Andrew Ikeda 0 Report post Posted February 29, 2004 Greetings Everyone! Ok, here is the scoop on ARM's (Adjustable Rate Mortgages) and the good, bad, and ugly. I will also attempt to clear up some misunderstandings about ARM type loans. To start, ask yourself why you are buying the property. If it is for lease purchase, flip, subject to, or as a rental, heck, even for owner occupied, then an ARM is something that you should definitely consider! Why? Well, if you know you are going to be 'out of the property' in say 2 years, would you want a 30 year fixed loan on it? Probably not, but this is the question most investors ask me. Let me illustrate: A 30 year loan right now is averaging around 6.0%. I will use a $200,000 property. Since we want 100% financing and want to avoid PMI, we will add a second loan to it at 9.95% 200,000 X 80% = 160,000(first)/ 6% interest/30 year term = $959.28 200,000 X 20% = 40,000(second)/9.95% interest/30 year term = $349.55 So our total for 100% CLTV/ 30 year fixed is $1,308.83 Now, lets take a look at an ARM that has been in the high 4% range in recent months!! The lenders are offering this only on first loans. Second loans are at 30 year fixed rates and one lender uses 6.75% on the second! 200,000 X 80% (first)/4.752%/30 year (for calculation) = $834.83 200,000 X 20% (second)/6.75%/30 year fixed = $259.44 Total payments $1,094.27 A savings of $214.56 per month. In one year, that is $2,574.73, in 30 years, that is a savings of $77,241.90 Now the great part is that the lenders let you start at 3.95% for Non Owner Occupied (NOO) and is the payment factor, NOT the interest rate. So the calculation looks like this: 160,000 (80% of 200,000)/3.95%/30 years = $759.26 Add our second at 6.75% = $259.44 Total montly payments $1018.70 The 3.95% is for NOO properties. For owner occupied, it is 1.95%. So with a rental property the savings is $290.13/month compared to a 30 year fixed loan payment! To keep this from getting too lengthy, allow me to move on. One of the ARM lenders also have 4 payment options: 1) minimum payment 2) interest only 3) principle and interest 4) 15 year fixed You can interchange every month. This month pay interest only, next month 15 year fixed payment, following month minimum payment. There is a 3 year prepayment penalty. For $200 you can convert this into a 30 year fixed after the 3rd year or refinance. One lender allows a buyer to ASSUME the loan!! All the new tenant/buyer has to do is a loan application and qualify! The payments on these loans increases 7.5% every year until you reach the fully indexed rate (currently 4.752%) and this takes about 5-8 years! This means that the loan amount will be below $834.83 calculated on the 4.752% rate above for the first few years! This gives you time to cashflow and build up equity at the same time. (Remember that you are paying mostly interest anyways on a 30 year fixed for the first 20 years). Also, with one lender this is a true BI-WEEKLY: Your loan amount is recalculated every two weeks so you are not paying interest on interest!! Now for the UGLY: 1) Unfortunately, there is no 100% financing for NOO only 70% with one lender and 80% with another. However, if it is owner occ. then you can get up to 95%! They will want you to OO it for at least one year (12 month Chain of Title). Now on to some misconceptions: Investors are always scared of the cap rates. One lender (whose calculations I used above) is at 11.95% and another one at 8.95%. Everyone freaks out on this. I should mention that most of these rates are based on the 90 day Certificate of Deposit rates (currently around 1.15%). For the cap rate to reach 11.95%, your 90 day CD's will have to pay around 8.5%. The lenders margin rate (banks rate) is around 3.5% and is always fixed. The prime rate (1.10% CD rates) are added onto the margin rate to come up with the fully indexed rate (4.752 currently) So then, the banks would be paying 8.5% on 90 day CD's and fixed rates will be around 13%. Notice how fixed rates are usually 2% higher at all times. Your property will double in value if the rates ever hit the cap rate. Not only that, you are only paying the minimum 3.95% anyways so your payments are not going to skyrocket! If the loan goes to a 'neg am' or negative amortization (in which you will pay longer to pay off the interest) then just refinance! Bottom line: DONT WORRY ABOUT IT! Interest only calculations are done similarly and the formula is: Loan amount X interest rate divided by 12 months Ex: 160,000 X 5.5% /12 = $733.33/month. (Some lenders are doing higher LTV's (loan to value) with no PMI on this type of loan) In the above, I mentioned two different lenders. The difference between lender A and B are as follows: Lender A: start rates are 1.95% owner occ and 3.95% NOO. 95% for owner occupied and up to 70% LTV for NOO. Loan is assumable and is a true Bi-weekly. Cap rate 11.95%. $200 to convert to another loan product type. Lender B: start rates are 1.25% owner occupied and 2.95% NOO. Up to 100% for owner occupied and 80% for NOO. Loan is NOT assumable and payments are monthly - no bi-weekly available. Cap rate 8.95%. No $200 to refi or change loan product. Whew! This was an awfully long post! I'll stop here while our minds are still clear! Hope this has been helpful to all of you. Andrew Ikeda (Mortgage/Investment Specialist) US Funding Group, Inc. 888-889-1640 ext 220 andrew.ikeda@usfundinggrp.com and/or andikeda@netscape.net Share this post Link to post Share on other sites
