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I am working with a bunch of home buyers right now. Their home buying experience and the process of securing financing has been rockier than most would like it. I feel bad for them. I wish there was something that I could do to make it better; but they have run in to volatility in the mortgage bond market not seen in at least 3 years.
If you wonder why my blogging has dropped off to just nights lately; you now know why. Volatility in the market requires a herculean effort to help customers navigate the turbulence. The number one question from my customers (as they watch their 30 year fixed quotes blast towards and above 7%) is:
It’s not an easy question to answer; and more than ever, this one is completely dependent on your particular situation. Here are some thoughts that I believe you should consider when determining what type of mortgage product you should choose right now.
Please note that I have no crystal ball.
Find your sweet spot
Everyone out there has their own ideas about what is risky and what is safe. Everyone has their own comfort level when it comes to money. It’s amazing - for the smart, rational, brilliant people we are; money is more of an emotional object that an intellectual one. We have an emotional connection with our money; either its a weak emotional one and we are more risk friendly or it’s a strong emotional one and we are more risk averse. I’m not saying that intellect doesn’t play a big part - I’m just saying let’s be sure to consider our emotional connection to money.
When we are talking interest rates we are talking money - and you need to find your personal sweet spot in your emotional comfort level. Take stock in where you think your risk sweet spot is - and use that as a guide to where to look when shopping for different loan programs.
Be Goldilocks
I have spent a lot of time thinking about, analyzing and reviewing dozens of unique borrowing situations over the last few days as interest rates have jumped. I have seen the classic Goldilocks behavior bear out (pun, thank you) during the recent market changes:
- Some borrowers go to the high cost 30 year fixed for ultimate security
- Some borrowers go to the mid-length ARMs such as 7 and 5 year fixed loans
- Some borrowers continue to gamble with a short-term loan or are floating their mortgage hoping for rates to reverse course
Who’s right? In my opinion, for most people who are buying a home that won’t be the last one they buy, the right thinking is the Goldilocks thinking. Choosing a 7 or 5 year fixed loan gives a good balance of mid-length security with 5 or 7 years of a fixed rate; while providing a lower monthly payment than a higher-rate 30 year product. In other words - it sounds just about right.
God doesn’t play dice, and neither should you
The short term rates, two-year loans and traditional 1-month ARMs should only be used in very specific circumstances where there is a clear plan for you as a borrower. This may be a credit-improvement plan, short-term housing plan or other very specialized mortgage situation. I can’t think of a good reason to use a short-term ARM when purchasing a home in this market.
The Losers sell at the bottom and buy at the top
The old Wall Street adage that the masses get slaughtered because they always sell at the bottom and buy at the top holds true in the mortgage world. While I believe that interest rates aren’t topping out quite yet; I do believe we will reach a stable level in the next few (6?) months. There is no benefit in locking in to an expensive 30 year mortgage payment if we are near the top of the market; especially if you have a good indication that your financial or living situation will change with in the next 5 to 7 years.
As the intermediate ARMs become a better value in terms of cost and rate compared to the 30 year rates it becomes critical to do your best forecast of how your life will look in the next 5 to 7 years.
If we are near the top (and I can’t say with confidence that we are) then doesn’t it make sense to lock in to something with a little more flexibility that is a little less expensive? I had a customer ask me about buying down a 30-year fixed rate (buying a loan down is where you pay points to the bank for a lower interest rate) and then immediately ask their options of refinancing in 6 months. You don’t pay thousands of dollars for a lower rate when you plan on refinancing in the near term. You also don’t take a more expensive 30 year loan if your mind is set on refinancing within a couple of years!
Go for flexibility
I strongly recommend to home buyers in this market to go for flexibility. If your credit scores allow, avoid prepayment penalties that lock you in to an interest rate for any fixed amount of time. If we are near the top of recent rate hikes it makes sense that the first rate decrease may not be too far off in the distance (within a year?) If that is the case do you want to be stuck paying a higher interest rate due to a prepayment penalty when rates ease? I didn’t think so.
If you do take a prepayment penalty to lower your rate try to take one for a maximum of one year. That will give you a combination of flexibility and lower payments without overly limiting your flexibility.
In summary - this was a very hard post for me to write, because each situation is different - your situation is different. My advice is to find the sweet spot - be Goldilocks, find a loan that is just right for you. Don’t panic and lock yourself in to a program that is too expensive for you and overly stretches your monthly budget; don’t put yourself in a situation where you can’t take advantage of falling rates (should that occur) and don’t be foolhardy and put yourself at the whims of an unfriendly market (short term ARMs).
Questions about your exact situation? Get an exact answer - none of this generally speaking crap - by emailing me directly or calling me at 949-859-3045. Instead of general concepts I’ll provide you pinpoint advice based on your current situation.
I would get a 15yr or 30yr fixed, regardless of how long I intend to live in the home. Here’s why:
1. I don’t want to assume interest rate risk in a global rising interest rate environment. Let the lender take the risk. By the way, the S&L crisis of the 1980’s, where hundreds of S&Ls went under, was due to rising interest rates, where banks had to pay the now higher rate on deposits but was stuck with the lower rate mortgages. The Fed learned to protect the banks, by making suckers out of all Americans who got ARMs at the lowest point in the interest rate cycle. Well, I won’t be their sucker.
2. Rates have nowhere to go but up, and some economists think we are at the beginning of a 20 year upcycle in interest rates. The bond market is cooled down today, but the momentum indicators are still up.
3. This is very important. If you want to sell your house in 5 years, and you have a fixed rate loan, you have a much better chance at getting a buyer. At a time when only 1% - 5% of all homes on the market will be selling, sellers who can offer carry backs or “land contracts” will have a 100% chance of selling. When interest rates are 10%, and you can offer your seller to carry a second on the home at 7%, you’ve got a deal.
Although a wrap around clause is a breach of contract, it is not illegal, according to the report I read a while back on a legal website. I would consult an attorney about this, and a CPA. But basically you let your buyer make the payments to you, so you still pay the lender, and he never finds out.
With an “all inclusive deed of trust”, your sale is recorded, it conveys full title. A land contract is not alway s recorded, and it conveys only equity; the deed is recorded only when all payments are made. So future liens against the seller may attach to the property.
To make this work, you need a good contract, and you set up a bank account that is only accessed by the buyer to make deposits, and for you to make payments to the lender.
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