Simple Mortgage Choices – Fixed ARM Or Hybrid

Under what circumstances in today’s mortgage market would the fixed, ARM, or hybrid mortgage be best utilized? While the decision to purchase a home is no doubt a major step based on the importance and size of the item being purchased, as well as on the fact that it is one of the few items which requires borrowed money in order to complete the purchase, the decision you will make on the best way to finance this kind of purchase must also be one of the most important decisions you will make.

However, your decision regarding the mortgage type that best suits your home purchase may not be the same after you become a homeowner and you wish to re-finance your home. Whether you are purchasing or want to refinance, the list of available mortgage types you would most likely be selecting from includes a fixed rate mortgage, an adjustable rate mortgage (ARM) or a hybrid mortgage which combines the two options.

The names are pretty much self explanatory but basically a fixed rate mortgage is a mortgage where the interest rate remains constant and an ARM is a mortgage where the interest rate varies. The ARM interest rate varies up and down based on an index such as the treasury 1-year, 3-year, 5-year or 7-year note or the 10-year T-Bill. However there are usually clauses which prevent the interest rate from rising or dropping dramatically during a specific period of time. This safety clause provides protection for both the homeowner and the lender.

Advantages of a Fixed Option

A fixed rate option is ideal for home buyers or refinancing homeowners with good credit who are able to lock in a favorable interest rate. For these homeowners the interest rate they are able to retain makes it worthwhile for the home buyer/homeowner to borrow at the newest, lowest interest rate. The major advantage to this type of financing option is stability. Home buyers/homeowners who finance with a fixed mortgage rate do not have to be concerned about payment variations during the life of the mortgage, thus the term “fixed rate”.

Disadvantages of a Fixed Option

Although the ability to lock in a favorable interest rate is an advantage it can also be considered a disadvantage. This is because home buyers who obtain a prevailing market interest rate at the time of purchase will not be able to take advantage of subsequent interest rate drops unless they re-finance. And every subsequent refinance will result in the homeowner incurring additional closing costs.

Advantages of an ARM Option

An ARM is favorable in situations where the interest rate is expected to drop in the near future. Home buyers and homeowners who are skilled at predicting trends in the economy and interest rates may consider financing with an ARM if they expect the rates to drop during the course of the loan period. However, interest rates are tied to a number of different factors and may rise unexpectedly at any time despite the predictions by industry experts.

A mortgage consumer who can reasonably predict the interest rate markets would be able to determine whether or not an ARM is the best financing option. However, since this is not possible for most home buyers and homeowners, they will have to either rely on their instincts and hope for the best or select a less risky option such as a fixed interest rate.

Disadvantages of an ARM Option

The most obvious disadvantage to financing with an ARM is that interest rates may rise significantly and unexpectedly. In these situations the homeowner may suddenly find themselves paying significantly more each month to compensate for the higher interest rates. While this is a disadvantage, there are some elements of protection for both the homeowner and the lender. This often comes in the form of a clause in the terms of the mortgage contract which prevents the interest rate from being raised or lowered by a certain percentage over a specific period of time.

Consider a Hybrid Financing Option

Home buyers and homeowners who are undecided and find certain aspects of fixed rate mortgages as well as certain aspects of ARMs to be appealing might consider a hybrid re-financing option. A hybrid loans is one which combines both fixed interest rate features and features of adjustable interest rates. This is often done by offering a fixed interest rate for an introductory period and then converting the mortgage to an ARM.

In this option, lenders typically offer introductory interest rates which are extremely enticing to encourage homeowners to choose this option. A hybrid loan may also work in the opposite way by offering an ARM for a certain amount of time and then converting the mortgage to a fixed rate mortgage. This version can be quite risky as the homeowner may find the interest rates at the conclusion of the introductory period are not favorable to the him/her.

Building Blocks for the First Time Home Buyer

Building blocks for the first time home buyer outlines the entire process of home buying that a first time home buyer may benefit from in his/her preparation for home ownership. There are four blocks of preparation which can be described as Preliminary, Before, During and After the purchase.

In many home buying transactions the process will begin with the priliminary and before stages (preparing yourself to make the purchase, and finding a suitable home) as in blocks One & Two below; And during (the mortgage financing process as in block Three below.

Block four is treated a little differently because it occurs after the transaction closes, but it must have been initiated between blocks One & Two because a first time home buyer must decide on the specific mortgage type (whether it be a conventional, a FHA-type, or VA).

In the case a FHA 203k rehabilitation mortgage loan the mortgage clause in a purchase contract would have to indicate that 203k mortgage financing will be a condition of the purchase. The building blocks for a home-purchase include the following:

Block One Preparation (personal) – Things you can review in preparation for your home purchase, like;

  • Job – Length of employment, job security, and good to excellent prospects for continued employment.
  • Savings – Having put aside enough money for down payment, closing costs and at least 3 months reserves (one month reserve equaling one month PITI)
  • Credit – Reasonable to excellent payment history on all accounts, account balances at or below 50% of account limits and reduction in the number of accounts to six or below (including balance transfers if necessary).

Block Two Preparation (house) will include;

  • Searching for and selecting the best home for your money
  • Real Estate Broker – Interviewing brokers, including buyer’s agents, that you will make your purchase with (or through)
  • FSBO (For Sale By Owner) – Going it without a broker includes contacting the home seller(s), making your offer directly to him/her/them, preparing and making your initial offer, and setting up your contracting signing (things that a broker would usually do).
  • Mortgage Broker/Lender – Arranging your own mortgage financing through a lender of your choosing is a right bestowed upon you by federal law.

Block Three Preparation (mortgage financing) includes;

  • The mortgage type and lender selection is left to the buyer to decide without any undue pressure (from anyone else).
  • Mortgage Type – Generally your choices would be Conventional, PMI, FHA and VA
  • Mortgage Application – Depending on the lender you select this application could be done by mail, the internet or in person. It really depends on how much of the work you want to do.
  • Appraisal Report – Although you pay the appraiser’s fee, you do not get to select the appraiser. This is done by your lender; And while you are entitle to a copy of the appraisal report, many lenders do not release it before the closing and/or without a written request from you.

Block Four Preparation (finding a licensed and insured general contractor);

  • The contractor plays a key role in a 203k-financed home purchase.
  • Contractor’s Estimate – Required to provide the mortgage lender’s personnel with an amount to be financed into the mortgage.
  • HUD Consultant’s Work Scope – Required by HUD to inspect the home, keep the work estimate figures in line with reasonable market rates, and establish the required contingency reserve.
  • HUD Consultant’s Work Inspections – Also required by HUD to insure that work is being done without any extended stoppages (30 days or more), as well as to authorize release of funds to the contractor.

For more about FHA-insured financing, visit the HUD website

Humor or Irony:

If the government can’t run business, how come businesses always run to the government for a bailout when it runs into trouble? FHA-insured mortgages… Government-run for over 75 years! Lest we forget?