'Alternative mortgages' gain a
There's a lot more out there than
plain-vanilla 30-year fixed-rate mortgages.
There are mortgages for people who have little or
no down payment money. There are loans for people, such as doctors
just out of medical school, who expect their incomes to skyrocket.
Loans for people who plan to move within a few years. Loans for
observant Muslims, who are prohibited by Islamic law from paying
"A lot of people are just thinking 30-year
fixed," says Bob Walters, senior vice president of Quicken
Loans, "and if someone tries to sell them something else,
they think, 'Hey, are you trying to scam me or something?'"
The answer is no. A good mortgage broker or loan
officer will ask questions to find out what kind of loan best suits
you. It might not be a 30-year fixed-rate loan. Walters says, with
perhaps a bit of hyperbole, that 30-year fixed-rate home loans "are
not the right mortgage for 90 percent of borrowers."
The case for hybrids
Walters feels passionately that most borrowers would be better
off getting hybrid ARMs -- adjustable-rate mortgages that have an
initial interest rate that lasts three to 10 years, then adjusts
The most common hybrid arms are known as 3/1, 5/1,
7/1 and 10/1. A 3/1 ARM starts out with a low rate that lasts three
years, then is adjusted annually. A 5/1 ARM has an introductory
rate that lasts five years, and 7/1 and 10/1 ARMs have intro rates
that last seven and 10 years.
Right now, people with good credit can get 3/1 ARMs
at less than 5 percent. Rates are so low today that it's almost
certain that a 3/1 ARM's rate will rise after three years. Most
ARMs can't rise more than 2 percentage points annually. So if you
get a 3/1 ARM today at an introductory rate of 4.5 percent and stay
in the house four years, you will pay 4.5 percent for three years,
and 6.5 percent the fourth year.
Compare that to paying 5.5 percent for four years
on a 30-year, fixed-rate loan of $150,000. Over four years, you
save $3,100 interest by going with the 3/1 ARM, while building about
$400 more equity.
Walters feels impatient with borrowers who ignore
the advantages of hybrid ARMs. "People say, 'I'm going to be
absolutely sure to pay a higher rate now, on the chance that they
might rise in three or four years,'" he says. "It's a
ARMs for the footloose
He could bolster his case by pointing out that few people live
in their homes long enough to pay off a 30-year mortgage. Half of
homeowners live in their houses for less than nine years. People
who plan to relocate or move up to a bigger house in a few years
should seriously consider hybrid ARMs.
There's always those buyers who are well-suited to
30-year fixed-rate loans: People who have little or no down payment
money. Some 30-year loans allow them to get around the no-down payment
Many lenders offer mortgages for 97 or 100 percent
of the home's price. You might see these marketed as Alt 97 or Flex
97 or Flex 100 loans, after the Fannie Mae and Freddie Mac programs
underlying them. You are expected to come up with cash of 3 percent
of the home's value, either as a down payment or to pay closing
You also are expected to come up with a down payment
of at least 3 percent on loans insured by the Federal Housing Administration.
These FHA-insured loans are permissive about the source of the 3
percent, which can come as gifts or as charitable donations. An
industry of nonprofit
down payment assistance programs has sprung up because of this
Here's how these programs work: The seller gives a
3 percent donation, plus a handling fee, to the down payment assistance
program, which then gives a 3 percent grant to the home buyer to
use as the down payment.
Which is better? Run the
Which is better: getting a 100 percent loan or getting an FHA
loan using a down payment assistance program?
"A really good case can be made that FHA with
down payment assistance can be a better alternative," says
Richard Ferguson, president of Neighborhood
Gold. The Provo, Utah,-based nonprofit has given grants to 30,000
To know for sure, you have to run the numbers. Ferguson
says that FHA mortgage insurance generally costs less than mortgage
insurance on conventional loans, and that rates on FHA-insured loans
often are lower than rates on conventional loans for 97 percent
of 100 percent of the home's value.
Rate and the cost of mortgage insurance aren't the
only factors. When a buyer uses a down payment program, the seller
is less likely to bargain on the home's price. That's another way
of saying that buyers pay more for houses when they use down payment
Many buyers do the math and conclude that down payment
assistance is a better deal. About one-third of FHA-insured loans
go to buyers who use down payment assistance programs, Ferguson
There are other creative ways to finance homes.
Interest-only mortgages, in which the borrower is
required to pay only interest for the first few years, are popular
with people with unpredictable incomes (for example, self-employed
people whose incomes are up one month and down the next). Interest-only
borrowers have the flexibility of paying only the interest when
money is tight, and interest plus principal when the money is rolling
Interest-only mortgages also are popular with people,
such as new doctors and lawyers, who know that their incomes will
rise much higher in a few years. Interest-only loans allow them
to buy houses that they otherwise can't afford, but will be able
to afford in a few years.
Then there is financing for observant Muslims, who
are prohibited from paying interest. American
Finance House - LARIBA puts together lease-purchase deals that
fall within guidelines approved by Islamic scholars.