BY GIBRAN NICHOLAS
Are Interest-Only ARMs Dead? I’m sure you’ve heard that incredulous gasp or moment of silence on the other end of the phone when you tell someone that they might benefit by considering an interest-only adjustable-rate mortgage (ARM). It’s as if the very mention of an interest-only ARM places you in a category of being, “One of THOSE”—a big bad mortgage broker who singlehandedly caused the whole housing, financial and economic crisis. So, I have two questions for you: 1. What role, if any, do interest-only ARMs have for today’s borrower? 2. If they do have a role, what is the most effective way to present this option to clients, prospects, and refer-
ral partners without looking and sounding like a lunatic?
The case of the missing $100,000 Consider a situation where a client has a 4.5 percent, $200,000, 15-year mortgage on a home that would be worth $500,000 under normal market conditions. The client wants to buy a new home immediately. They want to take advantage of the $6,500 long-time resident tax credit; they want to participate in the Fed’s $1.25 trillion mortgage rate subsidy; they want to get a fantastic deal on the purchase of a new home given the low housing values and buyer’s market.
However, due to the foreclosures and distressed sales in their neighborhood, they could only get $400,000 if they sold their current home today. If they wait a few years, the neighborhood values should recover to the point where they could get $500,000 for the house and pocket an extra $100,000. However, they don’t want to wait a few years to buy a new place. What, if anything can be done for these people?? Assume they could qualify for two mortgages, the one on the old home, while they keep it and wait for home values to recover, and a new mortgage on the new home that they purchase. Here’s a strategy that could make a lot of sense:
FEBRUARY 2010
ALABAMA MORTGAGE PROFESSIONAL MAGAZINE
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In spite of the brilliance of this strategy, you may be wondering, “How in the world do you get a client with a 720 credit score, who has never paid points in their life, to pay four points plus closing costs?” In this example, the four points plus about $2,500 in closing costs would total $13,700. This is a large sum of money to ask a borrower to pay— especially if they are used to getting “no cost loans” and/or not paying points. The best way to illustrate this for clients is to frame it in the context of an investment:
“Mister or Missus Client, this strategy involves your making an upfront investment of $13,700. You are not making this investment out of pocket; it is “It’s as if the very being taken out of the loan Keep the old home mention of an interamount. In other words, and turn it into a est-only ARM places it’s like a no-money-down rental, charging just you in a category of investment—it’s all being enough rent to cover being, ‘One of financed for you. So, the expenses. THOSE’—a big bad main question we need to Refinance the $200,000, 15-year mortgage on mortgage broker who answer here is: ‘What is the singlehandedly rate of return on this the old home into a 70 caused the whole investment?’ If the rate of LTV non-owner-occureturn is attractive to you, pied $280,000, sevenhousing, financial this investment opportuniyear interest-only mort- and economic crisis.” ty would be very worthgage. The borrower while and we should would need to pay move forward. If the rate about four points plus closing costs to get a 4.5 percent inter- of return is unattractive, pass on this est rate. They would walk away with opportunity and find another use for about $66,000 in net cash-out pro- your $13,700. Now, assume that this ceeds that would be used as a down- strategy allows you to sell the home in five years for $500,000 instead of sellpayment on the new home. The monthly payment on the $280,000, ing the home today for $400,000. This seven-year, interest-only mortgage means that we are paying $13,700 would be $1,050, compared the client’s today, in order to end up with an extra current $1,530 monthly payment with $100,000 in five years. The rate of their 15-year mortgage. The client saves return on your investment in that sce$480/month in cash flow—which nario would be 48.81 percent annually. means they can charge below market In other words, Mister or Missus Client, rent on that property and still break if you are happy earning 48.81 percent even. This will result in finding a tenant per year on a $13,700 investment, it more quickly, and avoiding the nega- would make perfect sense for you to tive cash flow associated with having implement the strategy that I have outlined here.” the property stay vacant. The client can sell the old home at Wow!! any time within the next seven years Can you imagine the impact you once market values recover. At that time, they will pocket the $100,000 would have if you were able to have they would have lost had they sold this type of a conversation with a the home today instead of refinanc- client? I’ve got to tell you, this is much ing into the interest only mortgage strategy outlined above. continued on page 13