I'm always pleased when people want to help me, when they want me to get ahead. Surely such motivations describe the many folks who write with ideas that will allow me to make smaller mortgage payments and thereby save money, cut costs and better my life.
Because such suggestions are made with only my best interests in mind, I like to review these offers if only to see what I'm missing. For instance, a recent correspondent said I could refinance my home and not make mortgage payments for three entire months. Now I ask, what could be fairer than that?
Why would a lender make such an offer? Because, said the letter, I've "earned it" and "my timely payment history should be rewarded."
If fairness, let's take a look at precisely what I've earned.
Suppose I have a $250,000 loan which is in need of refinancing. The first benefit found in the offer is that I would make no payments for three months. If the loan has an 8.222 annual percentage rate (APR) I would save $1,873 a month or $5,594 in cash during the start period.
Okay, that sure looks good. What else should I know?
A look at the fine print says the loan has a 0 percent rate and a zero payment for the first three months. Yippee! But, somehow, the APR is 8.222 percent. It turns out that this is a "variable rate loan" and after the start period low payments might produce negative amortization. In other words, if I chose the lowest monthly payment option I might be paying a lot less than the actual monthly interest cost for the loan.
But no problem, the lender will kindly add the unpaid interest to the mortgage balance, thereby increasing my debt for the next month.
Of course, the lender won't allow me to make those negative payments forever. When the loan balance reaches 110 percent of the original loan amount -- $275,000 -- then the lender has the right to call the loan.
The letter doesn't actually say how the interest rate is computed but there are some hints: The rate is equal to the MTA index plus a margin. The letter is dated January 4, 2007.
According to HSH Associates, a financial publisher, the MTA was at 4.933 for December 2006. If I've got the right index, it means the margin is 3.289 percent.
The margin is a number added to the index to create the ARM interest rate. While the index can rise and fall, the margin is one set figure. In this case, 4.933 plus 3.289 equals 8.222.
Is a 3.289 percent margin high or low? According to Freddie Mac, a typical ARM margin in 2006 was roughly 2.75 percent.
Let's see: We had no payments for the first three months of the loan and reduced our cash costs by $5,594. Had we made such payments, $484 would have gone for principal reduction and $5,110 would have gone for interest.
How long will it take for the lender to recapture that lost interest? The margin seems to be roughly .54 percent (3.289-2.75) higher than the typical margins mentioned by Freddie Mac. If we assume the loan balance neither rises or falls, then for the first 12 months after the start period the lender will earn $1,350 in additional interest.
Is the lender worried about recapturing lost interest? In some sense, sure. But the real value of this loan is that it has a higher rate than many other loans and thus can be re-sold at a premium to mortgage buyers.
While the big print says my "timely payment history should be rewarded," the small print says something else. It turns out that to get this loan I must meet underwriting criteria, my property must be acceptable collateral and I must be credit worthy.
In other words, I must apply and pass muster to get this financing. My timely payment history is not enough to secure this loan. Or darn. You'd think people who know about my timely payments could just sign me up automatically.
The letter says I must respond within seven days to take advantage of this great opportunity. I'm not sure what happens after seven days, but I won't make the deadline in this case.
As with all loans offers, to see what's attractive you need to contact as many lenders as possible to see which programs are best for you. For me, I'll take a pass on this one -- I don't see much benefit in replacing a fixed-rate mortgage at a low rate with an 8.22 percent adjustable -- a loan where rates can go higher still.
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