Dean's Blog

Homes are now undervalued compared with the size of the U.S. economy. The chart tracks the S&P/Case-Shiller National Home-Price Index and the value of gross domestic product before adjusting for inflation. By this measure, homes are the most undervalued in at least two decades, according to the BusinessWeek article that first published this story.

When you combine that with mortgage rates which have dropped again to the lowest point in the last 40 years, and we have almost a perfect storm for buying opportunities.

No matter where you live in the Pacific Northwest, whether it be Burlington, Mount Vernon, Anacortes, rural Skagit County or anywhere in Washington State, contact your professional mortgage advisor for a detailed analysis to help you make an informed decision.

The Adjustable Rate Mortgage (ARM) is a greatly misunderstood mortgage tool. There are certain circumstances when selecting an ARM makes sense, but it must be done with caution and a plan.

Many stories have been published recently about how ARMs have been one of the causes of the real estate bubble. That would be like saying aspirin should be banned because a few people’s headaches didn’t go away. An ARM is a tool – and not every tool is right for every situation. Many people selected an ARM just for its lower start rate without thinking how they might address the future.

Why might a person select an ARM?

Of course, adjustable rate mortgages are not for everybody. Here are some situations where a 5-year ARM might be a perfect fit:

• You’re buying and planning on selling your home in 5 years
• You already own your home and plan on selling in 5 years
• You expect to pay off your mortgage in the next 5 years (inheritance, selling other property, etc.)
• You already have an ARM and you need to start over with your base rate

Much like a doctor who performs a complete exam before prescribing a remedy, you must consult with your professional mortgage advisor to determine if an ARM is the right financial tool for you.

The 5-year ARM is a relative bargain right now

Yes, 30 year fixed rates are again near 40-year lows. Even compared to these low rates, the 5-year ARM is a huge bargain. Every week, Freddie Mac publishes data compiled from 125 banks across the country on interest rates. This chart’s comparison looks at the 30-year fixed rate and the 5-year adjustable.

• A year ago, the rates on both programs were basically the same
• Last month, there was almost a full 1% spread between the two programs

The difference, or spread, between these two programs can be a huge savings to a borrower when used correctly.

How does an ARM work?

Let’s take a look at one specific ARM – the 5/1 ARM:

The biggest advantage of an ARM is it has a fixed rate, but for a shorter period of time than a 30 year fixed program. Our example 5/1 ARM has a rate that will not change for the first 5 years. The rate is then recalculated and “adjusts” once every 12 months after that.

The new rate is based on the sum of the loans index plus the margin. The index varies from month-to-month and is identified in your note. For instance, one popular index is the 1-year LIBOR, which is currently at 1.130%. The  margin is a fixed number and also identified in your note – it might be 2.25%. So, if you had these terms in your note and your ARM was adjusting today, your new rate (the sum of these two numbers) might be 3.380%.

I say might be because there are limits, or “caps”, on how much your rate can go up and down on each adjustment. This is meant to protect you from the rate going higher and higher with no limits. The 5/1 ARM usually has  5/2/5 caps. That means the rate can only go up or down a maximum of 5% in the first adjustment (month 61), after which it can only go up or down a maximum of 2% in each subsequent adjustment, and the rate can never be more than 5% higher than the start rate.

You’ll notice another phenomenon. Notice that I said the rates can also adjust down. In the early 1980s when fixed rates were around 18% (yes, they were that high!), the ARM was a very popular choice because it adjusted downward as rates fell.

Again, consult your local professional mortgage advisor for assistance on selecting a program that is right for your particular situation.

Did you know that the home buyer’s tax credit is still available to certain people?

While the $8,000 tax credit for first-time home buyers and the $6,500 tax credit for repeat home buyers have expired for most buyers, certain members of the military, foreign service and intelligence community may still be eligible.

Extension of Tax Credit Deadlines

Qualified service members who are ordered on a period of official extended duty will have until April 30, 2011 to come under contract for a home purchase and until June 30, 2011 to close on that purchase. A person who is forced to return to the U.S. for medical reasons before completing an assignment of at least 90 days of qualified official extended duty outside of the United States may also qualify for the one-year extension.

Exemption from Tax Credit Recapture Rules

The rules of the tax credit state that homes that are sold or that cease to be used as a principal residence within three years of the initial purchase are subject ot recapture of the tax credit. However, qualified service members who sell or move from a tax credit home within three years of the initial purchase due to official extended duty are exempt from the recapture rule.

What does this mean for our area? Washington State is rich with military installations, including NAS Whidbey Island, Bangor Naval Base and Joint Base Lewis-McChord (formerly Fort Lewis Army Base and McChord Air Force Base). In my backyard, Oak Harbor hosts families who have been relocated to the Whidbey Island naval base from other parts of the country, and many choose to stay and make the Pacific Northwest their permanent home.

If you have family or friends who may qualify for these credits, make sure you let them know that their deadline has been extended. Our firm has been helping clients with Veteran’s Administration (VA) loans for over 25 years - contact me with your questions.

Here’s an important piece of advice for you while you are in the process of getting your new home loan: DO NOT apply for any other loans.

Beginning June 1, 2010, Fannie Mae will start requiring lenders to pull a second credit report just before the loan closes. The new quality control requirement is designed to prevent a type of fraud called "shot gunning," but the guidelines could send lenders on wild goose chases.

By pulling a second credit report, lenders can find out whether other creditors have recently requested information about the applicant – a red flag indicating someone might be trying to obtain several loans (from multiple, unwitting lenders) on the same property. Typically, a shotgun fraudster skips town with the proceeds of all his loans. Most of the lenders do not recoup a cent because their loans are subordinate to the first one recorded and the home will not fetch enough in a sale to cover the junior liens.

Pulling a second credit report would help stop such frauds, but lenders might also waste time checking out false alarms. If the lender is ready to fund and they see a new inquiry popping up, will they send their underwriter out to track down Honda Motor if the borrower is also trying to buy a new car?

The best answer has always been to speak with your professional mortgage advisor before making any credit changes, especially if you are in the process of obtaining a home loan.