Borrowers who are locked in to a fixed-rate mortgage however, may not be celebrating during times of lowering interest rates. When looking to refinance, they face a difficult choice: continue to pay a higher interest rate, or incur what is often thousands of dollars in penalty fees in order to break their current fixed contract.
They need to consider more than the interest rate – there can be a plethora of conditions attached to exit fees. For instance major banks charge upfront exit fees ranging from hundreds to over a thousand dollars. Charges can also be levied by the new lender.
While fees vary, a borrower who cancels his loan within the fixed period will usually be forced to compensate their mortgage provider for the “economic cost” of breaking their contract. As interest rates fall, this cost becomes greater, and it may already be too late for fixed borrowers to save by refinancing.
Such fees can often come as a shock to people who are on a fixed-term mortgage. They can be very are surprised when they hear what the break free cost is – often it can be far higher than people expect.
Low FHA interest rates from the FHA (Federal Housing Administration) have allowed families with low or moderate income to get the opportunity to buy their dream home. FHA loans are far easier to acquire and if the interest rates are compensated too, then they are obviously the best deal around.
The loan categories, which FHA offers are generally of two types: one is single family having 1-4 unit homes and the other is multi-family having 5 or higher number of unit homes.
For FHA home loans, you get an option of going for a buy down on the low FHA interest rates. When going for a 2-1 ratio, you get an option by which you can reduce your FHA mortgage interest rates by 2% in the first year, 1% in the second and follow it up by 0% from the following year. You also have an option of permanently lowering your rate of interest. If you were paying an interest of 6% for a loan, you can even lower it to 5.5%. However, to get this you have to meet a few guidelines laid by the FHA. Though this more preferred than a buy down option, if your seller pays for the permanent buy down and the buyer gets to occupy the property for three years.
Well. if the Federal Reserve doesn’t set rates, who does? I’m sure many of you reading this have seen the videos from the Chicago Board of Trade with all the members running around in their different colored coats, flashing hand signals, shouting buy or sell at the top of their lungs. It is there at the CBT, where other commodities are traded, are where the initial rates are set. Most long term mortgage rates are linked to the 10 Year Treasury Notes traded on the exchange. Why the 10 year Notes? Mainly because they are considered one of the safest bond instruments in the world. When the 10 Year Note goes up in price and the yield goes down, over the course of the next few days. the lower price will be reflected in the conforming mortgage rates.
But with the higher priced homes in California, where most are above the conforming loan limit, we move into the jumbo loan range above $417,000. Since the stimulus package things have changed for the jumbo market. Now that Fannie Mae and Freddie Mac are involved, we now have what are known as Agency Jumbos. These are jumbos that range between $417,001 and $662,500 here in Sonoma County, and are priced by Fannie and Freddie themselves. Up until the end of April however, the difference between the conforming rate and agency jumbo rates was still wide. It was nearly 1/2 point to 3/4 points. But in late April, both Fannie and Freddie narrowed that gap down to 1/4 to 3/8 points difference. Loans above the $662,500 mark are still considered jumbo loans and are priced by the lenders themselves at a much higher rate than the agency jumbos to attract investors to purchase them. Compared to agency jumbos, the standard jumbos are priced somewhere around 7.625% to 8 1/2 %. Why so high? Because investors are skittish about the higher loan amounts and want incentive to buy them.
As interest rates rose throughout the economy, it became more difficult to qualify for a mortgage at the same time that interest rates were resetting higher on existing mortgages. This had the effect of causing a severe decline in property values and a resulting credit crisis. So many mortgages have gone bad that it has become nearly impossible to figure out who owns these loans and what can be done about them.
The Federal Reserve has been lowering interest rates over nearly the past year in an effort to create more liquidity in the financial markets and alleviate some of the burden on homeowners. Interest rates are still resetting and causing mortgage payments to skyrocket, but they are smaller increases than they otherwise would be if interest rates were higher.
The already high foreclosure rates are also contributing to higher interest rates for new borrowers applying for mortgages. Lenders now know that giving out mortgages to people who had no income and did not put any money down was not the way to create lasting business. Lending standards have tightened dramatically, and banks are now requiring homeowners to put money down and prove that they can afford the mortgage.
But even this is somewhat counterproductive, as tighter lending means fewer people are able to qualify for mortgages, and property values need to decrease even further. Homeowners in foreclosure often find out that they are now underwater, owing more on their homes than they are worth. Borrowers, in order to qualify for loans at higher interest rates, are able to offer sellers less than if interest rates were lower; and the lack of qualified buyers in the market means that more properties will be available for sale. Homeowners who have to sell in this market environment may have to accept less or convince their lenders to accept a short sale.
There are other options too, but the point to consider is the impact of the decisions. In 2003, the likelihood would be that that same home could be worth over $325,000 if it was located here on the west coast and could have been renewed again at lower rates. This same couple would have those same key decisions– lifestyle and immediate benefit, or longer-term independence.
You can say that if our couple used some of the refinanced money to renovate their home, they would be adding value; however, the point is that if they had a vision and plan for their life, they might have considered the long-term costs of their decisions. Simply renewing the existing mortgage and maintaining the mortgage payments at the original level would mean this couple would be mortgage free in less than 15 years and would pay 10”s of thousands of dollars less in interest charges and only been out of pocket a couple hundred dollars more each month than the couple who renewed at the lower monthly payments, or refinanced more at each renewal.
If our young couple considering home ownership put themselves in a situation where they were financially stressed from month to month, there is a much higher probability they would consider a refinancing option, or other low rate alternative simply to keep supporting their lifestyle. There are so many strategies to use in personal finance, and more available each day. How does someone distinguish between what’s best and what’s merely good for the moment? The easiest is to develop your vision, set the goals and always use that as a guide when gathering information and making decisions before considering interest rates, fees, prices, and immediate desires. There really is no one perfect route to financial success – it will look completely different for each person, however, “if you don’t know where you’re going, you’ll probably end up somewhere else”.