With interest rates on the rise, it may be time for home buyers to take a fresh look at some alternatives to the 30-year, fixed-rate mortgage, which has dominated the mortgage market since the financial crisis.
While many out-of-the-mainstream loans got a black eye in the subprime debacle, today’s versions have been shorn of the toxic features—such as negative amortization and prepayment penalties—that tripped up many borrowers during the housing bubble a decade ago.
Plan to move
Experts say today’s adjustable-rate mortgages, or ARMs, as well as interest-only loans, are especially suitable for borrowers who expect to move before any rate increases can wipe out the savings in the early years. They’re also useful for sophisticated borrowers wrestling with uneven income, borrowers who expect their income to rise, or borrowers who are willing to bet they can invest their mortgage savings for a greater return elsewhere.
A sweet spot
Many borrowers can find a sweet spot, for example, in the so-called 7/1 adjustable-rate mortgage, which carries a fixed rate for seven years before starting annual adjustments. With a typical rate of 3.75%, the monthly payment on a $300,000 loan would be $1,389, compared with $1,449 for a 30-year, fixed-rate loan at 4.1%, saving the borrower $5,040 over seven years.
A disciplined borrower
So who would take such chances?
Experts say most people would be wise to stay away, but an interest-only deal would suit a “disciplined” borrower likely to move during the interest-only period, as well as borrowers who have uneven incomes, are confident they can invest the savings more profitably or expect a rising income to make big future payments bearable, says Ray Rodriguez, TD Bank’s regional mortgage-sales manager for the metropolitan New York area.
New underwriting rules
Today’s interest-only borrowers qualify within underwriting rules which usually require lower debt-to-income ratios, higher credit scores and larger down payments than in the past. The goal is to ensure the borrower can pay even after rates rise and the principal payments kick in.
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