Hope for Cautious Homebuyers

adjustable mortgage for homebuyerLoc Chau was looking for a super-low interest rate to finance his San Jose, Calif., condominium, a place he envisions living in for a few years. Super-low to him means below 4 percent.

So he opted for an adjustable-rate mortgage insured by the Federal Housing Administration as an alternative to a 30-year-fixed rate mortgage.

In November, 30-year fixed-rate mortgages hit a 40-year record low, averaging 4.17 percent. But now, they are back in the 5 percent range.

“I don’t plan to stay here forever. History tells me I’ve averaged five years in each place I’ve purchased, and I don’t see any benefit to lock in a rate that is higher. I didn’t want to go with 30 years,” Chau said.

Adjustable-rate loans can provide lower payments than a fixed-rate loan for the first several years, but those savings can go away after the reset period kicks in. Payments also can rise sharply, leaving borrowers in a tough spot.

Typically, borrowers who get adjustable-rate loans try to either sell the home or refinance before the reset kicks in. The lower reset caps of an FHA adjustable-rate loan provides borrowers with a more breathing room than conventional adjustable loans, which have higher reset caps.

Chau obtained a $343,000 FHA adjustable-rate loan with an interest rate of 3.77 percent through San Ramon, Calif.-based Mason-McDuffie Mortgage. He moved into his three-bedroom condo in January.

Chau said the lower reset caps of the FHA adjustable-rate loan will help avoid having a big reset rate if he is still in the home after five years.

“To me, that’s a no-brainer. It’s not that much, I can live with it if I need to stay here another year or two,” said Chau, a 41-year-old fiscal and operations manager for the city of San Francisco. “It’s pretty decent.”

As with any real estate product, there are trade-offs when comparing loans.

Many conventional loans require a minimum 20 percent down payment, while FHA loans can be financed with a minimum down payment of 3.5 percent. FHA loans have a lower down payment requirement, but they also can take longer to process.

The higher mortgage insurance cost associated with an FHA loan can raise borrowing costs, said Steve Donahue, vice president of mortgage origination at San Jose, Calif.-based Technology Credit Union. That factor that has to be weighed when considering their lower reset caps.

“It’s important (prospective buyers) talk to a qualified loan officer who can explain the difference between an FHA and conventional loan so they can really understand all the costs involved,” he said. “There are so many factors (besides interest rates) involved.”

Mortgage insurance, which is paid for by the borrower and protects the lender against default, is required when there is less than a 20 percent down payment. While mortgage insurance is tax deductible, depending on a borrower’s income, that tax break will go away after 2011.

A borrower who made a 10 percent down payment on a $277,500 home and financed a $250,000 loan with a 3.7 percent interest rate would have monthly mortgage insurance premiums of $98 on a conventional loan, compared to $177 on an FHA loan. There is also an upfront FHA mortgage insurance premium equal to 1 percent of the home’s purchase price, a cost that can be financed into the loan.

Starting April 18, FHA loans will see higher premiums for monthly mortgage insurance. Contact a mortgage professional for details.

FHA adjustable-rate loans can be the right loan for borrowers who are now looking for low rates and a low down payment, and who may stay in the home for longer than five years, said Kevin Conlon, senior vice president of operations at Mason-McDuffie.

“It allows them to get into a home and qualify at today’s prices for those homes,” he said. “In the sixth year, a (conventional adjustable-rate loan) can go the lifetime limit. That can be a big payment.”

Rising interest rates have resulted in more people considering adjustable-rate loans, said Tara Nicholle-Nelson, consumer educator for San Francisco-based Trulia.com, a real estate website.

“There’s something about that 4 percent interest rate. It seems like the Holy Grail of interest rates,” she said.

Still, she said, many borrowers are still shying away from adjustable-rate loans, which are viewed as one of the factors that created the housing crisis. Adjustable-rate loans are tied to financial indexes, which means when they reset at a future rate the new interest rate can be lower or higher.

“A lot of what was wrong with adjustable-rate loans, at the top of the market, was not the adjustable part of it. It was the interest-only or option ARM part of it,” she said, referring to loan features that allow borrowers to pay little or no principal. “Their payment is going way up because they were never making a full payment.”

Source: McClatchy-Tribune Information Services.