There are three types of variables: straight, fixed and variable and potential negative amortization loans. The straight variables are those that generally vary monthly and are totally dependent on the index of that loan. Earlier I said margin and index but the margin is a fixed margin and the variance occurs only when the index moves. The lower the margin, the smaller the move. The fixed and variables are the hybrids which are fixed for 1 year, 2 years, 3 years, 5 years and 10 years before becoming variable. These are generally the most popular of the variables.
The negative amortization loans, my least favorite, can produce an ever-increasing balance because the payment is lower than the required interest payment. The difference between the two is added to your existing balance and you end up paying interest on interest. In subsequent columns I will delve into each type of variable in greater detail.
The main reason I am excited about variables, especially straight variables, is that they are out of favor and the margins are very low because of the disfavor. Once the variables become the loans to own, the margins go up or the prepayment penalties come out. At the present time you can take a straight Libor arm, tied to the one-month or six month Libor, and get a margin in the low 1% range. It will cost a point but it is a margin that can keep you low through the entire length of the loan. If you want, you can take a margin in the high 1% range and not have any points to pay.
The one month Libor can vary every month if the index changes, the six month Libor changes every 6 months if the index moves. Both loans can be paid interest only for 10 years. Although both loans are in the six percent range currently, they could start moving down in the next several months. Three or four years ago they were in the 2% range when the Federal Reserve lowered the short-term rate, Federal Funds Rate, to 1%.
Most strategic moves are made in life when the outcome is not clear and the timing is suspect. Being a contrarian is not easy but can be extremely profitable when you are correct. Fixed rates are great and most people need to remain in them, as the risk reward scenario doesn't work for them. Fixed rates, which are in the high 5's to low 6% range, offer great rates; but when, and if, interest rates go down only those who have variables really benefit. As I said many time before, "YOU get to make the choice". Make it a good one!
Roger Schlesinger's Mortgage Minute is heard on hundreds of radio stations and daily on the Hugh Hewitt radio show and Michael Medved shows. Roger interacts with his hosts and explores the complicated financial markets in order to enlighten his listeners and direct them along their own unique road to financial freedom. Roger is the President and founder of Manhattan West Mortgage.