How would you like a mortgage loan
where you did not have to make the whole payment if you did not want
to? Or would you like a loan with an interest rate about one percent
below a thirty-year fixed rate mortgage and pay zero points? Or a
loan where you did not have to document your income, savings history,
or source of down payment? How would you like a mortgage payment of
only 1.95 (January, 2004) percent? You can have all that with the
11th District Cost of Funds (COFI) Adjustable Rate Mortgage.
Sound too good to be true? Sound like a bunch
of hype?
Each statement above is true. However, it is also
only part of the story and loan officers do not always tell you
the whole story when promoting this loan. Then other loan officer
try to scare you away from the adjustable rate mortgages. However,
once you become aware of all the details of the loan, it is an excellent
way to buy the house of your dreams, especially when fixed rates
begin to go up.
ARMs in General
Adjustable rate mortgages all have certain similar
features. They have an adjustment period, an index, a margin, and
a rate cap. The adjustment period is simply how often the rate changes.
Some change monthly, some change every six months, and some only
adjust once a year. Indexes are simply an easily monitored interest
rate that moves up and down over time. Adjustable rate mortgages
have different indexes. The margin is the difference between your
interest rate and the index. The margin does not change during the
term of the loan.
So if you have an adjustable rate mortgage and
you wanted to calculate your interest rate on your own, all you
have to do is look up the index in the paper or on the internet,
add the margin, and you have your rate.
Indexes and the 11th District
The "Prime Rate" you hear about in the
news is one interest rate index, although it is very rare that mortgages
are tied to this index. It is more common to find adjustable rate
mortgages tied to different treasury bill indexes, the average interest
rate paid on certificates of deposit, the London Inter-Bank Offered
Rate (LIBOR), and the 11th District Cost of Funds(COFI).
COFI ARM Index
The 11th District Cost of Funds (COFI) is the weighted
average of interest rates paid out on savings deposits by banking
institutions in the 11th district of the Federal Home Loan Bank
(FHLB), which is located in San Francisco. The 11th District includes
the states of California, Nevada, and Arizona.
The COFI index moves slower than the other indexes,
making it more stable. It also lags behind actual changes in the
interest rate market. For example, when rates begin to go up, the
COFI index may continue to decline for a couple of months before
it also begins to rise. However, when interest rates start to decline,
the COFI index may continue to go up for another couple of months,
too. It lags behind the market.
Monthly Adjustments Sound Scary?
Although you can get a COFI ARM with an adjustable
period of six months, you can get a lower margin if you go for the
monthly adjustment period. Since the margin plus the index equals
your interest rate, the lower margin is an advantage and most people
choose the monthly adjustment.
Monthly adjustments sound scary to the uninitiated,
but keep in mind that this is a slow moving index. Most other ARMS
have an annual cap of two percent a year. Since 1981, when the FHLB
began tracking the index, the most it has moved during any calendar
year is 1.6%. So why get a higher margin just to get a rate cap
that you probably will not use anyway?
The "life-of-loan" cap for the COFI ARM
is usually 11.95%. The most recent year that this cap could have
been reached was 1985. Plus, most experts do not expect a return
to the interest rates of the early 1980's when interest rates were
pushed up artificially to combat the inflation of the 1970's.
Make Only Part of Your Payment?
This is the really interesting feature of the loan.
You do not have to make the whole payment. Each month you get a
bill that has at least three payment options. One choice is the
full payment at the current interest rate. A second choice allows
you to pay only the interest that is due on the loan that particular
month, but does not pay anything towards the principal. Finally,
the third option gives you the choice to pay even less than that
and is called the "minimum payment."
The minimum payment when you start your loan can
be calculated as low as 1.95 percent. Keep in mind that this is
not the note rate on your loan, but just a way to calculate your
minimum payment.
Deferred Interest and Amortization
Of course, if you only make the minimum payment
each month, you are not paying all of the interest that is currently
due that month. You are deferring some of the interest that is currently
due on the loan and you will pay it later. The lender keeps track
of this deferred interest by adding it to the loan and the loan
balance gets larger. Neither you nor the lender wants this to continue
forever, so your minimum payment increases a bit each year.
The payment cap on the loan is 7.5%, which also
has nothing to do with the interest rate. All it means is the most
your minimum payment can increase from one year to the next is seven
and a half percent. For example, if your minimum payment is $1000
this year, next year the most it could be is $1075. This continues
each year until your payment is approximately equal to the payment
at the full note rate.
Just in case, there are fail-safes built into the
loan. If you continue making the only the minimum payment and your
current balance ever reaches 110 percent of the beginning balance,
the loan is re amortized to make sure you pay it off in thirty years
(or forty years, whichever option you chose). Every five years the
loan is re-amortized to make sure it pays off within the term of
the loan.
Stated Income and Other Features
Many COFI ARM lenders allow home buyers with good
credit to apply without documenting their income, assets, or source
of down payment. Of course, you have to make a twenty or twenty-five
percent down payment on your home purchase. This is helpful for
self-employed borrowers or those who have jobs where it is difficult
to document their income. Plus, some people just do not like the
bother of supplying W2 forms, tax returns and pay-stubs. Anyway,
it makes for a quick and easy loan approval.
Sub-Prime COFI ARMs
Some people have less than perfect credit and they
are used to being charged outrageous rates for past problems. Some
COFI lenders offer this same loan but have a slightly higher starting
payment and a higher margin. The end result is that your interest
rate would be about one percent higher.
Who Should Get This Loan?
Most people who get the COFI ARM are purchasing
a home between $300,000 and $650,000, but it is not limited to that.
It is a real favorite of those working in the financial industry
and those with higher incomes. One reason they like it is because
they consider any deferred interest to be an extended loan at a
very attractive rate. By making the minimum payment, they do other
things with the money.
Home buyers whose income has peaks and valleys,
such as self employed or commissioned salespeople also like the
loan, because it provides flexibility in the monthly payment. During
a slow month they can make the minimum payment if they choose.
Another reason borrowers like the loan is because
it allows for tax planning. The borrower can defer interest payments
and at the end of the year, analyze their tax situation. If it serves
their tax interests, they can make a lump sum payment toward any
interest that has been deferred and deduct it for tax purposes.
Starter Homes
If you're buying a home with the intention of living
in it for only a few years before you move up to a bigger home,
the COFI ARM makes sense, too. With this loan and its low start
payment you can often qualify for a larger home than you can when
applying for a fixed rate loan. This allows you to skip the intermediate
purchase and move up immediately to the home you really want, which
makes more sense and saves you money.
If you buy a home, then sell it to move up to a
bigger home, you are going to have to pay Realtor's commissions
and closing costs. On a $300,000 house, this would be around $25,000.
If you skip buying that home and buy the home you really want, you
save that money. Plus, you save money in another way. Say you live
in your intermediate purchase for five years, then move up and buy
another home with another thirty year mortgage. That is thirty-five
years of home loans. If you buy your ideal home now, you save five
years of mortgage payments. Depending on your loan amount, that
can be a lot of cash.
Conclusion
The COFI ARM is all about options.
