Actively Managing Your Mortgage, Part 2

Last month, we talked about Active Mortgage Management, the process of adjusting your mortgage strategy as the markets and your own circumstances change. We talked about this process in the context of a market cycle from 2002 to 2006, during which time rates hit all-time record lows then rose off of those lows. Because many of you made important loan decisions during this time, and since many of these decisions involved shorter-term loans, we now want to talk about Active Mortgage Management more in the context of your personal financial objectives.

Do the objectives that helped you choose your current loan still apply? Is it time to change course? Let’s find out. Below are some common loans and the objectives most frequently associated with these loans. Talk these options over with your mortgage planner to see if your mortgage strategy would benefit from any fine-tuning.

30-YR FIXED
Description: Loan for a fixed dollar amount. Rate fixed for 30 years. Required payments of principal plus interest never change; always calculated based on original principal balance.
Objectives: (1) Plan to keep property for more than 10 years, (2) Want fixed monthly costs over life of the loan.
Tip: “Buy down” your rate to save thousands over the long term.

30-YR FIXED, INTEREST-ONLY
Description: Loan for a fixed dollar amount. Two payment options in first 10 years: (1) principal plus interest, or (2) interest-only. Rate fixed for 30 years in both cases. After 10 years, loan re-amortized as 20-year loan using balance at that time, and requires principal plus interest payments.
Objectives: (1) Plan to keep property for more than 10 years, (2) Need monthly payment flexibility, especially early in the loan term.
Tip: Make sure income can support potentially higher payment in years 11-30.

40-YR FIXED
Description: Loan for a fixed dollar amount. Rate fixed for 40 years. Required payments of principal plus interest never change; always calculated based on original principal balance.
Objectives: (1) Plan to keep property for more than 10 years, (2) Want fixed monthly costs over life of the loan, (3) Need lower payments than a 30-yr loan can provide.
Tip: Consider a straight 40-yr loan instead of 30-yr loan with interest-only option.

5-YR ARM, INTEREST-ONLY
Description: 30-yr loan for a fixed dollar amount. Rate fixed for 5 years, then adjusts monthly, biannually or annually, depending on ARM type. Required payments of interest only for first 10 years. Payment calculated monthly based on current balance.
Objectives: (1) Plan to keep property for 5 years; NOTE: for this loan type, pair up your time horizon with the ARM term – if your objective was to keep property for 3 or 10 years, then you should consider a 3 or 10 year ARM, (2) Want to trade longer term for lower rate/payment.
Tip: Pay extra principal monthly so your payment gets recalculated at lower balance.

OPTION ARM
Description: 30-yr loan for a fixed dollar amount. Three payment options in first five years: (1) less than interest, (2) interest-only, or (3) principal plus interest. For option 1, payment adjusts once per year, but underlying rate is higher than the payment rate and can adjust monthly. For options 2 & 3, you can choose a rate that adjusts monthly, every 3 months, or a rate that is fixed for five years. NOTE: These loans are recast when the they reach the maximum allowed by individual lender (normally 110-125% of original balance).
Objectives: (1) Monthly cash flow is top priority, (2) Time horizon is maximum of five years.
Tip: If you take payment option #1 and incur “deferred interest” (also called negative amortization), this deferred interest can be paid at the end of the year it was incurred to give you some extra tax benefit.

HOME EQUITY LINE OF CREDIT (HELOC)
Description: Line of credit against which you can draw up to a maximum amount of your home’s equity. Pay interest only on what you use. Payment calculated monthly based on current balance. Rate can adjust monthly, and usually adjusts 3-8 times per year.
Objectives: (1) Need a source for emergency cash but don’t need cash now, (2) Need cash ready for a large purchase like a car or another property.
Tip: Convert non-housing debt to HELOC for lower rates and extra tax deductions.