Loans

Interest-Only Mortgage May Help Some Solve Mortgage Payment Issues

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Interest-Only Mortgage May Help Some Solve Mortgage Payment Issues

Question: Do you have any recommendations for ways to reduce the burden of high interest rates?

Answer: Hearing somebody suggest an interest-only mortgage may initially sound like a gimmick and bad financial advice, but for some buyers, an interest-only mortgage might be a great option to responsibly purchase more house within budget, with more control over your payments.

I was recently discussing mortgage options for a client with Skip Clasper of Citizens Bank (Skip.Clasper@citizensbank.com) and he brought up their interest-only mortgage product so I thought I’d share it here in case it can help anybody else. Most banks attach a higher interest rate to their interest-only product, but Citizens Bank does not (currently).

Standard Mortgage vs Interest-Only

A traditional mortgage is designed so that every payment is a combination of interest and principal, so that the loan is fully paid off after 30 years if you make the same minimum monthly payment each month. In the early part of the loan, most of your payment goes towards interest.

An interest-only mortgage is a loan that does not include any payment towards principal with each minimum monthly payment and thus lowers the amount you pay each month. Any money you pay over your minimum monthly payment goes directly towards principal and you can choose when and how much to make those extra payments. Note that in a standard mortgage, you can also pay additional money towards principal at any time, but you must make the minimum payment, which includes interest and principal.

The difference in payments between the two products isn’t massive because so much of your initial payments on a traditional mortgage are interest, but you can see from the table below that the difference in payments is enough to move most buyers into a new pricing tier (better/bigger home) or to become more competitive in the price tier you’re in (better chance of offer being selected). The table below doesn’t contain a $500k loan amount because the interest rates on lower loan limits are usually too high to justify.

A blue and white table with black text Description automatically generated

Who Should Consider an Interest-Only Loan

There are a handful of buyer profiles that I think should consider an interest-only mortgage to give themselves more spending power and/or more control of their loan payments:

  • Professionals with high bonus/commission compensation structures like attorneys, partners/executives, salespeople, and business owners. The key is making sure that you are allocating money from these windfall bonus/commission payments towards paying down your principal, but it helps keep your cashflow more manageable during the months where you have less or no income.
  • Homeowners who have high short/mid-term expenses like childcare. A family with two young kids in childcare may be paying $4,000+ per month and for most families, that cost will go away within a couple/few years. Once those costs drop off your budget, that money can be redirected into paying down the principal, if you haven’t yet been able to refinance into a lower interest payment.
  • Buyers where a new job or promotion is highly likely within a few years that will cause your income to increase enough that can start paying down the principal and make up for lower, interest-only payments early on. A good example of this is a couple where one person works and the other is in grad/medical school.
  • Buying a “forever home” and you’re finding yourself coming up a short on the budget you need to get into the right home and you don’t want the difficulty of managing higher payments in the first 2-3 years to prevent you from buying what you need for the next 20-30 years. There must be a reliable way for you to be able to be able to start paying down the principal (and catching yourself up) after a few years.

Waiting for Interest Rates to Drop to Refinance

A lot of buyers in today’s market are taking on higher mortgage payments than they can’t afford long-term and counting on interest rates to drop in a year or two so that they can refinance. While the odds are good that there will be a refi opportunity in the next 12-24 months, it’s far from certain and if you can’t sustain your minimum required payment on a traditional mortgage for more than 12-24 months, you’ve got a problem.

For buyers who are willing to take a gamble on a refi, an interest-only loan may be a safer way to wait for rates to drop because if it takes longer than expected, you have more control over how you pay down your mortgage prior to rates dropping enough for a refi.

Fiscal Responsibility is Key

The key to using an interest-only loan is to use it responsibly and have a solid plan in place to make payments towards principal rather than waking up 8-10 years into your loan payments with little to no dent in your loan balance (principal). If you do not trust yourself to do this, don’t even consider taking on an interest-only mortgage.

Qualifying is More Difficult

Interest-only mortgages are a riskier product for banks, so the lending standards are higher than a traditional loan. For most banks, you must qualify based on a 20yr amortization payment scheduled instead of a 30yr, meaning your debt-to-income ratio must be a lot stronger. Most banks also require you to have a significant amount of reserves after closing (retirement funds can usually be applied) and you need at least 20%-25% down.

