Archive for the ‘Loan Programs’ Category

an MTA loan, (sing) “More than meets the eye.”

September 8, 2006

pic_optimus.jpg

What if I told you could get a $200,000 mortgage at a 1% interest rate, with a minimum monthly payment of $643 per month!? And your payment would only adjust by about $50 per year no matter what the market does! Sound familiar? Too good to be true? (recall mother’s advice: “If it sounds too good to be true . . . it probably is.”)

If you have heard or read this before, most likely they are talking about an MTA loan. Here is why this loan is anything but “Optimus” for your home financing. The loan and monthly payments start out well-and-good but quickly ‘transform’ into something very different. Kind of reminds me of that time when Megatron was leading the Decepticons in their villainous plight to take over . . . (sorry, I have taken the Transformers analogy MUCH too far!! nerd alert!! nerd alert!!)

MTA stands for Monthly Treasury Index. This type of loan (generally named an MTA loan, a Pay-Flex loan or a Pay-Select loan) is a one month adjustable rate mortgage based on the MTA index. The MTA index is an index calculated based on the twelve month average of annual yields on actively traded US Treasury Securities — the Monthly Treasury Average Index. Because this index is an average of the previous twelve months, it is a much slower moving index than all other adjustable rate mortgage indices. For more information on adjustable rate mortgages (ARMs) and how they adjust, check out my previous post.

This loan does in fact have a rate of 1% . . . a “start-rate” of 1%. Based on the example above, the first month’s payment (of principle and interest) would be $643 per month. However, after the introduction period (usually a 1 month or 3 month period), the interest rate adjusts to the “real” interest rate = the MTA index plus a margin. The margin on this type of loan can vary between programs, but for the sake of this post, I’ll use 2.75%. With the MTA index currently sitting at 4.664 (as of September 9th), the “real” or fully-indexed rate would be 7.414%. Ouch! And to make matters worse, unlike most ARMs, this loan usually does not have a cap on adjustment (although it may have a life-time cap of 10% or so). Ouch again!

So what about the payment only going up $50 per year?

Here is where the loan gets even more confusing. The loan is called a “Pay-Flex” loan because it is sold to consumers with the idea that you have the flexibility to make one of four payments. You can make the minimum payment, an interest-only payment, a 30 year amortization payment or a 15 year amortization payment (the last two options are laughable at best). The consumer can select (hence the name “Pay-Select loan”) which option they want to pay. What a friendly loan!?? Just make whichever payment you like, no problem . . . not a problem if you like paying more interest of course.

In the example above, the payment (the minimum payment) will only increase by 7.5% per year. So if the first year’s payment (minimum payment) is $643 per month, the second year’s payment (minimum payment) will be $691. However, because the interest rate has adjusted up, the difference between the minimum monthly payment and the interest for the month . . . read carefully . . . will be added to the loan balance. So, for a $200,000 mortgage balance, now at a rate of 7.414%, the interest for one month would equate to $1,253. The minimum payment would be $592 TOO LOW even to cover the interest on the loan and that amount would be added to the loan balance (called negative amortization). Next month’s interest payment would be calculated on a new loan balance of $200,592. This cycle of adding to the loan balance would continue until the loan value had maxed-out at 115% of the original appraised value.

Bottom line, compared to an intermediate adjustable rate mortgage (a loan that is fixed for a set number of months or years like 3, 5, 7 or 10, and then converting to a 1 year ARM with caps on adjustment), now available — and extremely popular — with an interest-only payment, the usefulness of an MTA loan is pretty slim.

There may be one small argument that would say that because this loan adjusts as the market adjusts, a consumer will reap the benefit of falling interest rates (and a falling MTA index) automatically without the hassle and expense of refinancing, but it would be a pretty tough argument to make. If you looked at the average of the MTA index over the past 10 years (3.973 — which would equal a mortgage rate of 6.73%) and over the past 5 years (2.503, which would equal a mortgage rate of 5.25%), someone might make a mildly convincing argument.

But, if somone made the argument so compelling to you (especially at the beginning of 2004 when the MTA index was at it’s lowest point and the adjusted rate was 3.975%) now that things have transformed for the worse and the rate has gone up to 7.375%, and your interest-payment has gone from $662 per month to $1,229 per month, you might just wish you had a 30 year fixed rate loan at 5.25%.

