Monday, August 02, 2004

Assess the risks before taking that 'bargain' mortgage

Hunting for a bargain-rate mortgage? Better spend some time on the search.It won't take long to spot rates advertised in the low single digits. Choosing a "bargain" loan, though, could end up being a costly mistake.

More lenders are aggressively pushing mortgage products designed specifically so that borrowers' payments will hover below what they'd initially pay if they chose the industry standard -- the 30-year, fixed-rate mortgage, says Jack Guttentag, who dubs himself "the mortgage professor," and runs a consumer-oriented Web site. It could prove costly if a borrower grabs one of these mortgages without carefully examining the provisions in the contract for future payment hikes, notes Allegra Calder, research analyst at Harvard University's Joint Center for Housing Studies.

Calder worries that some home buyers are selecting the lower rate mortgages -- which are usually adjustable-rate mortgages (ARMs) -- so that they can afford payments on a house right now, without seriously pondering how they'll handle payment hikes later. Calder says her fear is borne out by the fact that "higher shares of ARMs are being made in cities where housing costs are relatively high. "As every consumer knows, however, a bargain should never be ignored.

Experts say that ARMs and other loans offering initial discounts are appropriate, as long as borrowers study key issues:- How does this loan really work? When a borrower applies for an ARM, lenders are required to provide them with a special disclosure sheet that outlines how the interest rate may change over time. The disclosure will detail how the rate can go up or down, based upon the movements of an index, like the one-year Treasury. The rate of the index at the time the mortgage comes up for adjustment, plus a margin, like 2 percentage points, is the new rate the borrower pays. "Different lending companies write their disclosures differently, and some of the disclosures are clearer than others," Guttentag says. It's not unusual for borrowers to ask for a copy of the disclosure to take to their financial adviser or to study at home before they sign it and formally apply, says Dave Mallon, vice president of the Midwest Financial Group Inc., Barrington.

At his Web site, www.mtgprofessor.com, Guttentag posts free tutorials and tables designed to help consumers make sense of ARM disclosures. "You print out a copy of the worksheet of ARM features and then get the loan officer to plug in the variables, " Guttentag says.- Can I handle the future risk? Suppose you choose a loan where the interest rate can rise each year, and by the end of the fourth year your rate is 5 percentage points higher than when you started.

Lenders won't give a mortgage to someone unless they're reasonably certain they'll be able to afford the payments, says Doug Duncan, economist at the Mortgage Bankers Association, a Washington D.C. trade group. Still, it's up to borrowers to ponder how comfortable they will be with a mortgage payment that may be much bigger in years ahead. In many cases, a lender will approve a borrower for ARMs that adjust each year based upon the highest possible rate on that first year adjustment, says Bill Silverthorne, loan officer, Ameritrust Mortgage Corp., Crystal Lake.

Still, it's up to the borrower to decide whether she or he will have the income to handle bigger payments year ahead.- Am I excited about the size of the first monthly payment? Borrowers tend to make mistakes if they choose a loan primarily because their initial monthly payment is lower than it would be with other mortgage options, Calder says.If lenders or others involved in the home-buying transaction aggressively tout how much the first monthly payment is, be especially wary, she warns.

Guttentag concurs that focusing on the size of the first monthly payment can distract borrowers from the actual cost of the mortgage. In particular, he's concerned about a mortgage type known as the "flexible payment ARM". "These are usually offered at a starting interest rate of less then 2 percent, but that jumps significantly by the second month," Guttentag notes. However, borrowers are able to keep the same payment throughout the first year, with the extra interest charge amounts added to the loan balance.But eventually, borrowers are required to catch up, and they could find that their monthly payments several years down the road are double what they started at, Guttentag warns. "I think 99 percent of the people who go into this, don't know [the details]," he concludes.

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