I started my working career at an early age and carried with me the belief “work hard and your employer will be loyal.” I still have this same belief today, because it is true as long as you understand your employer’s wants, needs, and limitations. Also, the definition of loyalty can mean different things for different people and employers. I will give you my definition of employer loyalty later. First a little background because some of you are probably ready to have a Mike Tyson bar fight over the term employer loyalty.
First, let me state I’m a big fan of the “no mortgage strategy” meaning a home that is completely paid for with cash and has no mortgage lien against it. Debt can be dangerous, but most of our fellow citizens will need a mortgage to purchase their first home.
Actually, this wasn’t always the case, but leave it consumers to want a bigger, newer houses. In many large cities houses today are like most other disposable consumer products. Houses are bought not on necessarily for needs but on consumer wants and desires. We desire more bedrooms, more bathrooms, and “yes” we all need a game room. We need granite counter tops and wood floors…oh and 3 car garages.
My first house at the age of 27 was a 4 bedroom 2 1/2 bath, it had wood floors, formal dining room, formal living room, open kitchen with slate floors, large island in the center, family room with special art nooks everywhere, gas fireplace(Houston TX really),spacious patio with a three level water fountain. I could list another 20 things this house had that I really didn’t need. I did added granite counter tops after buying it. Looking back why did I buy this huge house? Previously, I owned a two bedroom one bath condo closer to work which had everything I really needed. Stop! Stop! Let’s get back to mortgage financing.
For the average American borrower a 30 year or 15 year fixed rate mortgage(Dave Ramsey preferred) is probably the right choice. It the choice I made when buying the condo and then the much, much larger house. Only, later in life I learned about interest-only and adjustable rate loans. Now, on the last two homes I purchased “really last two homes” I used a interest-only loan product. Whoa that is risky some will say. When I tell you it is an interest-only that is almost completely unhedged you should just have a stroke. Whoa the heart muscles are tightening. Just remember Interest-only loans do offer a lot of flexibility.
Whoa..Whoa average Joes and Josephines don’t need flexibility. I agree, but if you read financial blogs and are looking to increase your knowledge you might not be average.
Ok, let’s dig in here. Banks and financial institutions lend money to borrowers. Borrowers pay interest. Pretty basic right? Banks and financial institutions set the interest rate based on risk which can come in several forms. There is borrower risk, collateral risk, time horizon risk, and many more. If we just look at mortgages the time horizon is one of the largest determinants of rate or risk. Meaning a 30 year fixed rate mortgage should have a higher rate than a 15 year fixed rate due to the long time horizon. Banks and other lenders charge a higher rate to hedge interest rates over this longer period of time. So part of the rate is a cost for hedging. Well in the “nonconforming” world of mortgages, some lenders offer 3 year adjustable rate mortgages(ARMs), 5 year adjustable rate mortgages(ARMs), 7 year ARMs, and 10 year ARMs. Most of the ARM loans coming in either fully amortizing versions or interest-only versions.
So what is you what lowest initial rate? Then you probably need to go completely unhedged. Damnnnnn that sounds scary. To others that sounds “awesome!” I started in the scary camp and oved overtime into that sounds “awesome” camp.
Merrill Lynch and Morgan Stanley offer an “unhedged mortgage” where the rate can adjust monthly and does. I used the Merrill Lynch product which they call the PrimeFirst. The PrimeFirst is a 25 year adjustable rate mortgage with an initial interest-only period for 10 years followed by a fully amortized payments for the remaining 15 years. The rate is based on LIBOR. There are no prepayment penalties. That is it!
What if rates increase? The PrimeFirst has a lifetime rate cap based on the initial rate plus 5% or 12%(whichever is greater.) Basically, in my case 12% would be the highest it could ever go.
Let’s look at the starting real rate. Today the base rate is 2.125%. The comes from the 1-month LIBOR (.491 on 7/25/16) plus a spread of approximately 1.633%. Remember completely unhedged and can change monthly.
However, there is a way to hedge the PrimeFirst. Merrill Lynch allowed me to buy the rate down. For 2 points upfront I bought the spread all the way down to .750%. So currently, my rate is 1.25%. LIBOR .491 plus .750 = 1.241. Merrill Lynch rounds this to 1.25%.
My history with this product started in 2013. I borrowed $105K to buy a beach bungalow to spend time with boys before they grow up. The bungalow was valued at $149K. When I first got the mortgage the rate was .875% all in for almost two years. Currently, the required monthly payments is $88.47 each month for interest. That is less than my cellphone bill. Less than my electric bill, and less than my monthly car insurance bill. One day I do hope to be car free as I move up the scale of “Badassity.”
So this product offers a low cost to borrow money. It offers improved cash-flow if needed and more flexibility to deploy cash to fund other goals. That why I feel comfortable using this product. To help SWAN, I have liquid assets that could be used to pay off the mortgage should rates rise crazy style. In the meantime I pay more then just the $88.47 each month. My goal is to have it paid off before the 10 year interest-only period ends. I am tracking for an even earlier payoff currently.
So yes there are mortgages currently at 1.25% and it is possible. Keep sharing knowledge.
Note: Merrill Lynch has the qualification/underwriting hurdle for this mortgage higher than standard mortgages.