This is always an interesting discussion I have regularly with customers who call. This one ranks up there with “what’s today’s best rate?” for frequency.

I get to discussing various options with people and try my best to explain to them terms and amortization periods. I explain what a closed mortgage is and then they ask, “how about a variable mortgage?” Followed by “what’s todays best variable rate?”

I don’t try and steer people away from this type of option, but similar to the line of credit (LOC) and what I call the credit trap, generally people don’t understand how to use this option.

Think of it like buying stock in the stock market. Most people (not all) tend to buy what ‘they’ think is a good deal. They buy and pray that it goes up, and pray & pray…

Similarly people get into variable mortgages thinking they’ve got a good deal. The thought is, well if the prime rate drops, then my interest rate will drop right along with it. So they sit and pray the prime goes down.

Now when the bank announces that prime is going up a tenth of a point, these folks who were praying almost immediately call and say “lock me in QUICK!!” Are you sure? Yes, I can’t afford an increase in my payment.

This, of course begs the question, so why were you in this product in the first place? I then have to break the bad news to them that when I convert them over to a fixed rate, the payment is going to go up, because even the best fixed broker rate is going to be higher (especially after a bank rate hike).

So, unless my customer is a financial planner or an accountant who is working on a strategy to save some money short term with a view to lock in if the rates increase by a quarter point or more, I’m not likely going to put someone in a variable rate.

Now the last remaining question is, what’s the difference between an ARM and a VRM.

One is Adjustable, the other is Variable. The simplest way to explain the difference is one is changed periodically the other moves with the change in prime. And what I’ve discovered is that each lender has a slightly different take on each. Some offer only ARMs and others offer both. Getting into the details of different products from different lenders shows that some ARMs are very similar to others VRMs.

My advice, if this kind of product seems to fit your needs better than a fixed rate, understand what it is you want and ask for it by name. Do your research, explain to your broker why you want a particular product and go from there. If you don’t want to invest the time to figure out what product is best for you, then expect to get a fixed at “today’s best rate”.

It’s simple. People generally understand a fixed monthly payment that might go up or down slightly when they go to renew (at 3 or 5 years most commonly). This makes for simple budgeting.

Don’t feel you are tied into only paying the same monthly amount, all mortgages (with a few exceptions) offer some kind of prepayment option. You have the option to increase payments or put down a lump sum.

Actually, the simplest and easiest way to reduce your amortization is to switch to what we call accelerated bi-weekly payments. This cuts your payments in half (as they are now every two weeks in stead of 4), but the bonus part is you have 2 extra payments each year (26 payments not 24). These extra payments go directly on to your principal. The net effect is to reduce your amortization period by years! Yes YEARS! On a 5 year term, you can get up to 3 year reduction in your amortization (i.e. 25 becomes just over 17 at renewal). Not bad for 10 “extra” payments.

I guess that’s my big tip for the day.

Until next time.

Open and closed mortgages. These seem like fairly straight forward items.

Open mortgages or “fully” open as I hear it referred to so many times. This of course implies that lenders definition of “open” varies from institution to institution. Open should mean just that, you are able to at any time switch from your current mortgage to any other type of mortgage with no cost, fees or interest differential or pay down (off?) any amount at any time. Normally people would switch to a closed mortgage but some will switch to a variable open mortgage, but I’m getting a little ahead of myself.

Now when they say “no fees”, this is a relative term. If you stay with the same lending institution, then yes “no fees”. But if you decide to take your business elsewhere, well then there’s this little matter of an administration fee in order to close out your account. But that’s a bank fee, not a mortgage fee, right? Hm. When I have to tell my clients that there is a close out fee, generally they say they thought it was an open mortgage with no fees. Fortunately most of the lenders I deal with recognize this “gotcha” and agree to cover the fee up to a certain amount.

My question is, today, how much does it really cost to mark a file on the computer as closed? I digress.

The item I have run into recently are LOC (covered in the last post). These in theory were supposed to be considered open mortgages. Unfortunately what certain institutions have done is to not register these as mortgages on title, but instead as a collateral loan. Big deal you say? Well, when your lawyer hands you a $700 bill for de-registering the loan and registering a new first mortgage, don’t call me.

If it was just a straight switch from one lender to another as it should be, then there would be no need to change the registered mortgage, except to say who the new mortgage holder is and no cost to the client.

Now think about this for a minute, lending institutions have convinced you that a LOC is the way to go. Revolving credit, open mortgage that you can pay down any amount at any time, no restrictions. You planned on winning that lottery next week any way right? Instead, you fall into that credit trap, don’t pay down a cent on your mortgage. Get frustrated by the whole situation and decide it’s time to switch lenders. It’s an “open” LOC. Just a matter of paying it out and getting a fixed payment mortgage. Great plan, until the lender or mortgage broker calls to say that the “open” LOC is a loan and your lawyer has to get involved to de-register/register.

