Variable-rate mortgage question

December 17, 2004 1:04 PM

I currently have a monthly mortgage payment of $850/month. About $150 of that is mortgage insurance + property taxes.

If I get one of those fancy split 80/20 mortgages, in which the variable-rate 20% portion is used to satisfy the downpayment requirement and remove the mortgage insurance, am I going to get hosed at some point? Finding decent advice about this has been difficult.
posted by mecran01 to work & money (13 comments total)

With the interest rate going up as fast as it is right now, yes, you'll get hosed.
posted by SpecialK at 1:09 PM on December 17, 2004

According to my calculations, it has to get up around 17% for me to approach the level of my current payment. How likely is that?
posted by mecran01 at 1:20 PM on December 17, 2004

Having just gone through getting a mortgage (I got an 80/15/5), I might be able to offer some advice. Whether or not you'll get screwed really depends on just how variable the 20% really is. Is it a 3 yr ARM, 5yr ARM, or is it one of those that can always adjust with prime rate? If it adjusts with prime, then how far above prime are you (mine is .75% above prime)? I worked out the calculations and figured interest would have to go way up before it'd match the mortgage insurance I would have paid otherwise. And, you can deduct that interest from your income taxes, which you can't do with mortgage insurance.
posted by split atom at 1:41 PM on December 17, 2004

You don't say home much is tax and how much is PMI. But, yeah, interest rates have to jump up a lot for this not to be a good deal for you. Assuming your mortgage is currently at 5.825%, your current monthly interest/principle payment of $700 would mean that you have a $118k mortgage. Assuming that you're paying $60/mo for PMI, the 80/20 is a better deal than the current mortgage + PMI until that ARM reaches around 9.5% (where did you get 17%? Are you counting the whole $150 as PMI? You'll still have to pay your property taxes). That's a lot.

I'm guessing at a bunch of numbers of course.

There are good reasons to expect interest rates to increase significantly in the near future, but 400 basis points seems like quite a jump.

(On preview - I hadn't even considered the tax deductions).

Email me if you want me to send you the excel sheet I used to figure this out. Or just look up the PMT function.
posted by bonecrusher at 1:46 PM on December 17, 2004

One other option depending on how long you have owned- -

With home price appreciation going up at the rate it has been, you may be able to find a lender with a decent rate who thinks your house is worth ~120% of what you paid for it. At that point you could refinance with them and the PMI would vanish completely. The upside of this is that you aren't taking out extra loans, so you just stop paying the money entirely. If you go to an 80/20 you're stuck paying that amount even if your house appreciates .

I managed to do this not too long after I bought (perhaps a year). There are rules about how quickly the same lender can cancel your PMI, but no hard and fast rules about doing it during a refi. It's very lender-specific, with the main driver being how long after a sale do they accept the sale price as gospel rather than doing their own appraisal.
posted by true at 2:09 PM on December 17, 2004

I have no idea how relevant this may become, but in my lifetime as a homeowner, I've known mortgage rates as high as 16%. And I'm not all that old. Admittedly, it took four successive Presidents' spectacularly boneheaded economic policies to accomplish this, but:

1) It can happen.

2) The clowns in office now are just the boys to do it again.
posted by mojohand at 2:14 PM on December 17, 2004

still, interest rates are hardly "rocketing skyward". We can MAYBE expect them to go up a percent and a half in the next 2 years.

just get a 30 year fixed on the 20% if you're so nervous about it. Am I missing something here? I really can't imagine a scenario where you're better off with a PMI.
posted by glenwood at 3:03 PM on December 17, 2004

When I got an 80/20 to cover my first home purchase, my finance guy said "call me in four years and we'll refi the balloon away." In my situation -- I was financed to the gills on a property with some long term equity potential but nothing that was going to double down in a matter of months -- an 80/20 arrangement was the best by far, and I don't forsee rates climbing to the point where it would stop being a good idea.

If they do start to trend that way, I doubt it will take a mere 5 or 7 years, and there ought to be some warning signs.
posted by majick at 4:51 PM on December 17, 2004

Without knowing your exact figures it is hard to say.

You may want to consider the fees associated with refinancing- Lenders policy, Title search, origination, underwriting, tax service, recording, etc. (These can add up quick.) If you paid your principal down by what it will cost to refinance, you may have the 20%.

Depending on how long you have had your current loan and what property values are doing in your area, it may be better to just get a new appraisal reflecting 20% equity. If the "comps" in your area have gone up since your last appraisal or if the appraiser can find some better comps then you may have the equity you need. One of the best ways to make your appraisal go up is by adding heated and cooled square footage to your house. You can close in a garage or porch or sun room for more living space and add the value you need.
posted by Mhead at 9:47 PM on December 17, 2004

Since the US is close to record-low interest rates it is very unlikely that rates will go anywhere but up. I don't understand why *anyone* would agree to a variable rate loan these days.
posted by b1tr0t at 1:07 AM on December 18, 2004

We just did something similar this week to get rid of PMI. We took out a HELOC for the difference between our current equity and 20% of the value of the property (which was down to $10,000 even though we've only been here a year-- thank you insne housing market). The HELOC's rate is about a point higher than our new mortgage and the rate is locked in for 5 years. From our perspective it was worth it because we cut our total monthly payment by about 20% and it's very likely we'll sell within 5 years, so the risk on the HELOC is minimal.

That said, we're going to put the 20% savings toward the HELOC (unless I rethink that, which I'm doing right now) to get rid of it. If you can find a 5/7/x year lock-in where x is greater than the # of years you're likely to keep the property, you will have minimized your risk.

I don't understand why *anyone* would agree to a variable rate loan these days.

That's because you're risk-averse (maybe you're not, but that statement sounds like it). Economically speaking, there are risk lovers, risk neutrals and the risk averse. I tend to think of myself as risk neutral because it's (to me) the rational approach, but it's hard to divine one's own profile. So the *anyone* you're wondering about winds up being someone who either didn't think things through or someone who looked at the probability of rate hikes and the probability of it affecting their case and decided the savings you can get right now offset that risk. Our willingness to take on this "risk" (as perceived by the loan company) resulted in a rate below what we could get in a fixed product. Understand that you pay a price for the assurance of that fixed rate.
posted by yerfatma at 7:41 AM on December 18, 2004

Here's one example of the prime climbing three points in two years. I found out it is possible to have the 20% portion of the loan capped as well, so it never exceeds x points in a given time frame, and can't exceed x percentage total.

disclaimer: I am risk averse. And historically, there is no way in helsinki that rates won't go up. It is just a question of when, and how much.

Taken from http://mortgage-x.com/general/indexes/prime.asp

March 7, 1986 9.00----->February 24, 1989 11.50
posted by mecran01 at 10:23 AM on December 18, 2004

With China preparing to float the Yuan, I can only see volatility in currency rates and interest rates in the coming decade. With interest rates so low now, a variable rate loan gives you much more potential downside than upside. It isn't quite as bad as shorting a stock or writing options (both of which give you unlimited downside potential), however.
posted by Kwantsar at 10:43 AM on December 18, 2004