- The Washington Times - Thursday, September 7, 2006

A shift in real estate from a sellers’ market to a balanced market, with more homes for sale at a slower pace than over the past four years, influences the financial decisions consumers make when purchasing a home.

Concern about a potential increase in interest rates also impacts decision-making when it comes to mortgages.

In recent years, many buyers faced with the rapid rise in home prices in the Washington area turned to interest-only mortgage loans that can offer lower monthly payments during an initial period of just interest payments.

Financial experts grew concerned about the possibility of borrowers having difficulty making the payments for their homes when the interest-only period of the loan ended, particularly when the loans carried an adjustable rate and interest rates were rising.

Despite this concern, interest-only mortgages remain the most popular loan product in the Washington area. But while interest-only loans started as an adjustable-rate loan, the most popular versions these days have a fixed rate.

“The most appealing loans now are fixed-rate loans for 30 years, with interest-only payments for the first 10 years,” says Barbara Roubo, branch manager of Accubank Mortgage in Fairfax, a division of National City Mortgage.

“The principal on the loan is paid during the last 20 years of the loan, so the payments definitely go up after 10 years, but at least borrowers know ahead of time what their payments will be,” she says. “You don’t get what I call the double whammy of adjustable interest-only loans, which had the guarantee of a larger monthly payment for the balance of the term from amortizing the principal, and the potential for a rate increase as much as 5 percent.”

Bob Gill, branch manager for First Horizon Home Loans in Centreville, says fixed interest-only loans are also popular with his customers.

“People like not having to worry about a rate change for 10 years,” Mr. Gill says. “But they need to be aware that there’s quite a comeuppance at the end of 10 years, with an increase in the payment of one and a half or two times. A lot of people will probably want to get out of it at that time by refinancing or selling the home.”

Mr. Gill points out that with the difference between an adjustable rate loan and a fixed-rate loan currently as little as 1/4 percent, very few borrowers opt to accept the risk of an interest rate increase.

“Some people are still opting for an adjustable-rate loan if they know for certain that they are only here for a short time, such as military personnel,” Mr. Gill says. “Some people also know they will sell their home at a certain time because they have kids going to college or for some other reason, and then it can make sense to take the additional savings of an adjustable-rate loan.”

Phil Drew, branch manager for Carteret Mortgage in McLean, says he believes the 30-year fixed-rate interest-only loans offer a very secure program for most consumers, particularly because in the Washington area most people stay in one home for only five to seven years.

“The only downside is that during the last 20 years you have to make a higher payment than you would have had with a straight 30-year loan,” Mr. Drew says.

“But it’s not that big of a bump, especially if you assume that your income will rise over the years,” he says. “If your income just keeps up with the cost of living, then as a proportion of the budget the payment should be acceptable. That’s assuming you could only qualify for the loan with interest-only in the first place. A lot of people want the lower payments of the interest-only loan but could qualify for the fully amortized loan anyway.”

Mr. Drew reviews the payment schedule with his clients for each of the 30 years of the loan. But even when working with a lender who does not go over the payment schedule verbally, consumers can see the new payment on the truth-in-lending papers at the settlement.

“The advantage of a fixed-rate interest-only loan is that the payments stay exactly the same for the first 10 years and then they stay exactly the same for the last 20 years,” Mr. Drew says. “The payments won’t change, and people have 10 years to figure out how they will adjust their budget to accommodate the increased monthly payment.”

The fixed-rate interest-only loans also allow borrowers the flexibility of paying some of their principal during the first 10 years if they wish, which will reduce the monthly payments during the last 20 years of the loan.

These loans usually do not have a prepayment penalty, so borrowers can refinance at any time without owing additional fees.

In addition to the lower monthly payments associated with interest-only loans, consumers accepted them eagerly because they assumed that home values would continue to climb quickly enough to build equity in the property even without paying down the principal.

As the local housing market slows, property values are less likely to continue ascending as rapidly.

“The reality hasn’t set in yet for a lot of people that after five years of double-digit appreciation, and in some neighborhoods, 30 percent appreciation, that home prices won’t be rising as fast,” Mr. Drew says. “But I think we are still above normal for appreciation, with sales prices in a lot of neighborhoods going up, at least for the homes that are selling. Historically most properties show an increase in value of at least 5 percent per year.”

Mr. Drew says 40- and even 50-year fixed-rate mortgages are popular with some borrowers, which are effectively almost interest only because so little of the principal is paid during the first 10 or 15 years.

“The only real disadvantage to such a long-term loan is that you don’t build equity very quickly,” Mr. Drew says. “Some financial planners recommend maintaining a big mortgage because it permits use to maximize the equity in your home and maximize the tax benefits of homeownership.”

Other loan products are developed to appeal to specific market segments, such as first-time buyers and move-up buyers.

In 2005, move-up buyers had less concern about the possible necessity of financing two homes at once because once they found a home to buy they could rely on selling their existing home quickly.

In today’s market, with homes taking longer to sell, move-up buyers sometimes need to arrange special financing to transition from one home to the next.

Accubank Mortgage offers a Principal Assistance Loan that allows borrowers to qualify for a 100 percent financing loan on the new home if they have a contract on the existing home but have not yet gone to settlement.

“Some borrowers can qualify for the loans on both homes, especially when there are two incomes,” says Accubank’s Ms. Roubo. “If not, homeowners can borrow the equity from the home they already own, then pay off that loan at the settlement when it sells. They can also obtain financing on the home they are purchasing and pay off part of that loan when their first home sells.”

Ms. Roubo says more and more move-up buyers are choosing to rent their first property until the market changes, offsetting their mortgage payments on the two homes with the rental payments.

At First Horizon Home Loans, Mr. Gill says borrowers can take advantage of a No Ratio loan product with “super expanded criteria” designed for move-up buyers.

“This loan product comes as a three-, five- or 10-year adjustable rate mortgage or a 30-year fixed-rate loan and doesn’t rely at all on debt-to-income ratios the way traditional loans do,” Mr. Gill says.

“The program focuses instead on the strengths and other aspects of the borrowers such as their credit score and their resources,” he says. “We realize that even if someone has to carry the mortgages on two homes, it is just temporary, for a few months or so. As long as they have good credit and decent reserves, we know they could make both payments for a while.”

Mr. Drew recommends that move-up buyers sell their current home first and then negotiate a lease-back because then the consumers will know for certain how much the house is worth.

“Most people are not willing to do this, so we do a lot of bridge loans to transition people from one home to the next,” Mr. Drew says. “But bridge loans can cost as much as $10,000, so it’s better to sell the home first.”

Borrowers can use a bridge loan to pay off the mortgage on the old house or to buy the new home, or they can take out a second mortgage to pull out cash from the old house to use as a down payment for the new house, Mr. Drew says.

First-time buyers can take advantage of a variety of programs that offer down payment and closing cost assistance. Many programs are available with 100 percent financing and below market interest rates to encourage homeownership.

Information is available from Fannie Mae (www.fanniemae.com), the Federal Home Loan Mortgage Corp. (Freddie Mac, www.freddiemac.com) and housing agencies, District of Columbia Housing Authority (www.dchousing.org), Virginia Housing Development Authority (www.vhda.com) and the Maryland Department of Housing and Community Development (www.dhcd.state.md.us).

“About the only thing that has really changed for first-time buyers is that lenders are now willing to do 100 percent financing mortgages,” Mr. Drew says.

“First-time buyers have much less of a need for cash. The days of needing to accumulate a 20 percent down payment are over.”

Mr. Drew says he believes first-time buyers would be better to served to make a down payment of a least some portion, though.

“I think having a stake in the house is important,” he says.

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