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By Jeff Blovits, Franklin Bank
Branch Owner
Over recent months, many people have been asking whether or not the monthly adjustable rate mortgages, which are currently yielding unbelievably attractive interest rates, are a wise financial move. These indices, which include the Monthly Treasury Average, the monthly LIBOR and the 11th District Cost of Funds Index (COFI), are fully-indexing out right now at anywhere between 3-4%, depending on the margin.
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Billboards and marketing ads on radio and TV have been having a field day with the low monthly payments generated by this very aggressive adjustable rate mortgage. So the question is, "Is this loan right for you?"
The answer is greatly dependent upon your existing circumstances, and short- and long-term needs. With recent statements from Alan Greenspan about the probable continual slow growth of the economy generating further interest rate hikes, one must wonder whether or not this is a dangerous proposition. It is a danger proposition if you cannot afford to be in this type of a gambling situation. Conventional logic says that high commodity prices, high property values and more importantly, a very robust federal budget deficit will ultimately lead the Federal Reserve to tighten monetary policy, consistently and fairly aggressively over the next several years. If this is to occur, this will no doubt generate an increase in short-term interest rate indices, such as those aforementioned.
Individual home owners who are obtaining this type of loan because it provides for an attractive payment right now, need be forewarned that the likelihood of this payment being available in the future is not very high. If you can absorb significant increases in interest rate without having it affect your lifestyle, then there are certainly ancillary benefits associated with this type of loan right now. Let's look at a few examples.
- You have strong cash flow on a monthly basis. You have a reasonable amount of assets invested. You are wanting to take out this type of loan to improve your cash flow even further so you can invest that cash into instruments of investment that you believe will out-earn the cost of that 4% debt. This would be a prudent financial move, once again, as long as subsequent increases in interest rates are not going to cripple you financially.
- You own a home and anticipate that you will not live there for more than another 2 to 3 years prior to moving to a different property.
This would be a great example of when this loan would be dynamite for you. Over the course of the next 2 to 3 years, you would have an incredibly affordable monthly payment. Who really cares, when you get right down to it, how much interest rates go up in the next 24 to 36 months if you are not going to be in this loan any longer to see it.
- You are a cyclical-income wage earner. Let's say hypothetically, you are a CPA and a significant amount of your income comes to you during a 3 to 4 month period of time when you are doing a lot of tax preparation. During those other 8 or 9 months of the year, cash flow is tight. This type of loan allows for you to weather the rainy days with a very affordable monthly payment in the short-term, until which time the cash flow starts coming in. A word of wisdom, however, when the cash flow is robust, make sure you are either setting money aside or pre-paying the principal to subsequently lower the monthly payment in future months, especially in the event of further interest rate increases.
On the flip side, it is not a wise financial move to be taking out this type of loan because it's the only loan on which you can afford the monthly payment on your new house. This would be a sure sign that you are potentially over-buying and should be buying a lesser-valued property.
Recent statistics have shown that these types of loans are causing concern for many of the major mortgage-banking companies across the country, who are preparing their staff for the large amount of foreclosure proceedings in the future as a result of people over-extending themselves in taking out these types of loans.
The moral of the story is to make sure the circumstances you are in fit the need for this type of loan.
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