Originally posted on September 13, 2014
From The Wall Street Journal, via Associated Press
(Subsequently edited by Dick Crawford)
The basics: Banks need to make more loans; jumbo loan rates have come down more than .5% this year; the ARM is making a come back; you need a good credit profile to play.
Forget what you knew about getting a home loan. The credit game is changing. Taking a big mortgage to buy a large house may no longer mean a higher interest rate.
Rates on many consumer loans have come down this year as more lenders compete to win over borrowers. What’s more, some riskier loans are starting to make more financial sense.
Large mortgages, known as jumbos, have carried lower average fixed interest rates than smaller home loans for five consecutive weeks through Sept. 5—an anomaly and the longest such stretch for 30-year mortgages since at least 1986, according to mortgage-info data from website HSH.com.
The caveat, but no surprise: you often need top credit scores to get the best deals.
“If you have very good credit and you’re able to [take] on debt, this is the time to borrow,” says Joseph Pucella, a vice president and senior credit officer at Moody’s Investors Service, a credit-ratings firm based in New York. “Rates are very low still and the banks are competing for that type of customer, so you’ve got more options.”
The deals are being offered as banks, hungry for revenue, try to drum up business. The loans are mostly targeted at borrowers with high credit scores, in most cases at least a 720 FICO score on a scale that runs from 300 to 850. Applicants often need to clear several additional hurdles, such as providing income documentation and maintaining a low overall debt load.
Borrowers are jumping at the opportunity. Excluding home loans, $390.9 billion in consumer loans—including student loans, car loans and personal loans—was originated in the first five months of 2014, according to the latest data from credit-reporting firm Equifax. That is up 11% from the first five months a year before and the highest for that period since 2007, when lending standards were looser.
For home buyers, it can pay to go big. In a twist on long-standing practices, interest rates on mortgages for pricier homes are now cheaper than mortgages that accompany lower-priced properties.
That’s because interest rates on regular mortgages are largely set by the investors who buy the loans, such as Fannie Mae and Freddie Mac, and the costs associated with these loans have increased. Jumbo mortgages, by contrast, are mostly held by the banks that make the loans, and lenders have lowered those rates to attract desirable borrowers.
Rates on 30-year fixed-rate jumbo mortgages—those that exceed $417,000 in most parts of the U.S. or $625,500 in pricier markets like New York and San Francisco—averaged 4.14% during the week ended Sept. 5, compared with 4.18% for smaller 30-year fixed mortgages, according to HSH.com. These rates have fallen by more than half a percentage point since the beginning of 2014.
With real-estate values spiking in many markets, the decline in jumbo rates could help ease the sting of higher prices.
Another option for home shoppers: an adjustable-rate mortgage. Most ARMs have a fixed interest rate for a set number of years before they begin to adjust annually.
The risk: Once the loan’s interest rate adjusts, borrowers could end up with much larger monthly payments and have a difficult time holding on to their house, depending on where interest rates stand. ARM rates are typically pegged to the London interbank offered rate, and can rise or decline. Most ARM rates can rise by a maximum of five or six percentage points over the life of the loan.
ARMs with a 30-year repayment period and a fixed rate for the first 10 years offer a more conservative option: Their average rate of 3.79% for the week ended Sept. 5 is 0.39 point cheaper than that of 30-year fixed-rate mortgages, according to HSH.com.
Many borrowers won’t need the loans for more than this fixed period. The typical seller in 2013 owned his home for nine years, according to the National Association of Realtors.
Consider a 30-year ARM of $400,000 with a fixed rate of 3.79% for the first 10 years. A borrower will pay about $136,267 in interest charges over the first 10 years—some $14,941 less than what a borrower with a 30-year fixed-rate mortgage would pay in interest over the first 10 years assuming a 4.18% interest rate.
Bob Griendling and his wife took out an ARM with a 3.5% fixed rate for 10 years in April when they purchased a home in St. Petersburg, Fla. “[It] was a damn good deal for 10 years, knowing we had the wherewithal to pay it off if we had to,” says the 66-year-old retiree.
Borrowers who are considering an ARM should look for one with a fixed rate at least as long as the period they are planning to keep the home. They should also put aside some of the savings they realize from the lower initial monthly payments. That extra cash could come in handy in case they need to stay in the property longer and their monthly payment rises.