Still
Time to Refinance? (continued)
Fully
adjustable versus the Hybrid?
LIBOR-based
loans are not the only adjustable loans in town. So called
“hybrid adjustable mortgages” have also become
increasingly popular. The majority of these loans are set
at a spread (margin) to the one-year Treasury rate. The
loan rate is fixed for a defined period of time, then adjusts
according to the where the one-year treasury is when the
fixed period is up. The most popular and competitively priced
version is the 5-year fixed.
When
we wrote about this in April 2003, the spread between 1-month
LIBOR loans and 5-year fixed loans was 1.9%, with the LIBOR
having the lower rate. As we go to press today, this spread
has almost evaporated, narrowing to 0.5% for refinances
(and a mere 0.3% for new purchases). In part, this is due
to the flattening of the yield curve, as discussed in Jason
Thomas’s article. Further, our recent survey of expectations
for the 1-month LIBOR came up with an average of 4.3 - 4.4%
over the next 3-5 years, resulting in a rate of 5.15 to
5.25%, with the margin. This means that the 5-year fixed
rate is currently less than where we think the 1-month LIBOR
loans will be within a year, creating an enticing refinancing
opportunity.
If
we’re right about the extent of increase in the 1-month
LIBOR rate, then refinancing to a 5-year fixed mortgage
could be an even better move. Our analyses indicate that
refinancing a $1.1 million, 1-month LIBOR mortgage (even
given a margin over LIBOR of only 0.85%) to a 5-year fixed
pays off in about 2 years (maybe 3 years if prepayment penalties
are involved). Once beyond the 2-3 year mark, the savings
compound as you benefit from the fixed nature of the rate
over the remainder of the five year period.
Still, probably not a permanent solution
Part
of the price of these interest-only advantages is the need
to re-evaluate the mortgage choice from time to time. Is
this short-term uncertainty and periodic restructuring (whether
3 years, 5 years, or 10) worth it? We think it is! The alternative
is a long term fixed and amortizing mortgage. Over time,
the advantage of an interest-only mortgage for $1.1 million
could easily be $20,000 (per year!) in after-tax net worth
advantage.
Kacy
Gott and
Andy Hamilton
| Interest-only
mortgages have received plenty of negative press lately
by some in the media who claim that they create a “false
sense of affordability” for many people. In other
words, they have become the mortgage product of choice
for people who cannot afford an amortizing loan. The
media is correct in asserting that interest-only loans
can be dangerous, but the risk is not in the loan product
itself. The people who could be hurt by these mortgages
are the ones who could not otherwise afford the home
with an amortizing mortgage. Our clients do not fit
this profile, and they should take advantage of the
long-term financial benefits that interest-only mortgages
offer. |
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