Editor’s Note: The following is a guest post by George. He’s a Baltimore Oriole’s fan who is trying to become a better writer. (I think he’s a pretty good one already.)
I’ve been scouring the market for a property. After years of going nowhere paying rent, I decided that my money could be put to better use paying down an investment than making somebody else rich.
I’m not sure why I paid rent for so many years – perhaps it was because we never felt sure about where we wanted to lay down roots. Regardless, it’s better to own the asset and enjoy the benefits of ownership than to have nothing to show for all your hard work.
This got me thinking: How do you find the perfect mortgage for your needs?
We’re living in difficult times. The Federal Reserve Bank – the Fed – is increasing interest rates, and this means the cost of credit is going up. This has a profound effect on long-term debt, especially if you do not to lock in a low rate with your mortgage broker, bank, or financial institution.
That’s the short-term perspective, but with increasing global uncertainty it’s never a sure bet which way interest rates will go over 10, 20 or 30 years.
Consider the people who locked in their mortgages at fixed rates 10, or 15 years ago, and then the Federal Funds Rate was eroded away to historic lows since the 2008 global financial crisis.
Nonetheless, this highly charged topic requires careful thought, planning and decision-making.
What are the benefits of a variable mortgage versus a fixed mortgage?
Let’s say you are considering purchasing a property worth $300,000, and you’re looking to put down 20% ($60,000) and take out a variable mortgage. That leaves you with $240,000 to pay back over the lifetime of your loan. A variable rate mortgage, often known as a floating rate mortgage, means that the interest rate on that home loan will fluctuate according to what the federal funds rate is doing.
More specifically, it moves in tandem with the prime interest rate. This is true in all countries that offer variable mortgages and/or fixed mortgages.
What will the Central Bank Do?
If you have an inkling as to how the Fed, the Bank of England, the Bank of Canada, or the European Central Bank is going to move with respect to interest rates, you may be inclined to lock in a fixed interest rate or a variable interest rate. In the US now, the trend appears to be moving in favor of increasing interest rates, making a fixed mortgage more attractive.
However, nothing is ironclad. Floating mortgages can go in any direction. People who opt for them are hoping that the interest rate that have locked in will be better than the interest rate by the time they are finished paying their mortgage.
Truth is: nobody knows which way interest rates are going to go over the long-term.
A fixed mortgage by contrast is fixed at the current rate. If you like certainty, and you’re not interested in the current state of the economy, a fixed mortgage is something that you can bank on not to change. People in many countries around the world prefer fixed-rate mortgages, since they provide that certainty that is so absent in the broader economy.
Of course, there are alternative options available to homeowners in the form of hybrid mortgages which allow a specific portion of the mortgage to be fixed, and a specific portion to be variable. Think of it as a compromise solution which gives you the best, or the worst, of both worlds.
Understand your options with mortgages
When you’re evaluating the pros and cons of variable and fixed/closed mortgages , it’s important to understand all options available to you based on your current financial situation. A closed mortgage and a mixed mortgage are also available. These refer to your ability to repay your mortgage prior to full duration of the mortgage term.
If you have excess funds available, or you will be coming into excess funds, you may wish to repay your mortgage ahead of time, to save on interest-related payments. Be advised that if you have a closed mortgage, you will have to make payments until the final payment is due on your term. Occasionally, banks and financial institutions will permit prepayments, but this is at the discretion of your mortgage provider.
By conducting the necessary research, you can avoid a lot of headaches, and possible financial ruin. Don’t get sucked into the wrong mortgage, because you may pay dearly for it over the long-term.
Hi, just curious on your thoughts of a 1st lien HELOC as Michael Lush has been promoting on the internet and in his YouTube videos.
It sounds nice, and mathematically I can see it saving a few years on my mortgage, but I don’t see mathematically how it can pay off my mortgage in 5-7 years like he proposes.
Just curious if you had heard of that product and what your thoughts were on his philosophy (the HELOC becomes your bank account, you get all your deposits in there and use a normal debit card to access money when you need it, you pay all your bills that way, etc.)
Lazy Man says
I hadn’t heard of that Jeremy. I can’t see what the benefit would be to using a HELOC as a general banking account.
From what he says, having all of your money/income deposited into a HELOC makes the principal balance lower, and interest accrues on the daily balance, so you are paying less interest each month. Also the intro rate for the first year is pretty good and then it still would be lower at least for a couple of years than a traditional mortgage. It is interest only until year 10 when principal kicks in, but according to Michael it is supposed to be paid off before then anyways. Mathematically it does make sense but is not a secured product like a traditional mortgage. If you watch two or three of his YouTube videos you might get a better idea than I do since you deal with money stuff a lot more than I do. Just curious as to your thoughts.
Lazy Man says
When we created our HELOC it didn’t impact the principal balance of our mortgage. It was simply a different line of credit in addition to our mortgage (which went unchanged).
Without watching the YouTube videos (it’s not convenient), it sounds like he’s saying that you take the HELOC money to pay down the principle of the mortgage. Then with your income coming into HELOC you are getting credit for paying off the interest in that every day. If that’s the case, it sounds like a terrible idea… if it’s even possible.
First, you can usually only get a HELOC up to 80% LTV (loan-to-value) meaning the bank still wants you to have 20% down. So if you buy a house with 20% down, you’d be able to get a HELOC of $0, which isn’t helpful. If you want to get a HELOC of 10%, you’d have to have 70% LTV and you could have just put 30% down to start.
Second, if you were to use your HELOC to pay down the principle of your mortgage, you’ve got yourself in a difficult financial situation. HELOC interest rates are usually more than the original mortgage rates, so you are paying a higher price. Also, you’ve essentially maxed-out a potential safety net to pay down principle early when you didn’t need to.
I’ll try to check out those YouTube videos, but I don’t think there’s anything particularly useful here. I went to his website and it seemed like he was trying to get people to sign-up for more information rather than explaining how it works. That’s not a good sign.
Lazy Man says
I did a little more reading and DoughRoller covers it pretty well. He’s been blogging from around 2006 like I have and sometimes covers stuff better (don’t tell him that!). Here’s the article on that: http://www.doughroller.net/mortgages/can-you-really-pay-off-your-mortgage-early-with-a-heloc/
So it seems there’s a little math to the whole thing, but it sounds like spinning plates while climbing Mount Everest. It seems that it’s better known as the Truth in Equity plan, which is mentioned here: https://www.biggerpockets.com/forums/92/topics/50067-truth-in-equity-helocs. It seems that most people seem to say that it’s extremely dangerous. Jon Holdman in that thread seems to make the most sense of it that I’ve seen.
The issues around a mortgage don’t really change, try to find lowest rate, but being a bit older I can remember doing a refinance to get from 14% to 12%. So while rates are going up they are still very low historically. I’ve always been a chicken and gone with fixed, but friends with more money and the ability to gamble on a variable have done better in the end.
Lazy Man says
That’s my thought as well, Wesley. Thanks for the independent perspective.