Last week’s show, titled “Anatomy of a Mortgage,” covered many topics that are rarely associated with mortgages but which play an integral part: the home itself, the housing market, and the broader economy. This week, we’re looking at the most important part of a mortgage—the loan—in-depth and as thoroughly as possible. With so many changes to the lending industry, and so many vague and esoteric terms constantly thrown about, it’s important for everyone to be proficient, if not fluent, in the language of lending.
As mentioned last week, a mortgage is a loan secured by an asset. The loan itself can take many forms, but the vast majority of residential mortgage loans are 15- or 30-year fixed rate loans. This means the loan is amortized over 15 or 30 years—that is, the starting principal and the interest projected to accrue are calculated and the total payoff is divided into regular monthly payments for the life of the loan—and the interest rate cannot change. Most individuals shopping for a mortgage will eventually consider whether to opt for a 15 year or a 30 year. While the 15-year mortgage will have a substantially higher monthly payment than the 30-year, it will save tens, if not hundreds, of thousands of dollars in interest throughout the life of the loan. Individuals should consider their personal financial goals to decide whether it’s more important to free up money now or to save money for the future.
Outside of fixed rate loans, some people may opt for Adjustable Rate Mortgages (ARMs), as those loans typically offer better initial rates than fixed rate loans. These loans can, however, adjust periodically throughout the life of the loan. With interest rates at near-historic loans, it would be unwise for most people to choose an ARM over a fixed rate loan. From where we are now, interest rates have nowhere to go but up. It’s also worth taking a moment to acknowledge that fixed rate loans covering up to 30 years are found in few countries around the world, and the vast majority of the developed world uses medium term (10 to 15 years) adjustable rate mortgages as they are far more fiscally sound that long-term fixed rate loans.
The rate offered on a given day is the result of innumerable economic factors, but is generally tied to the 10-year US Treasury—whose price is also the result of innumerable economic factors. A lender will set a par rate, which is the rate offered without either discount points or a credit, but consumers may choose to select a higher rate if they want a lender credit or a lower rate if they wish to pay extra for it out-of-pocket.
There is no right or wrong answer as to whether one should choose a higher or lower rate. Those buying a house or refinancing from a much higher rate may want a lender credit to help pay closing costs to keep their cash needed to close lower, and may therefore choose a higher rate. Those who expect to keep a home for the entirety of the loan may choose to buy discount points upfront since the interest saved over the life of the loan far outweighs the initial cost of lowering the rate. A consumer should choose the rate that best fits with their financial goals and helps accomplish them.
There are many factors to consider when shopping for a mortgage, and no matter how much I’m able to cover in a given week there is still a lot more to know. It’s my hope to cover every aspect of the mortgage loan as this year progresses, but any listeners with specific questions should feel free, as always, to reach out to me personally to have their questions addressed. A home loan will be the biggest financial decision most individuals make in their lifetime, so it is imperative that they are as informed and knowledgeable about the product they choose as possible.
4-4-15 Anatomy Of A Mortgage: Part II