Maximizing Your Buying Power

Interest rates on mortgages are continuing to hold at historically low levels. These low levels combined with the tremendous variety of lenders and loan products available to the consumer, provide an opportunity that has never existed before. The smart borrower can put together financing packages that his parents never would have even dreamed of.

This article touches on a few ways consumers can use current low rates and new loan programs to save money. Since a home mortgage is usually the single largest outstanding item of debt on a personal balance sheet, managing this debt wisely can reap substantial benefits to almost every homeowner. Some useful techniques include the following:

No Closing Cost Loans

Any loan where the broker or lender pays all of your closing costs is commonly referred to as a ``no closing cost'' loan. These closing costs would include title & escrow fees, appraisal, lender's fees, credit report fees, and other expenses which are non-recurring over the life of the loan. Lender's use the term non-recurring to refer to only those expenses which are one time, and to exclude items such as interest, insurance, and property taxes, which are considered recurring closing costs because they will continue to be expenses every month. Recurring costs are not covered expenses in a no closing cost loan.

In the mortgage market, there are a variety of interest rate and point combinations available to the borrower at any point in time for the same product or loan type. As an example, for a loan amount of $200,000 a borrower can be quoted 6.75% with .875% points, 7.0% with zero points, or 7.25% with no closing costs. All three of these quotes are for a 30 year fixed rate mortgage. The lender allows the borrower to choose amongst rate and point combinations since some people prefer a lower rate immediately, while others prefer minimizing how much they pay out of pocket up front. Thus, the borrower can select the combination which feels most comfortable to their personal situation. For some borrowers, the no closing cost option of 7.25%, while providing a slightly higher rate, still requires the least investment up front and therefore is the best option.

No closing cost loans can be used for either a refinance or a purchase transaction, although they are most commonly associated with a refinance. A no cost refinance is the quickest way to generate immediate interest rate and payment savings with no up front investment in closing costs. To continue with our example, let's assume that a borrower is currently at 7.5% on a 30 year fixed rate loan and is interested in refinancing now that interest rates are declining. But what is the best time to finally ``bite the bullet'' and lock in a rate? If the person chooses to refinance using the no closing cost method, it doesn't matter when they lock in, so long as they are immediately saving money by refinancing. By choosing the 7.25% no closing cost loan, their payment would decrease right away, with no up front investment to refinance. Should interest rates continue to decline, the borrower can simply refinance again to obtain additional savings.

In a purchase situation a no closing cost option can work extremely well when the borrower has limited funds available for closing or when the rate market is declining and the borrower may want to refinance quickly. While most people associate a purchase with paying points just to obtain tax deductibility of the points, this is too simplistic a view. While the tax deductibility is an important factor, it is only one consideration for a borrower. Paying points up front to secure a low rate, in a steadily declining interest rate market, may be simply throwing money away.

With a true no closing cost loan, you can refinance for any incremental drop in your interest rate. Because there is absolutely no investment in up front costs, the savings of refinancing are immediate. In a market where you believe rates may continue to fall, it makes sense to refinance at no cost. Should interest rates decline further, you can refinance again without having to recoup the closing costs. Many borrowers refinance every year or less at no cost, while keeping their initial teaser rate in an Adjustable Rate Mortgage!

Hybrid Loans - Shorter Fixed Periods

If you want the security of a fixed rate mortgage but like the lower payments of an adjustable rate mortgage (ARM), a hybrid loan may be the product for you. A hybrid loan is one of the many loans currently available that is fixed for a shorter time than the traditional 30 or 15 years.

Hybrid loans can be found with fixed rate periods of 3, 5, 7, and 10 years. All of these loans are still amortized over 30 years so there is no need to worry about the monthly payment being too high. And at the end of the fixed period, these loans automatically roll into another ARM, so there is no balloon payment to anticipate. By matching up how long you plan on keeping your loan with the closest fixed term you can minimize your interest rate, since a 30 year fixed mortgage is a much more expensive option.

The advantage of a hybrid loan is the lower rate of interest that they require. The table below shows sample rates and payments for several hybrid loan products compared to the 30 year fixed. All payments are based upon a loan amount of $200,000 and quotes assume zero points.

Using ARM Teaser Rates in Your Debt Strategy

Many lenders offer low introductory rates on mortgages which then adjust after some period of time, typically six months or one year. These Adjustable Rate Mortgages with low teaser rates can be used successfully to minimize mortgage payments and interest costs. While this type of loan may seem risky, it can be the perfect loan in a stable or declining rate environment to use while interest rates hold steady or continue to fall. This type of approach relies on using no closing cost or low point loan choices, versus paying up front points and costs.

Any borrower can take advantage of the teaser rate options, however the strategy of refinancing frequently to replace the teaser with another teaser rate works best when the borrower's loan balance is at least $200,000. This is because below this amount it is difficult to obtain a no closing cost loan. The higher the loan balance, the better this strategy works. When the ARM is about ready to adjust up again, the borrower can refinance again for no cost at another low teaser rate.

Many borrowers have been successful in averaging their interest rates below 7% for the better part of the last four years. With the advent of Web mortgage sources it is now easier to obtain rate information and follow the market closely for such opportunities.

Risks to this strategy include facing an unfavorable interest market when the time comes to refinance. However, the market does not move overnight and it is possible to lock in a rate quickly when movements upward are detected. Alternatively, when you consider all of the savings on the front end, a slightly higher than expected rate on the back end may still leave you ahead of the game.

Eliminating Mortgage Insurance (MI)

If you purchased your home with less than 20% down, chances are you have a loan that is insured by ``Mortgage Insurance'' (MI). Most borrowers are aware that they are paying it on a monthly basis, but you can check your statement to be sure. As your home appreciates or your loan balance decreases (or a combination of the two), your equity in the home will exceed 20%. At that time a favored method of eliminating the MI tied to the loan is to refinance. The savings on the MI alone can often warrant the refinance.

Be aware that mortgage lenders value your property at what the comparable homes have sold for in the last 6 months, not what they are currently listed for. If you are close to that 20% mark, ask your mortgage source to give you a ``compel search'' figure which will tell you what the lenders will see your home's value as.