In my world, this moves from a simple “switch” (from one lender to another) to an refinance. Refinance means an appraiser has to visit, because the new lender wants to ensure the value of the property. The original mortgage amount is history with only a register loan against the property. The value of the property is assumed higher than the loan.

So that’s an open mortgage with a twist. It’s not really a mortgage and you don’t find this out until you decide to switch lenders or refinance. Or put another way, this is a way for the banks to keep you as a customer as you probably don’t want to pay the fees, but they will be willing to absorb the cost in order to switch you to another of their mortgage products.

Did I ever mention that banks are in the business of making money? They are quite good at it actually.

Closed mortgages. Implies that you have agreed to pay the same payment for the duration of the term. Whether that term is 1, 2, 3, etc years. Fixed payments at a fixed rate. All lenders do offer pre-payment options, like increasing your monthly payment or lump sum amounts yearly. These are usually percentages (10-25% lump sum or 15-25% increase). If you want to go beyond this amount, say lump sum of 50%, they then want you to pay an interest differential or 3 months interest. Effectively you are breaking out of your mortgage.

Lets say you sign up for a 5 year term and the rates drop a year later. You decide that it must be time to break out and get a new mortgage at the new lower rate. On the surface, yes this is probably a financially prudent idea. Just don’t forget to add in the cost of breaking out to your total calculation. If you do the math, you’ll likely see that unless the rate drop is significant (say at least 1.5%) you’ll likely end up paying more in break out costs than you will be saving over the lifetime of the new term. Don’t forget, it’s 3 months OR the interest differential which ever is HIGHER to break out of most mortgages. This is the banks “safety” clause if you will. Remember they’re in the game of making money.

Well, I thought this would be a short post. Looks like I’ll have to cover off ARM and VRM in the next post.

Last time we talked about conventional, hi-ratio, the A and Alt-A market and something called the sub-prime or B market.

As promised lets look at refinances, equity take outs, reverse mortgages, blanket mortgages and home equity lines of credit.

Refi/ETO -  surprisingly or not, most long term home owners refinance their mortgage at least once. It seems that once the folks move in they magically discover that they have to maintain their investment. Everything from lawn mowers to paint. There’s always one room that needs redecorating or remodeling. So after a few years of this folks discover that they’ve done most of these changes via credit cards and are a little tired of paying 19% interest. They look at their mortgage and say, why don’t we reduce our payments by paying out our credit cards with some equity from our mortgage.
They are refinancing their credit cards with lower interest (but longer term) mortgage payment by using the existing equity, or stated differently, they are taking-out equity from their home.

If you have a plan (i.e. something akin to a budget) where you actually plan to effectively pay down the added amount great. For many however, this is simply what some call a “home equity” trap. As long as the value of your house goes up, you have money to borrow. Bad thinking all around.
In my opinion, ETO should only ever be used to solve a major problem (i.e. some large unexpected high interest debt). Not a way to fix your poor credit spending habits.  If you want to consolidate debt, then get a consolidation loan. I would still use this as a last resort. These to me are just an easy fix. There is a more outgoing monthly than incoming. This needs to be address first, then tackle one credit card at a time.

I understand there are different situations where it makes sense, like using the cash to invest in a cash flow positive property or an investment that pays a higher rate of return than the mortgage, but most folks aren’t using it this way.

Reverse mortgage. Again this should be used in only certain situations. First off you need to be over 60 to be considered and plan on not living for very long. It strikes me as a bit morbid on the one hand and a way to reduce the amount of inheritance to your kids. The concept is interesting for older folks with no mortgage, this allows them to borrow up to 40% LTV without having to pay it back until the property is sold. The plan is to give these folks enough cash to fix or repair something or take that one last vacation they’ve been planning all their life.

Don’t be fooled, the lack of payments (or debt service) adds up. Yes, interest still compounds and we’re talking significant interest rates (prime + 2). If the borrowers live too long then eventually the mortgage increases to match the full value of the house. If they don’t repair the house (they are getting older now) then the value of the house can drop. Upon the sale, the lender takes the hit, but they are counting on folks only living their natural life span (78 men, 81 women?). So it’s a numbers game just like any other.

Blanket mortgage. This is where you have 1 mortgage covering off several properties. Think in terms of being a developer. You have multiple properties, but only one mortgage payment.  In the case of the developer as each house is sold, a partial payout is completed.

And you thought this was only available in colder climates.

Home Equity Lines of Credit or HELOC. Again going back to Refi/ETO, similar idea only instead of changing your first mortgage, you register a 2nd mortgage as a line of credit (LOC). Home equity trap is still there. Rates are higher. Who would use this? Folks who have high expenditures that they know will be paid back in the short term. So, say again someone in the construction business who has to buy all their materials at the beginning of the project, but in the end they know the sale of the property will more than cover the LOC. They just need to service the debt until the sale.
Next time, we’ll look at Open vs Closed mortgages. Along with adjustable (ARM) & variable rates (VRM).