Interest rates are on the rise, and that means the 25 percent of homeowners who hold adjustable-rate mortgages are beginning to feel the pinch. Gerri Willis at CNNMoney has some advice to help these folks guard against higher rates. She recommends that homeowners:
- Know the stakes. The increased rates can make hundreds of dollars of difference in your monthly payment, all of which goes to interest.
- Buy some time. Though it will cost now, you will likely save in the long-run by refinancing with your current lender. Call to see which options are available to you.
- Re-evaluate your home equity line of credit. Pay off your HELOC if possible (but beware prepayment penalties). Otherwise, consider refinancing it into a new loan with your mortgage.
- Don’t consolidate. Though it’s tempting, it’s probably cheaper not to consolidate your other debts into your mortgage. A mortgage stretches out your payments so that you may actually pay more in the long run.
- Forget the fees. Get rid of private mortgage insurance, if you can. Check to be certain you’re not paying other unnecessary fees.
Read the entire article at CNNMoney.
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In Australia, people applying for a mortgage or refinancing have the choice of mixing their interest rate payment plan in to flavours: A portion of your payment is based on a variable rate and the other portion on a fixed interest rate.
Because of the tightening regime of the federal banks of countries around the world, it is safe to say it would be wise to be overweight on the fixed interest side of your loan.
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The best thing you can do in these times is #1 above: to UNDERSTAND your mortgage. According to a lot of news stories, an amazing percentage of people don’t. Apparently, many people were enticed into taking out > idiotic mortgages, assuming that real estate prices always go up. As we are seeing, they don’t. Not only that, people seem to think that “the bank wouldn’t have given me the loan if I couldn’t pay it back”. Unfortunately, this is also no longer true. Strong incentives existed for a few years for banks to make stupid loans.
Many newspaper reports talk about the problems coming in the future for people with adjustable rate mortgages (ARM) when they start to adjust. For interest only mortgages where the money owed keeps going up (Interest Only Option ARMS), there are even earlier dates when the payments can skyrocket: once the loan principle grows to a certain amount, instead of paying just part of the interest you suddenly have to start paying down the principal also. (The loan is said to “recast”.) This could happen sooner than the ARM rate reset for some loans. So the moral of the story again is: UNDERSTAND your mortgage.
Mortgages are highly “leveraged” purchases: you put a small down payment on a large asset, financing the rest with a loan. With a 10% downpayment, if the market value of the house goes up 10%, you just made 23% on your money. Of course, if the house’s market value goes down 10% instead, you just lost _163%_ of your down payment “investment”. (These numbers assume it would cost you around 7% of the sales price to sell a house. If those results don’t look right to you, learn to calculate it yourself and understand your mortgage.)
If you have too much loan, you may already be sinking. If you don’t understand your mortgage, you won’t know when to start counting the life boats…
More importantly, renting (before the foreclosure gets on the credit rating), and getting the foreclosure over with might be the best financial strategy for a particularly hopeless situation. It is generally much more expensive to pay the “carrying costs” of a house than to rent. The deer in the headlights freeze – LA LA LA LA LA I don’t want to think about it – system is not how to Get Rich Slowly. UNDERSTAND your mortgage and your situation.
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The risk you take applying free cash to other investments (in place of mortgage pre-payments) is something rarely discussed but its impact can be HUGE.
Scenario = 290K 10yr ARM with 5.375 initial rate, Monthly Prin + Int of $1,650 before reset in 2015. If you pay between $1,500 and $2,000 in extra principal payments per month (more or less depending on availability) you could have the mortgage principal down to $0 in 8-10 years.
Scenario results = Interest expense for the life of the loan goes from $300K to roughly $90K (= $210K SAVED). Investment opportunities during that 10yr period you didn’t participate in might? or might not have been profitable… But the risk-free $210K is a guaranteed win. You could have invested in stocks over the same period and lost your shirt. Since historical stock performance is NOT a guarantee of future returns, households should weigh their current debt burdens MUCH MORE carefully against risk and opportunity cost. Paying off ARMs before the first reset could end up being the cheapest money you ever get.
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