Many potential home buyers are priced out of the housing market, either because they lack the required down payment or because they cannot afford the monthly payments. When a home buyer goes to a lender to get qualified for a new home loan one of the critical factors the lender looks at is today’s income. The amount of the monthly payments a family can afford depends on the income, or dual income, earned per month. Usually borrowers will occupy the home well into the future, when their income is likely to be much higher, but it is just today’s income that is considered.
Lenders set their mortgage interest rates based on their cost of the funds plus a margin for their profit. This margin reflects the lender’s estimate of the future rate of inflation. Traditionally lenders have offered fixed rate mortgages to borrowers that provide for a monthly payment that is constant for the life of the loan (typically thirty years).
In the 1970’s more and more families were being priced out of the market so lenders sought a way to make it easier for more families to qualify for loans. Lenders were not being humanitarians; they stay in business by making loans. When the price of a product or service is too expensive for potential customers to buy, you either have to make the product more affordable or suffer financially; perhaps even go out of business. In the late 1970’s lenders came up with the idea of the variable interest rate loan and the adjustable interest rate loan.
These loans are basically the same in theory, but have minor variations. The initial interest rate is ordinarily below the going rate of a traditional fixed rate mortgage. The biggest benefit to the adjustable rate mortgage is that because the initial rate is lower, the monthly payments are lower. When a lender is qualifying a buyer for a loan the ratio of the monthly income to the monthly payment is improved. This was good for the banks because they could make more loans. It was also good for buyers because they were able to purchase a home that they may not have been able to afford with a fixed rate loan.
Due to the financial and mortgage melt down in 2008, many new regulations have made borrowing much more difficult. Today lenders are much more stringent in the qualifying process.
With either a fixed rate or adjustable loan the best rates available will require a minimum of 20% down payment.
If a buyer fully intends to stay in their home for a long time the best choice is always to get a fixed rate loan and enjoy the comfort of knowing that your payment will remain constant. On the other hand, if it is known that the home will be an interim residence the low payment advantage of an adjustable rate loan should be considered.
Usually acquiring the home now is the single most important issue. If a buyer doesn’t like the loan, or would prefer another loan, they can refinance later when their income is higher and, in all probability, the home will be worth more. The loan that allows a buyer to obtain their dreamhome now should be considered the best loan.
This article was published in the San Francisco Examiner.
Articles are written by Eric Ruxton and Larry Aikins, owners of Terrace Realty, Inc. and Terrace Associates, Inc. in Redwood City. Terrace has been in business more than 55 years and in addition to being an independent Brokerage Company, also owns and operates rental properties.