index, such as the prime lending rate, and changes in connection with changes to the index rate. While most straightforward, they aren’t the most common.
According to Freddie Mac’s most recent ARM survey, hybrid mortgages remain the most common ARM in the market. Specifically, consumers favored the 5/1 ARM, which is a product whereby the interest rate is fixed for the first five years of the term and then adjusts annually thereafter. Hybrid ARM products provide a medium level of interest rate risk for borrowers, coupling the risk-less fixed rate product with the risky adjustable rate product.
Timing the Market
According to Freddie Mac, ARM loans account for only 10 percent of today’s mortgage production compared to approximately 40 percent of the mortgages that were outstanding in 2004. Consumers are obviously attempting to lock in historically low interest rates and leave the interest rate risk to the banks. Rates are low, house prices are depressed and financing options abound; if you’re looking to buy a home, now may just be the perfect time to enter the market.
This article was written by Chad Fisher for Lima One Capital. Of all of the Georgia hard money lenders Lima One Capital prides itself on its superior client service, lack of hidden fees and ability to close loans quickly.