If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at Eli@EliResidential.com.

If you’d like a question answered in my weekly column or to discuss buying, selling, renting, or investing, please send an email to Eli@EliResidential.com. To read any of my older posts, visit the blog section of my website at EliResidential.com. Call me directly at (703) 539-2529.

Video summaries of some articles can be found on YouTube on the Eli Residential channel.

Eli Tucker is a licensed Realtor in Virginia, Washington DC, and Maryland with RLAH @properties, 4040 N Fairfax Dr #10C Arlington VA 22203. (703) 390-9460.

The Right Lender Makes A Big Difference

elieliresidentialcom Arlington, Buyer, Loan , , , , , , 1 Comment
The Right Lender Makes A Big Difference

Question: Does it matter which lender/mortgage company I choose when I purchase a home?

Answer: Choosing a good lender is one of the most important decisions you make during the home buying process. In a competitive market like we’re in now, choosing the right lender goes beyond a low interest rate and access to good loan products; it can be the difference between having your offer accepted or passed over.

Stronger Offers

Better Pre-Approval: When I review offers on behalf of a Seller, I put a lot of value in the quality of the lender/bank who wrote the pre-approval letter for the Buyer. A lender who has taken the time to review credit and financial documents, and get a thorough understanding of the Buyer, means the risk of financing falling through is much lower than with lenders who generate pre-approvals based on a short form with inputs from the Buyer, without verification.

Most agents representing a Seller will contact the lender on the pre-approval letter to ensure they’re responsive, personally familiar with the Buyer’s financial qualifications, and are confident in closing based on the contract terms (price, settlement timeline, etc). Having a lender on your side who will answer the phone and understands the importance this communication can make all the difference in a competitive market.

Close Faster: Online lenders, larger banks, and credit unions often have difficulty closing in less than 35-45 days, but a good lender can often settle in less than three weeks. If you find yourself competing for a property, working with a lender who can close quickly will significantly increase the probability of your offer being chosen compared to a lender who needs at least five weeks.

Don’t Miss Settlement

Good lenders do not miss the settlement date. Their reputation and business rely on it. If you miss the contracted settlement date, you’re (usually) in default and expose yourself to risks including loss of Earnest Money Deposit, incurring the Seller’s carrying costs, or having the contract voided by the Seller.

A good question to ask your lender is where their staff works. There are quite a few people involved in getting your loan approved including the loan officer, processor, and underwriters. Lenders with a history of missing settlement deadlines often have staff working in different locations, that don’t regularly work together. If your lender works in the same physical office as those people, that’s a good indication that they can handle issues efficiently and have a higher probability of meeting the settlement date.

Don’t Get Duped (Interest Rate vs APR)

Be careful when you’re comparing interest rates, especially online rates. Make sure you’re comparing the Annual Percentage Rate (APR), not the interest rate. Many lenders advertise lower rates by including points (you pay cash up-front for a lower rate) or they charge higher fees. The APR is a measure of the total cost of the loan, including points, fees, and interest rate and allows for an apples-to-apples comparison.

Additionally, the advertised rates are often based on the ideal borrower profile and loan amounts. A true rate quote requires the lender to have your credit information, debts, income, purchase price, and down payment. Even with that information, I’ve seen lenders quote low rates to capture a Buyer’s attention and then increase the rate/fees once it comes time to lock everything in. Be careful and ask questions.

Reliable Pre-Approvals

A reliable pre-approval gives you the confidence that you’ll qualify for the loan you’re applying for. Weak pre-approval letters lead to surprises during the loan application process, which can lead to rejection letters, delays, and/or a lot of wasted time and money. The last thing you want is to find out you don’t qualify after you’ve spent money on a home inspection, appraisal, and started packing for a move that may not happen. Having a lender review all of your documents early also gives you time to fix credit scores, debt ratios, and more in order to increase your purchasing power and/or lower your interest rates.

