I need help with a mortgage question - fast!

Factual Questions
1

We are almost finished with securing financing for a home. I really screwed up estimating the mortgage payments, and when we got the papers saying the final mortgage payment amount would be a little over two weeks’ pay, I freaked out. Oh, it could be done, but it’s penny-pinching time, and will be until I freaking die. We asked the bank if there was a way we could bring it down.

One solution suggested to lowering the payment is this:

This doesn’t even sound like English. So I asked what that meant - he said:

I’m still confused, and a little apprehensive. Aren’t ARMs what caused the whole mortgage crisis in the first place? Isn’t that a stupid risk? Isn’t hoping it’ll get better naive? Is this setting me up for disaster? I’ve already brought $7000 into closing. I can’t see scraping up more than $2000 more in any short amount of time. There’s no other money. I simply read the reports and formulas online wrong and got bad estimates when I was pre-approved (for way more than the price of the house). I don’t know where or how I screwed up, but I did.

I know the great minds of the Dope can explain this to me in a way I’ll understand.
Can someone please break this down for me?

2

How to buy down a mortage

3

My humble recommendation: If you don’t like, or can’t afford, the terms of the loan, don’t sign the papers. Don’t expect any changes to be made post-closing, either. It doesn’t matter that there have been people working towards getting your loan closed. Those people aren’t going to be there to help pay your mortgage payments. Don’t let them pressure you, and don’t feel guilty if you delay your closing.

Bottom line: Tell them to restructure your loan to something you can afford (for the duration, too; it may start with a low rate, but if it adjusts to a rate beyond your means, you are merely setting yourself up for disaster later).

4

There’s nothing inherently bad about buying down the points on the loan; you just have to decide if it’s right for you.

ARMs can be dangerous, though. You really need to look at 1) when the rate can be changed and 2) how much it can be changed. Some ARMs are OK; some can go up drastically in a short amount of time.

Given your claim that you can barely make the mortgage payments as it is, I’d be wary of getting an ARM, since even the best of them can and will increase your monthly payment amount over time.

I second what Atomicktom says: If the payment are going to be that difficult, don’t sign the loan. Go find another loan or a cheaper house.

5

Be aware that most people’s mortgage payment isn’t just principal & interest on the loan for their home. It also usually includes escrow for home owner’s insurance and property taxes.
You really need to budget around that amount.
For me it is the difference between a $970 monthly payment (P&I), and a $1300 monthly payment.

6

You could, conceivably, roll the “buy-down” point(s) into the mortgage amount. For example, if you’re buying a house with a 100,000 mortgage, and want to pay a point to bring the rate down (I think a 1% point would lower it either 1/8 or 1/4 of a point), then you could write the mortgage for 101,000 instead. That would increase the payment slightly.

For example: 100,000 for 30 years at 6% gives a payment of 599.55 if my spreadsheet is correct. 101,000 for 30 years at 5.875% (1/8 point buydown) = 597.45. NOT a big savings. 100,000 for 30 years at 5.875% = 591.54. Obviously those differences would be magnified somewhat for a larger mortgage.

When looking at an ARM, you need to look at two things when estimating adjustment: what is the max it can adjust at one time, and what’s the max it can adjust over the lifetime. Typically you’ll see something like 2% per adjustment, up to a max of 5% over the life of the loan. There certainly are ARMS that can adjust to the full maximum in any single adjustment; I don’t know how common those are.

So in 3 years, that 6% loan (assuming a 3/1 ARM and a 2/5 cap) might adjust up to 8% - even if interest rates have gone so insane that a brand-new loan would be 12%. Then the year after, it would go to 10, then the year after, to 11. If interest rates stay low, you might not see much of a change.

Going with the 100,000 loan at 6% and a 3/1 ARM (numbers not guaranteed to be correct, they’re using a spreadsheet I created for fooling around with refi options):
Your payment for 3 years would be 599.97.
Then it adjusts. If it goes all the way to 8%, the payment would be 724.74 for the next 12 months.
Then it adjusts again. If it goes all the way to 10%, the payment would be 856.25 for the next 12 months.
Then it adjusts again. If it goes all the way to 11%, the payment would be 923.54. It would never get any higher than that and if rates drop, it might even decrease.

