You really need to know

Roger Schlesinger
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Posted: Oct 04, 2007 12:00 AM

For years most borrowers who own houses have rejected the idea of learning all there is to know about the mortgage market; at least in my opinion. I speak with dozens of borrowers on a daily basis, year after year, and their knowledge of the tools available to them and the programs that could make a huge difference is definitely lacking. It is akin to playing baseball for the first time and going to bat without any idea of what could be thrown at you: fast ball, curve, slider, change up, etc. Worse than that, once you hit the ball you are not sure where to go. Are things really that bad? Perhaps not, but even if they are half that bad, it is too much. People need to know what is going on and how to protect their assets and limit their liabilities.

How many people do you think really understood the "option ARM"? According to those I speak with who now are facing problems because their loan balances are increasing due to the negative amortization while the values of their properties are declining: not many, if any at all. Besides, like many other borrowers, they got caught in a sub-prime loan. (Only one company out of 10 to 15 sub-prime lenders that I know offered the "option arm".) It is finally time to stop making excuses and learn what you need to know when you borrow and when you borrower more than you can afford to repay.

There is a lender that will guarantee you a fixed loan under "prime" that has excited everyone I have talked with until I tell them that the "prime rate" is currently 8.25% (now 7.75%). And no, the Federal Reserve doesn't regulate the "prime rate". Influence, yes; regulate, no.

An ARM (adjustable rate mortgage) is not necessarily a bad loan. In fact, jumbo ARMs that are fixed for 5, 7 or 10 years are currently the best instruments available in that market.

I hear from borrowers daily who wish to dump their ARMs, or certainly won't take one because they want a fixed mortgage. If they really understood the mortgage choices, they wouldn't be making those comments.

Before I start explaining I must discuss the willingness of people to suspend their belief system to take a home equity line in the 8% range (give or take 1/2 percent or more) to pay off a 1st mortgage loan in the 6% or low 7% range because of a "formula" that has been discovered. How could that possibly work? And in as much as you need great cash flow to make it work why not skip the HELOC and just pay off your mortgage? Think about the obvious!

No two borrowers are the same, have the same qualifications or the same goals. Stop listening to your friends and family and start learning! An "option ARM" gives you 4 ways to pay your mortgage. Three have too high an interest rate in most cases, and the fourth one can really get you in trouble unless you are in a low interest rate environment.

Do you even know what you need to look for in the loan to protect yourself? The margin!

Each month you take the value of the index (monthly treasury average, LIBOR prime, etc.)

and add it to the margin to determine the interest rate. When you start getting margins above the low 2% range you can see how fast the interest rate can go up. If the index is at 4.75% and you add a margin of 2% your interest rate is 6.75%. If the index goes up 1/4% then your rate will be 7%. If you margin is 3.75% then the 6.75% interest rate mentioned above is 8.5% and when it goes up 1/4% you are at 8.75%. Is there any wonder why you have the amount of negative amortization (rising balances) that you have? The amounts being added to your balances are unpaid interest (negative amortization), which is added to principal and forces you to pay interest on interest. No one should ever have to do that.

Whenever the Federal Reserve raises the Federal Funds Rate (the interest rate member banks charge each other to borrower "over night money"), banks generally move the "prime interest rate" (interest charged to their best customers) the same amount in the same direction. Home equity lines of credit are the beneficiaries of these moves because the prime rate is used as their index.

Adjustable rate mortgages can change monthly, semi-annually, annually or be fixed for 2, 3, 5, 7, 10 or 15 years before they begin to change. There is a place for all of these types of loans and you need to know which would work best for you, if any. The longer fixed term arms work for most people because of their tendency to need money, the variation of interest rates over time and the fact that people have become more nomadic and move more frequently than their parents.

You may have just learned one small fact or several but at least it is a start. You really need to know because the financial world acts like a police officer: failure to know the law is not an excuse. Failure to know how your mortgage works generally doesn't get your money back in case you get caught in the "sub-prime" mess or anything that might be similar.