How to Avoid Getting the Wrong Home Loan
(After All, It's Your Money)

13. What Is Subordination?

When you refinance your home mortgage, you may also have a 2nd mortgage or equity credit line (a line of credit you borrower against as needed) that you are paying on as well. What happens here? You generally have a couple of choices. It may be advantageous to let your new mortgage pay off both your old 1st and 2nd, oftentimes bringing your overall rate down considerably. On the other hand, sometimes you may decide that you want to keep your 2nd. If this is the case, the 2nd needs to be subordinated to the new 1st. Simply put, the old 2nd is placed once again in the 2nd position behind your new first. This requires that the lender of the 2nd subordinate to the new 1st. Most of the time this works—sometimes it doesn't.

If you are borrowing more money on your 1st, the holders of the 2nd may decide their security is now diminished and they may elect not to subordinate. If this is the case, your only option will be to pay them off (by increasing the size of your first) or forget about doing the loan altogether. Sometimes the borrower of an equity credit line (also considered to be a 2nd) will decide they want to keep their credit line. This will now call for subordination.

The risk is, sometimes the lender of the 2nd will not subordinate fast enough, thus risking that a loan lock on a new 1st will be lost (locks are time sensitive, usually lasting 15-50 days). This often happens in a very busy market, with many borrowers trying to refinance at the same time. Luckily, equity credit lines are easy to get. It may be easier to just consolidate the 1st/2nd together and pick up a new credit line after the loan closes.

14. What About More Exotic-Type Loans?

What type of loan is best for you? Do I get a 30-year or 15-year fixed, or do I go for something more exotic? Below are a few explanations of some of the more popular loans.

  • Fixed Rate Loan - Fixed rate with loan terms ranging from 10-30 years. At the end of the term, the loan is paid off.
  • Balloon Loan - Usually a fixed rate loan amortized over 30 years, but at lower than market rate for the 30-year fixed. What's the catch? This type of loan becomes due and payable before it is fully paid off. So, a loan such as a 30-year due in 15 years would have the 30-year payment, but the balance would be due in 15 years. A $200,000 loan at 6% would have a balance of about $142,000 after 15 years. In this example, this balance would become due and payable at this time. The borrower could either pay off the balance or refinance again with perhaps the same lender or another of his choosing, provided he/she still qualifies for a loan.
  • 3/1, 5/1, 7/1, & 10/1 ARM - ARM stands for adjustable rate mortgage. The way these loans work is that they give you a fixed rate for 3, 5, 7 or 10 years, always below the 30-year fixed rate (the 3-year term being the best start rate, with the 5, 7, and 10 following). After the start rate term has completed, the loan adjusts to a variable rate loan based on any number of indexes, oftentimes the LIBOR. The rate then changes once a year based on the index that the loan tracks plus a margin. As an example, many of these types of loans-at the time of this writing-will follow the LIBOR index + a margin of 2.75%. The LIBOR currently is about 1.20%. Hence if you had a 3/1 ARM which is 36 months old today, your new interest rate for the following year will be 3.95%. Not bad-but remember-rates go up as well as down. With the variable rate option, the LIBOR index will more or less follow other rates. Hence if the rates go up, so will your payment. This type of loan is usually recommended for those who are looking for some payment relief, or who don't plan on being in the home for very long, or who will refinance often. On the other hand, interest rates have been trending lower for so long that there are many who have had these loans on their homes for years. I once had one for 17 years.
  • 1% Variable Option Loan - These loans come in a variety of types. A popular example we work with commonly allows the borrower to pick one of 3 payment options each month. They can pick a minimum payment, an interest only payment, or a fully amortized payment. These loans involve just a little bit more understanding, but oftentimes allow tremendous payment reductions for a period of time. In fact, the borrowers can often take money out of their home and still end up with a lower payment than the one they had.

Example:

Bob and Mary currently have a home worth $550,000 with a mortgage of $200,000 at 7%. Their house monthly payment is $1,330.61. Bob and Mary want to refinance their home and take out $50,000 to consolidate some debt. They hope to keep their payment the same or less, at least for a period of time:

Three Payment Option - (12MAT Index 2.504%, Margin 2.50%, at the time of this writing) These loans are great for so many different types of financial situations, even people on fixed or lower incomes who have equity in their home, but need to get their payments lowered (and, possibly, some cash out).

minpayment.gif

*Fixed payment for 12 months, then increases 7.5% each year for 5 years. After 5 years, the option goes away.
**Option goes away after 5 years.

What does all this mean? For simplicity's sake, let's assume that the above payments are to be paid on a monthly basis. If you elect the minimum payment, the difference between the "Minimum Monthly Payment" and the "Interest Only Payment" would be added to your loan balance each month. If you elect to make the "Interest Only Payment" your loan balance does not go up or down. Finally, if you elect to make the full "Principle and Interest Payment" you will pay interest and some principle each month.

You say you would love that $804.09 house payment, but are concerned about adding principle to your loan each month? Consider doing the same loan on a bi-weekly payment basis. Instead of a minimum payment of $804.09, you would make a payment every other week of $402.05. Since there are 26 bi-weekly payments a year, this will force you to make another full minimum payment. If rates continue to remain relatively low, these extra two payments will go a long way in helping to insure that less principal gets added to your loan.

Even if you elect to only make the monthly minimum payment you should consider the following as a potential offset to increasing loan balances. Housing prices have been going up at historic rates. In fact if you own a California residence, prices have been steadily climbing for years. Although history is no guarantee of what the future may hold, in many instances housing appreciation has historically outpaced any add on to principle that would have been caused by this type of loan!

15. What Are Locking Rates?

Rates are always changing, and, there are different rates for many different types of loans. Some rates change daily, some change less frequently. Generally speaking, the most competitive rates are reserved for persons with the best credit, and these rates change daily, sometimes 2-3 times in a single day. It is this type of loan that should be locked at the beginning of the loan process. It is the lender's means of providing you a comfort level that the rate you anticipated at the beginning of the loan process will be provided to you at the close of the loan. Rate locks are time sensitive, (usually 15-50 days).

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