So - if you go with an ARM to get lower up-front payments, you need to think seriously about what could happen when the initial 1, 3, 5, or whatever commitment period expires. Calculate the max the payment could adjust after that and see what happens with it.

If someone tries to get you to go for one of those loans where you pay less than the interest that’s accruing… run like hell. Needing to go that route to afford the payment = “you can’t afford the house”.

I will caution you - if you’ve been approved for financing at the payment stated, you may not be able to walk away from the purchase without forfeiting whatever earnest money you’ve put up - typically a few percent of the purchase price.

Oh - and as others have said, your escrow payments (tax, insurance) will be added on top of the principal+interest payment. Ours is over 600 dollars a month (property taxes are over 6,000 a year and insurance is about a thousand; we’re in a high-rent area). They’re about 25% on top of the principal and interest.

One interesting thing about an adjustable mortgage: if you’ve managed to pay a bit extra before it adjusts, the new payment is calculated taking that into consideration. In the above example, say you throw 50 dollars a month extra into it during the 3 years, the payment after 3 years would be something like 715.54 as opposed to 724-something. Not a huge difference but worth noting.

7

I always considered myself financially responsible but we somehow missed the little detail that our first house purchase was an ARM (I understood things slightly differently when we bought our house). Right before the mortgage crisis started making major headlines, I got a letter from our bank cheerfully notifying us of a rate hike to 8.5% and a massive monthly payment increase. We never missed a payment and our credit was perfect. The house had appreciated a lot too.

The old bank wouldn’t help at all. I called Bank of America and they instantly went over everything on the phone while simultaeously pulling credit checks and everything else to see what they could do. We actually ended up saving money instantly because the fixed rates at the time were lower than our ARM.

I feel very lucky and thankful but I would flat out warn anyone against getting an ARM in today’s climate unless you possess a degree from an elite business school. The terms are vague and too confusing. You can get burned in an instant and the uncertainty isn’t worth anything you might save. Go for a fixed mortgage and take comfort in the fact that you will know what your mortgage payment will be with just some variability fort other things like taxes and insurance. You can always refinance later if things change drastically in your favor later.

8

With everything on the news, you’re thinking of taking on an ARM for a house you can barely afford before it rises?

Don’t do it, don’t sign!

Run away, far, fast and now!

Now, start over again. (Embarassed? Switch realtors and banks if you must!) This time, stick to a house you can comfortably afford to make the payments on. Negotiate financing from the beginning again, avoid ARM’s like the plague. After 5 years of making the payments and building equity, switch to an ARM if you still feel the need.

Taking on more house than you can afford is a recipe for disaster. It means one misfortune, (illness, job loss, new furnace or roof), could put you in a position to miss a payment and possibly lose the house and your credit rating in the process. It will be really hard to come back from, if that should happen. Much better to set yourself up for success than for failure.

Please don’t do this thing.

9

Not substantially, no. If you’re freaking out about it now, trust that gut feeling.

The options to pay points to lower the rate of a mortgage will have a small effect, but there’s no way you’re going to get a huge reduction by shifting numbers around with the mortgage. Whatever rate you were approved for, with the amount the house costs isn’t something you can change by much.

How much do you stand to lose if you walk away at this point?

10

You didn’t say what the components of your monthly payment are. Is it PITI or just P&I? Sounds like one element might be the private mortgage insurance (PMI) which gets charged if you put less than 20% down on a place. There’s escrow amounts for taxes, too.

Your mtg. payment shouldn’t be half your monthly income, but keep in mind that you will be getting more money back from the IRS next year and in all years from now on because what you’re actually paying is mostly interest and it’s deductible.

11

First question: What does your contract say about you backing out of purchasing the house.
Actually, that’s the only question. Answer that, and you’re halfway home.
If you are ready to take any hit that the contract specifies, or if there is none at all, bail out now, or find a different finance company.
A buydown means more cash out of pocket now.
Avoid an ARM at all costs.

greatshakes