Further, in competitive markets like this, it’s common for winning offers to waive the Financing Contingency (protects your deposit in the event you don’t qualify for your mortgage). Having a thorough pre-approval done can give you the confidence needed to waive this contingency, and be competitive, with limited risk.

Loan Consultant

In most cases, buyers should be considering multiple loan products and finding the best fit. This is particularly true if you’re buying and selling a property, if you’re exploring low down payment options, or if you’re planning to own the property for less than 10 years and can benefit from the lower rates of an Adjustable Rate Mortgage (ARM). A good lender will have access to a wide range of great products and be able to advise you on the type of loan that nets you the best long-term results.

If you’re considering buying or in the process of talking to lenders, I’d be happy to make some recommendations based on your financial situation, type of purchase, and goals. Feel free to reach out to me at Eli@EliResidential.com.

2021 Interest Rate Projections

elieliresidentialcom Arlington, Buyer, Home Owner, Loan , , , , , 0 Comment
2021 Interest Rate Projections

Question: Do you expect mortgage rates to increase in 2021?

Answer: Happy new year everybody! Historically low mortgage rates in 2020 were one of a few factors that drove real estate prices up across the country (except in the condo market). This time last year, the Mortgage Bankers Association and Freddie Mac each predicted that rates would remain near 2019 levels through 2021, with an average 30yr Fixed Rate hovering around 3.7-3.8% through that period.

As it turns out, rates averaged about a full percent less than those projections. Rates fell consistently throughout the year, except for a brief but sharp increase in mid-March when markets went crazy with the first news of COVID-related shutdowns, until the Fed stepped in with liquidity. Below are some charts from Freddie Mac showing average mortgage rates over the last 50, 10, and 1 year.

Average Mortgage Rates Since 1971

Average Mortgage Rates Since 2010

Average Mortgage Rates in 2020

Rates in 2021+

The Mortgage Bankers Association and Freddie Mac each predict that 30yr Fixed Rates will increase slightly in 2021 and hover around 3%-3.2% in 2021. Beyond 2021, the Mortgage Bankers Association sees rates averaging 3.6% in 2022 and 4.1% in 2023.

An increase to 4% or higher mortgage rates will likely cause the rapid appreciation we’ve seen over the last couple of years to slow down, but I don’t think it will lead to a pull-back in prices unless it is combined with a migration from the DC Metro due to major changes in telework policy.

If you’re considering purchasing in 2021, I wrote a column in 2019 about my favorite mortgage programs that you might find helpful. If there’s anything I can do to help you prepare for a purchase, don’t hesitate to email me at Eli@EliResidential.com.

2020+ Interest Rate Predictions

elieliresidentialcom Arlington, Buyer, Loan , , , , , 1 Comment
2020+ Interest Rate Predictions

Question: Do you expect interest rates to remain low in 2020?

Answer: Mortgage rates increased sharply in 2018, peaking at 7+ year highs in the fall of 2018, and most experts expected that trend to continue into 2019 and for 30yr rates to clear the 5% mark for the first time since spring 2010. However, changes in economic policy and financial markets pushed rates down at the end of 2018 and throughout 2019, coming close to all-time lows in the 2nd half of 2019.

Average 30yr Fixed Mortgage Rate Since 1971
Average 30yr Fixed Mortgage Rate Since 2010
Rates in 2020+

The Mortgage Bankers Association and Freddie Mac each predict that rates will remain low, right around current levels, through 2021 with an average 30yr Fixed Rate hovering around 3.7-3.8% through that period. The Mortgage Bankers Association predicts that rates won’t start increasing until 2022, when they’re predicting the average rate to increase modestly to 4.1%.

If these projections are accurate, it should support strong price growth over the next few years in Arlington, Northern VA, and the greater DC Metro.

However, keep in mind that just over 12 months ago, most experts predicted that mortgage rates would be over 5% by 2020 and, according to Freddie Mac, the average 30yr Fixed Rate last week was 3.64%. Changes in the global or US economy, the election, and the stock market can all change the course of rates in 2020 and beyond.

Lender Advice

If you’re considering purchasing in 2020, I wrote a column a few years ago about the value of a good lender that I’d encourage you to review. If you’d like to talk to somebody, I suggest reaching out to Jake Ryon of First Home Mortgage at JRyon@firsthome.com.

