On September 21 of this year I wrote a column, "I Didn't Know This - Did You?" talking about seven instances in the mortgage industry that either confused most people or were completely unknown by the group. I received a fair amount of correspondence that ratified my suspicion that most people have a desire to understand more about mortgages. I decided to continue on with another seven, and hope the results might be as good or better than the earlier article. I am going to talk with you about interest only loans, paying points, bi-weekly mortgage payments, the option arm, sub prime loans, margins in a variable loan, and the cost of rental unit financing. I think you are going to be surprised about what you know and don't know about mortgage loans.
Let's start with a shocker. Interest only loans do not exist. Interest only is an optional way to pay a standard loan – it is not a type of loan. One can have an interest only option on a 30-year fixed, or a five year arm, or on a straight variable, etc. I believe there are even some companies that offer interest only on loans that are amortized less than 30 years, but I haven't personally seen one.
Interest only options are set for a period of years and can be used every month, or once in a while (say three months a year), or never at all, your choice. The option provides you the opportunity to pay just the interest on the loan, not the principal, whenever you choose to do that. It results in a lower payment and doesn't have any negative side effects, as your balance remains the same when you pay interest only.
You can now understand why Wall Street is wrong about the interest only option. It doesn't hasten the loss of a home by anyone, as you have the remedies to fix the problem of property valuation within your loan: the ability to pay the principal down anytime you are worried about the equity or lack thereof in your house.
Now it is time to get to the point, so to speak. What is a point? When should it be used and not used? And what are the tax ramifications of point(s)? One point is equal to one percent of the loan balance, and is prepaid interest given to a lender to get a lower interest rate. The way to analyze the value of the point(s) is to take the difference in the monthly payments with a point and without a point and then divide the difference into the cost of the point. This will tell you, in months, how long it will take you to pay yourself back by the monthly savings you get from the lower interest rate. Two years or less is great, two years to three years is okay but over three years is questionable.
Example: A $300,000 loan that is 30 year fixed. Rate of 6.375% with zero points or 6.125% with one point.
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.