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Adjustable Rate Mortgages . . . OOOOhhhhhhh . . . . AAAAhhhhh

July 7, 2006

“click, click, click, click, click, click, click . . . click, click, click”

coaster

Adjustable rate mortgages (ARMs) have become increasingly popular over the past few years . . . and not so much in the past six months. With mortgage rates hitting historic lows a few years ago, some adjustable rate mortgages (with rates in the high 3% and low 4%) were just too good for consumers to pass up. Just think (or remember, if you were one of them), if you owed $200,000 on your mortgage at 7%, you could refinance and drop your payment by $500, $600 or even $700 per month. Good idea? or too good to be true?

For a lot of consumers, ARMs were (and in some few cases still are) a good tool to help manage their monthly payment. Because the average homeowner stays in a house for 6 to 7 years (and in Atlanta, I would guess that timeframe to be even lower), the need for a 30 year mortgage is not entirely practical. This of course, flies in the face of our parent’s advice and life-experience . . . “I remember when Jimmy Carter was President, we had a 15% rate on our mortgage and it was an adjustable rate loan!”

The issue lies in how people use the tool. A lot of consumers used interest-only adjustable rate mortgages (specifically the first type of interest-only ARM introduced to the market which was a one-month adjustable rate loan) to purchase more house than they could typically afford. With hopes of upward mobility and/or a steady increase in salary at work, some of those people now find themselves in a pinch to make their payment. This one-month ARM mortgage, and now most adjustable rate mortgages, are based on the LIBOR index which is loosely tied to Prime rate. Prime rate, follows the Federal Funding rate (see previous post), so, basically, as the Feds have raised the Federal funding rate (now 17 times in a row), people with one-month LIBOR arms have watched their rate go up more than 4.0% in the past year and a half. Hopefully, most have not watched the whole time and have at some point refinanced out of that one month LIBOR ARM and into something a little longer-term. If you have not yet refinanced, stop reading and call me . . . seriously, that’s enough . . . stop reading and pick up the phone.

If you leveraged this type of loan as a tool to save cash, and if you “got-in” and “got-out” at the right times (even with the cost of refinancing your mortgage twice — once to “get-in” and once to “get-out”), you probably saved a few thousand dollars. And depending on how long you stay in your house (since the last time you refinance) will determine if you made the best decision . . . or if you would have been better off locking-in for 30 years at 4.875%.

Despite the bad-press that ARM’s are now getting (hey, I’d be angry if my payment went up by $600 over the course of two years), certainly they can’t be that bad, right? In 2004, Fed Chief Alan Greenspan had this to say about adjustable rate mortgages: “”Homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.” Realizing that many consumers have gotten over their heads, and as the state of the economy has changed, I think the past Fed Chief would urge people to use caution when considering an adjustable rate mortgage (and specifically ones with an interest-only option).

index graph

Just as a piece of historical/common sense/mortgage-trivia . . . by looking at the graph above, when do you think that the one-month-interest-only adjustable rate mortgages became most popular (remember, the rate is based on the LIBOR index)? You guessed it . . . 2003.

Since the time of the introduction of the 1 month and 6 month ARMs, investors now offer intermediate adjustable rate mortgages (sometimes called “fixed-term adjustable rate mortgages”) that have a period of time in which the rate is fixed — usually 3, 5, 7 or 10 years. These types of loans give consumers the benefit of an interest-only payment (and a slightly lower rate compared to a 30 year fixed) with the security of a fixed interest rate for a certain time-period — 3 years, 5 years, etc. Unfortunately, with the Feds movement in short-term rates (and the subsequent movement in the LIBOR index) these types of loan rates have become squeezed closer to the fixed rate loan to where the savings, and benefit, of these types of loans have become less and less appealing. Because the monthly payment also increases to a principle and interest payment at the time of the first rate adjustment, consumers should be careful to weigh the benefits of a lower payment with the risk of still being in the house at the time the payment adjusts.

There are certainly some advantages to having an interest-only ARM. The interest-only payment allows flexibility in cash-flow, allowing consumers to put money other places (consumer debt, car payments, retirement savings, education savings, etc).

What would happen if we both purchased identical houses in the same neighborhood and mortgaged $200,000. (The reason I say the “identical house in the same neighborhood” is to take the variable of appreciation out of the argument). You obtained a 30 year fixed-rate mortgage at 6.5% and I got a 10/1 interest-only ARM at 6.375%. My total monthly payment (interest only) would be $202 less than yours, but your payment would include a principle and interest payment. If I invested the $202 per month in a mutual-fund account, who would end up ahead after 5 years? 10 years? What if I took the additional $202 and pre-paid the mortgage? Who would be ahead?

The answer to these questions and my advice to ONLY prepay a loan that re-casts, next time.