If you’d like to meet to discuss buying or selling in the area, don’t hesitate to reach out to me at Eli@EliResidential.com.

Are Appraisal Values Keeping Up With Sale Prices?

elieliresidentialcom Arlington, Buyer, Loan , , , 0 Comment
Are Appraisal Values Keeping Up With Sale Prices?

Question: Given the recent appreciate in real estate values, are you seeing more homes appraise for less than the sale price?

Answer: As we saw in last week’s column, the Arlington real estate market has appreciated rapidly over the last six months which increases the chances that an Appraiser cannot find past sales to support the price the buyer and seller have agreed to, thus increasing the amount of low appraisals in Arlington over the last six months (unfortunately there’s no data to back that up so it’s based on what I’ve seen and heard in the market). Generally, appraisal values lag behind actual market appreciation by a few months.

Banks Often Require Appraisals

If a buyer is getting a mortgage, the bank almost always requires a third-party appraisal to assess the property’s market value. While one can easily make the argument that the price the buyer and seller have agreed to is the market value, banks don’t look at it that way, hence the third-party appraisal.

Appraisals are largely based on comparable home sales over the last six months. It’s a common myth that Appraisers can only use sales from the last six months, but more recent sales are given more weight than sales 6+ months ago. Ultimately, it’s the Appraisers job to determine the market value of a home using the best available information.

Impact of a Low Appraisal

If the appraised value comes in at or above the purchase price, all is good in the eyes of the bank so things continue as planned (note: a higher appraised value has no impact on your assessed value for tax purposes).

If the appraised value is lower than the purchase price, the bank usually requires you to negotiate a reduced sale price to match the appraised value or put more money down to cover the difference between the sale price and appraised value, multiplied by your loan-to-value (LTV) ratio. In some cases, you can also change the type of loan you’re using to satisfy the bank.

The easiest way to calculate LTV is subtract your down payment percentage from 100%. In other words, if you’re putting 20% down, your LTV is 80%. If there’s a $10,000 difference between the sale price and appraised value, you’ll usually be required to bring an extra $8,000 ($10,000*.8) to the table.

All of this can change depending on your loan program and down payment, so it’s important to understand the impact a low appraisal will have on your deal prior to making an offer.

Protection Through An Appraisal Contingency

The Appraisal Contingency is one of the “Big Three” contingencies that are common to sales contracts in Northern Virginia. The Home Inspection and Financing Contingencies are the other two.

The Appraisal Contingency gives buyers an out, with a full return of their Deposit, in the event the appraisal is below the sale price and the seller is unwilling to reduce the sale price or the buyer is unwilling to make up the difference or change loan products.

If you include an Appraisal Contingency in your offer, it’s a good idea to ask your lender how long it will take to order and complete the appraisal so you can structure the contingency period around that timeline. Remember, shorter contingency periods are more attractive to sellers and longer periods generally favor the buyer.

When To Waive The Appraisal Contingency

Sometimes waiving an Appraisal Contingency is the right strategic decision when making an offer. If you’re competing against other offers, especially if they’re cash (no appraisal needed), you should talk with your agent and lender about the risk and reward of giving up this protection. In some cases, sellers will choose an offer with less risk (fewer or no contingencies) instead of the highest offer, especially when the sale price is well above recent comparable sales.

Removing the Appraisal Contingency altogether isn’t your only option either. There are ways to reduce the seller’s risk exposure, thus making your offer more competitive, while also limiting your risk exposure in the event of a really low appraisal.

Disputing a Low Appraisal

If you disagree with the appraised value, ask your lender about the dispute process. First review the appraisal report to understand what sales and details the Appraiser used to determine the value. The best chance you have at getting an appraisal adjustment is to provide the Appraiser with different sales that more accurately represent the subject property’s value, with an explanation.

Managing appraisal risk/contingencies is one of many strategic decisions you’ll make as a buyer or that you’ll have to assess as a seller. Don’t hesitate to reach out to me by email at Eli@EliResidential.com if you have any additional questions!