DEFERRED INTEREST LOAN PROGRAM

Our customer was comfortable  using an adjustable rate mortgage (ARM) program or fixed for 3-5 years, rather than a more typical fixed rate mortgage.  He receives significant annual bonuses in August and wanted to minimize his monthly cash outlay for their home.  The home they selected put them into a Jumbo loan category, even though the property was priced well below market value.

They planned on having the home for no more than 5 years.  Credit scores, income, reserves were all good.

We had them put 20% down and put them in a deferred interest loan program.  This type of loan is an ARM amortized over 30 years and the initial rate is 2% to 4% below the current market rate for a predetermined short period of time (few months).

The rate then adjusts to the fully indexed rate and you have four payment options each month:  (1) the payment based on the initial start rate for the remainder of the first year’s payments, (2) the fully indexed payment amount amortized over 30 years, (3) the fully indexed payment amount amortized over 15 years or (4) an interest only payment based on the indexed rate amortized over 30 years.  If they choose the lower start rate payment amount, the additional interest due would be deferred and added to the principal balance.  This additional interest will still be considered tax deductible interest when paid.

The second year, you have the option of making the fully indexed payment amount or a payment equal to the initial minimum payment times the annual cap rate - in this case 7.5%.  Essentially, the lender is agreeing to let the borrower underpay the real amount of the mortgage payment, applying the shortfall to the total due.

This program was right for this situation and this borrower because (1) they understood and were comfortable with the index/margin methodology and (2) the sizeable yearly bonus allowed them to "catch up" on the interest deferred during that tax year with out increasing the principal balance.  In fact, the buyers were planning on paying the rest of  the bonus towards additional principal reduction at the same time they paid their deferred interest.

This borrower could have qualified for this program with just a 10% down payment, but chose to put 20% down.

This program has also been known as a negative amortization loan.

As strange as it may seem, a home purchased well below market value is no more attractive to most lenders than one at market value.... There is no "best loan" - it has to fit the buyer's situation.  How long they will be in the house should be a significant factor...

Reserves are liquid assets available after closing.

The ARM program was the best choice for them.  A 5/1 ARM (fixed rate for 5 years with an annual adjustment beginning in the 61st month) was another option.  They would have been in a Jumbo program (slightly higher rate than a conforming loan size under $252,700)) with the 5/1 ARM, so the difference between the current indexed rate and the ARM rate was more pronounced than if the loan size was smaller.

The rate will be tied to a published index (COFI, 1 yr T-Bill, LIBOR, MTA, etc.) with a margin.  In other words the rate will be the margin + the index and will modify or adjust the current index value at specified intervals.   For example, the index is 1 year treasury bills and the margin is 2.5%.  The rate would adjust to 2.5% over the treasury bill rate the end of the specified interval.  If the index was 5.35% on the anniversary date the rate would be 7.85%.

7.5% is not the rate, it is the percentage increase.  For example: The program starts at a 2.95% rate for the first month on a $475,000 loan size.  It adjusts to the index after the third month.  The first three month’s payment is $1,984.95.  The fourth month it adjusts to the fully indexed payment-index rate + margin-which in this case is $3,229.00.  This is the payment required to fully amortize the loan.  You have the option of paying $3,229 or $1,984.95.  If you choose the deferred interest payment, the additional interest is added to your principal balance.  During the second 12 months, your negative amortization payment cannot increase over 7.5% of the original amount, $1,984 x 1.075% or $2,132.80.

The purpose of this loan was to allow the buyers to make a lower monthly payment and take advantage of the annual bonus to pay insurance, taxes and deferred interest.  This helped them with cash flow during the year.

Of course, the monthly payments would have been considerably higher due to loan size and the escrow account.

RATIO PROBLEMS

Our borrower had recently completed construction on her dream home when an unexpected change in finances left her unable to meet the mortgage obligation. The choices were to sell the home at a distressed price or have it refinanced to an affordable amount.  Her income as an attorney was expected to increase dramatically within five years.

We were able to acquire a small gift from her parents to reduce the principle and refinance to a substantially lower interest rate on a 5/1 ARM (Adjustable Rate Mortgage).

This enabled her to keep her home and put this single mother in a very favorable asset position.

Two ratios are used when qualifying a borrower.  The first, or front end, is the entire house payment-PITI-as a percentage of monthly gross income.  The second and most important of the two is the back end ratio.  This is the monthly PITI + monthly revolving and installment debt payments.  Guidelines vary, but a back end ratio around 40 is good. The gift money allowed her to reduce the loan size and in combination with the lower rate on the ARM, she was able to improve her cash flow.

Adjustable Rate Mortgage - The rate is fixed for 5 years and adjusted once per year beginning with the 61^st month  A five year ARM is roughly .25% to .375% lower in rate than a comparable 30 year fixed rate.

She protected her original investment, which may have been jeopardized in a distressed sale environment.

GIFT EQUITY

Our borrowers had been living in their in-laws' home and making all mortgage payments for five years.

