It's the height of the annual homebuying season, and anyone with an interest in the real estate market should be excused for having no idea what's going on.
Economists and analysts are waiting impatiently for signs that price gains are slowing. Everyone knows interest rates are inevitably going up — except that they've recently trended lower than a year ago.
For all the confusion, some things remain eternal, including the lure of homeownership and the question of how to pay for it. To help navigate a market that continues to confound eight years after the housing bubble burst, IBD turned to some of the smartest people in the mortgage world to ask what kind of financing they chose for their homes.
Reducing Near-Term Cash Flow
Zillow Chief Economist Stan Humphries has a 7/1 adjustable-rate mortgage — a 30-year loan with a 2.6% interest rate that's locked in for seven years and can increase only a certain amount each year thereafter, to a total cap of 6 percentage points over the initial rate. The ARM option was much cheaper than a fixed rate in December 2012, when Humphries took out the loan, he said, and even its highest possible rate, 8.6%, is "not that bad in historical terms.
For Humphries, the goal was to minimize monthly costs.
"It wasn't worth me getting a better case in seven years and having to pay more every month for seven years," he said. As a real estate professional, he's also aware that most people live in their homes for far shorter periods than they expect. Seven years is the median.
"Americans spend an enormous time shopping for their home and as little time as possible shopping for their mortgage," Humphries said. "My sense is that people find it distasteful. It's complex and it's a little bit like car shopping where you have to ask for multiple quotes from people who tend to be aggressive.
An online calculator linked to lenders can take some of the used-car salesman out of the process.
One such calculator is on Zillow Mortgage Marketplace. On Wednesday, the lowest 7/1 ARM for a loan to purchase a $223,300 home — the U.S. median as of June, according to the National Association of Realtors — with 20% down carried an interest rate of 3%, with a monthly principal and interest payment of $753. That compared with a 30-year fixed rate at 4.085% and a monthly payment of $853.
That's a savings of $8,400 over the initial seven-year period.
And the maximum payment after the loan starts to adjust
Based on the balance after seven years, a 9% maximum interest rate could ratchet up the payment to $1,289. While it's not clear how high interest rates will climb, higher rates are inevitable.
'I Don't Want More Debt'
Guy Cecala, publisher of Inside Mortgage Finance, takes a different tack. He has a 15-year fixed mortgage with a 3.25% rate and is more concerned about his overall level of debt. Like all the examples in this story, Cecala's mortgage is fully amortized.
"I always caution people: Don't be that focused on your monthly payment as much as the total amount you're borrowing and how much you're paying down," he told IBD.
One of the 15-year fixed's charms is that the principal "noticeably drops every year and you really get the sense that you're reducing your mortgage debt," Cecala said.
It would be one thing if people took out a 30-year, fixed-rate loan and paid down extra principal every month, leaving themselves the option of not paying extra in an emergency — or using that little monthly extra to build up a rainy-day fund. But few people are that disciplined, he says.
Cecala is encouraged at seeing more consumers interested in shorter-term fixed-rate mortgages, some as low as eight or 10 years for refinancings. "Some people say, 'I don't want to have any more debt,'" he said. "That was one of the lessons we learned from the crisis — any debt can be dangerous.
Using Zillow's Marketplace and assuming the same purchase price as in the above example, a borrower would pay $73,454 ($853 a month) over seven years for the 30-year fixed mortgage, of which only $24,903 is principal, leaving a mortgage balance of $153,737.
With a 15-year fixed, currently available at 3%, the borrower would pay $105,980 ($1,234 a month), of which $73,466 would be principal, leaving a balance of only $105,174.
Borrowers should recognize that lower mortgage interest payments also mean a lower tax deduction.
'We're Plain Vanilla'
From Daren Blomquist's perspective as vice president and spokesman for RealtyTrac, which provides data on foreclosures and other distressed sales, watching the real estate bubble form and burst made him "even more conservative than I already was.
For him, a traditional 30-year, fixed-rate mortgage is perfect because it forces a kind of long-term budget on his family's expenses.
"My approach is, it's something I make sure I can afford and there aren't going to be any surprises down the road," Blomquist said.
Whether or not he's still living in his Mission Viejo, Calif., home in 30 years, he figures he'll own the house for a long time.
"The philosophy I live by in real estate is what I heard from my wife's great-grandfather who lived to 103 and came to California and bought property in Long Beach long ago," Blomquist said. "His philosophy was if you take care of a piece of real estate for 20 years, it will take care of you for a lifetime.
Most adjustable-rate mortgages carry caps on how high the interest can spike, but borrowers considering ARMs should think hard about how high monthly payments could spike in a worst-case scenario.
Many mortgage professionals counsel clients on the fence about a 30-year fixed vs. a different product to opt for the conservative choice and pay down a little extra principal each month.
That lets borrowers budget more easily and offers flexibility to be more aggressive when it's possible.
The interest rate will just be a little higher than the borrower would get for a shorter-loan term.
A 30-year loan also is a good choice for homeowners who think they'll stay put, or at least own the home, for a long time. Blomquist's home could easily be converted to a rental should he and his family move, he says.
'I'm Prepared To Take Risk'
Elyse Cherry is CEO of Boston Community Capital, a nonprofit that's run programs for struggling homeowners since long before the subprime crisis. Boston Community developed an innovative program to keep families in homes they might otherwise lose by buying them in a short sale and reselling them to the owner at a reduced price and fixed-rate financing.
Cherry opted for something less conventional when it came to her personal finances. Her 30-year mortgage, a "5 and 5 with a 2 and 6 cap," resets the interest rate every five years. The rate increase is capped at 2 points in any reset. The interest rate starts at 2.75%. That rate, for a median-priced home with a 20% down payment, gets a monthly payment of $729 a month .
"I can look at this and say, I feel confident I will either not be in the home or be able to pay off the mortgage," Cherry said. "I'm prepared to take that risk.
Exotic mortgage products caused a lot of trouble for many homeowners, Cherry says, and most people don't have the ability, or the willingness, to assess the risks associated with them.
"When I look at the mortgage market, it's really a bell curve," she said. "For the lower-income end, I think it's important that people have customized products, like paying every two weeks. And on the larger mortgages, people also need customization. The standard products work best for the middle of the curve.
That may be a relief to the millions of Americans who opt for a 30-year, fixed-rate mortgage over every other option. The Mortgage Bankers Association tracks ARMs as a share of all mortgage originations back to 1990, and the highest that proportion ever reached was 37% in March 2005.