Fixed Rate Financing
Fixed Rate Financing almost died out but has made a strong comeback in light of the subprime meltdown of the mid-2000s. Fixed Rate loans offer fixed payments that only change when taxes or insurance coverage changes. A client can get a rate break of about 2% by choosing a shorter maturity, 15-year home loan, but payments will be higher. Consequently, a client would not qualify for the same home loan amount as a 30-year FR, and would have to accept a lower real estate home loan amount. Under the current rates, these home loans perform best over the long run since rates can vary greatly on Adjustable Rate Mortgages.
The Adjustable Rate Mortgage(ARM) has been around for about 20 years. ARMs are an alternative to fixed rate financing. Initial rates begin as much as 4% lower, compared to fixed rate home loans. A typical one-year ARM has a 2% annual cap and a 6% life cap over the initial rate, which is adjusted annually in concert with a national index that reflects current interest rates. At adjustment, this program employs the current index rate and adds a margin that generally varies around 2.5% to 2.7%. So be careful choosing an ARM. These loans are attractive for properties that will be sold in 4 to 5 years because a large sum of cash flow can be saved during the first two years. Under some circumstances, these real estate loans can even help a client qualify for a larger home loan because of the lower initial rates.
Balloon Loans serve as an alternative to ARMs and fixed rate programs, but demand careful consideration prior to application. The home loans are fixed for 5 to 7 years at a lower rate when compared to fixed rate home loans, and, remember, their payments are amortized over 30 years. A 7-year program saves .375% annually and a 5-year program saves .75% annually compared to a 30-year fixed rate. These real estate loans are due in full at the end of 5 to 7 years, although a client could (with restrictions) roll the home loan over to a fixed rate (plus 2%) at the maturity date. These are real estate loans for individuals who will hold properties for 3 to 7 years and who prefer fixed rate financing at lower rates.
The FHA, Federal Housing Administration, has an attractive ARM program offering more protection to a homeowner. The program offers a 1% annual cap and a 5% life cap. Although based on the same index as conventional ARMs, the margin is much lower at 2.0 – 2.25%.
Note: None of the above programs have pre-payment penalties under FNMA guidelines and are based on simple interest calculations. The adjustable rate real estate loans may be assumed with restrictions under their original terms, but the fixed rate and balloon programs are not assumable.