Both borrower and co-borrower had marginal credit, recent job changes and no funds with which to close.  In-laws were moving out of state and needed funds from the proceeds of the sale of the property.

The selling price was established at $120, 000 and we were able to get the property appraised for $150,000.  The parents were able to gift equity the closing costs and leave the equity position at 20%.

We then sat down with an underwriter and employed a common sense approach to the credit and job related issues.

The kids are in the house and the folks send us Christmas cards every year from Colorado.

The borrower’s were required to document mortgage payments and provided copies of 12 months cancelled checks.  The seller provided a letter indicating they had received timely payments for 5 years.

Job changes within the same industry for advancement and/or better compensation are viewed favorably by lenders.

If the appraisal will support the value, a relative can gift a minimum of 20% equity to be applied towards closing costs and/or down payment.  Anything less than 20% doesn’t work.

One of the things we love about dealing with our clients and underwriters personally is the opportunity to make the loan process both reasonable and personal - sometimes it has to be more than just numbers!

The borrowers could have qualified for an FHA 3% down program and have the sellers contribute up to 6% toward the closing costs and down payment.

ONE TIME CLOSE WITH REMODEL

Our borrower had great credit scores and loved the floor plan, but wanted to upgrade the home by renovating the kitchen and bathrooms prior to moving in.

The sales price was $100,000.  The planned improvements were contracted for at $20,000 and improved the appraised value of the home to $125,000.

The contract and contractor is approved, the seller is paid at closing and the contractor is paid upon completion of the work.

Our customer paid 5% of the cost of the home + the cost of the improvements (5% x $120,000 or $6,000) as the down payment.

The customer escrowed another 50% of the value of the improvements with the title company at closing.  This is to provide a cushion in case the buyer decides to add options or upgrades to the original contract work.  The money is escrowed with the title company and with any unused portion of the escrowed funds reimbursed to the buyer upon completion of the work.

The borrower could also have closed on the purchase price of the home and then taken out a home improvement loan (second lien) for the value of the remodel contract.  The home improvement loan is typically at a slightly higher rate than a first lien mortgage and amortized over 15 years.

The appraiser is also the one who does the inspection for approval of percentage of completion payments in more extensive renovation projects.  They will provide the final inspection with photos upon completion.

Not only do the improvements get done before they occupy the home, this programs provides an opportunity to amortize the improvements over 30 years instead of 15 years. - lower payments.

In other words,  the escrow now has $30,000 in it ($20,000 + $10,000)  This is in case there is a dispute with the contractor or the borrower decides to upgrade the work and increase the contract amount.

 If you are a little short on cash, escrowing another 50% of the value of the improvements might place the second lien option in more favorable light.  If you have the cash, analyze the programs based on long term dollars.  If you don’t care when the pool goes in or if the improvements are such that you can close on the house without them and you’re okay with the 15 year payment structure, go with the second lien after you move in.

REFINANCE

Our borrowers had a principal balance on their current mortgage slightly over $150,000 and an interest rate about 2% over the current market rate. If everything worked out for them, they planned on downsizing when the kids got out of school-in about five years.

Did it make sense for them to refinance?

Yes, it did.  They chose a program where the rate was slightly higher than the market rate, but the monthly savings amounted to a net gain of over $8,000 if they stayed for the full five years-more if they stayed longer.

It did make sense for them to refinance and they are glad they did.  The kids will be too-college isn't cheap!!

It is not the rate differential that matters most-it's the dollars.  The size and efficiency of your current payment vs. the size and efficiency of your potential new payment.

How long you plan on being in the home is a critical question.  You have to be able to analyze the refinance options over the period of time you plan to be in the home.  It doesn't always make sense to refinance.

If they were planning on being in the home for six or seven years, a better choice might have been to "roll in" or include the cost of the refinance in the new loan and benefit from a lower interest rate.  More savings per month for a longer period of time.

If they were planning on paying the mortgage off and owning the home, we would have placed them in a 15 year mortgage for about the same monthly payment they had been making.  They would have saved  over five years of monthly payments!

CASH-OUT REFINANCE

Our borrower was overwhelmed with credit card debt.  He just couldn't make a dent in that principal balance because of the high interest rates on the credit cards. He had been in his current home for seven years and for several reasons had a substantial amount of equity.

Our borrower really liked his home, but could not really determine how long he might be there.

We put him in a program that refinanced the balance of his current mortgage and the title company gave him a check at closing that allowed him to pay off the credit cards.

There was even enough money left over to celebrate with a steak dinner. In Texas, you are only allowed to get cash from the equity in your home up to 80% of the appraised market value of the home.  In other words, your mortgage loan, with the cash-out included, cannot exceed 80%.

Since he was unsure how long he was going to be in the home and the rate on his current mortgage was slightly higher than the rate he could get on our 30 year fixed rate loan, he chose that program.  Another option would have been to take out a second lien mortgage and leave his current mortgage in place.  Most second lien cash-out mortgages are for 15 years, although there are longer terms available.

Interest rates on cash-out programs are slightly higher than the rates on a comparable sized mortgage refinance without the cash-out feature.