Conventional wisdom does not result in a conventional mortgage
Posted Oct 23 2008 6:20pm
Conventional wisdom is to buy a house because over time inflation will make this a wise decision. That hedge on inflation has worked well in the past. So, with mortgage rates at near historic lows, why aren't home buyers locking in their interest rates with conventional mortgages?
Most people believe they will sell their home after five to seven years and are looking for the lowest monthly payment plan over this period. That is why, nationally, interest-only and adjustable products made up 63% of mortgages written in the second half of 2004, according to the Mortgage Bankers Association. Interest-only loans (where you don't pay anything against the loan principal for 2-10 years), nationally, are running at 23% through May 2005.
But today's low interest-only payments for those who stay in their house long enough can face a jump of $500 to $1,000 or more in monthly payments. Here is how it works, compared to a conventional mortgage, for a loan of $400,000 on a five-year adjustable, interest-only loan at an average rate of 5.46% with a current monthly payment of $1,820. After five years with the interest rate staying the same, the monthly payment rises to $2,425 or $2,945 if the interest rate rises to 7.46%. Whereas, locking in the 5.84% interest rate in a 30-year conventional mortgage, the monthly payment stays the same at $2,357 and after five years the loan principal would be reduced $28,526.
With some banks and mortgage lenders becoming increasingly aggressive in their practices, can the bubble bursting be near? Discouraging hyper-aggressive lenders from extending mortgages to high-risk borrowers is having limited success.
For the economy, a slowdown in home demand and prices could reduce consumer spending. In the last three years , from 2002 to 2004, homeowners who refinanced their mortgages took out $400 billion in extra cash which was pumped back into the economy. That source is going to dry up.