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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2005

A Flexible Alternative

MTA payment-option ARMs offer choices for many kinds of borrowers

A Flexible Alternative

Fixed-rate mortgages take the guesswork out of figuring interest. Unfortunately, they also remove payment flexibility. Fortunately, payment-option ARMs can offer those looking for a home — especially first-time buyers, seasonal workers, new professionals and those who work on commission — much more flexibility with their purchases because of the many payment options and adjustable rates available. And none offers more purchasing flexibility than the 12-Month Treasury Average (MTA) payment-option ARM.

Options for varying situations

Whatever their situation, many prospective borrowers can select an MTA payment option that will benefit them. A first-time homebuyer can finance as much as 100 percent with lender-paid mortgage insurance. Medical students fresh out of school can purchase a home by making minimum payments with a 1-percent start rate; later, when their income increases, they can choose a payment option of 30- or 40-year amortization, or even a 15-year program. Seasonal employees working only nine months of the year can make fixed-interest-rate payments for those nine months and then make only the minimum payment during their off months.

Salespeople who are on 100-percent commission often experience significant monthly income fluctuations. During their better months, they can make 15- or 30-year fixed-interest-rate payments. When they encounter slower months, they can switch to making minimum payments. Investors can defer their interest all year long and then pay the deferred interest at the end of the year, which will provide them with another tax deduction.

If borrowers want to purchase a larger or more expensive home now rather than later, an MTA will help by providing lower rates at the beginning of the mortgage so they can afford that home today. These savings further permit borrowers to pay down high-interest bills, such as credit cards. Plus, if the potential homebuyer expects to occupy the home for only a short time, an MTA mortgage can be the wisest move. Likewise, if homeowners relocate to a more expensive area, they’ll be able to afford more than they would with another type of mortgage. Borrowers seeking to avoid high-interest-rate bridge loans can use MTA products for interim financing.

Interest periods and prepayment penalties

Unlike other adjustable-rate programs such as London Interbank Offered Rate or Cost-of-funds Index, MTA mortgages are based on the 12-Month Treasury Average, as their name suggests. Therefore, they are not affected by the volatility of daily interest movements. Each month, the MTA index adjusts to reflect the average for previous 12 months and, as a result, avoids the greater fluctuations of other volatile indices.

Lenders offer initial interest periods of one, three, six and 12 months, with five-year fixed payments. The popularity of a one-month fixed payment for five years is increasing. It affords the borrower the combination of payment flexibility and five-year fixed payments in most cases. Some lenders do not have deferred interest, depending on the length of the fixed payment. The lifetime caps for the mortgage will vary, depending on the lender, and range from 9.95 percent to 10.95 percent.

Prepayment penalties differ. Options normally include one-year, two-year and three-year prepayment penalties. Only a few lenders offer a two-year prepayment penalty, but it’s a great selling point to consumers and can be priced more competitively than a three-year.

Lock periods can also range anywhere from 12 to 60 days, again depending on the lender. Some lenders allow limited liability companies, 40-year amortizations with lender-paid mortgage insurance, along with unlimited cash-out at most loan-to-value ratios.

MTAs vs. conventional mortgages

Borrowers taking advantage of MTA products’ payment flexibility will notice a distinct difference from more-conventional types of mortgages. There is a significant difference between a minimum payment plan with a start rate of 1 percent, creating a $1,286 payment, and a 30-year fixed rate (5.875 percent) with a monthly payment of $2,366. That adds up to a $1,080 monthly difference, which would result in a $12,960 savings each year. The borrower can put that money toward other bills, home improvements or savings.

Another benefit is that if mortgage interest is your only tax deduction, the interest-only and lowest-payment option enables you to keep your deduction at its current level, if you choose.

The following are two examples of how MTA mortgages can be used to fit different borrowers’ circumstances:

Debra has owned a two-unit rental building for almost 10 years. As the market has remained strong for the past four years, she has acquired a great deal of equity from this rental. Furthermore, she started her own business five years ago. The business is now thriving, and she thinks this would be a good time to diversify her investments.

Debra has her eye on a four-unit building nearby and would like to purchase it. Because she’s been pouring just about all of her assets back into her business, she doesn’t have enough liquid assets at hand to make the down payment. She even has considered the possibility of liquidating her 401(k) to provide the funds to make that down payment.

She checks with her broker, who advises against liquidating the 401(k) and warns her of the potential tax consequences. Instead, the broker recommends that Debra refinance her current two-unit rental for the cash out and use this money for the down payment on the four-unit property. He then suggests she take a one-month MTA mortgage with a five-year fixed-minimum-payment period. Debra can choose the minimum-payment option if she has cash-flow problems with her business.

The five-year fixed-payment period gives her a much-larger comfort zone; she can use the program for the cash-out refinance as well as for the purchase. Not only has Debra left her retirement funds untouched, but her broker also now has two loans instead of one. Both are happy.

Sandra and Steve have decided to buy their first home. They are both salespeople and are aware that their incomes will fluctuate from month to month. Although they’ve been saving for their home for quite some time, they only have enough to make a 10-percent down payment.

They approach their broker, who suggests a one-month MTA with a 12-month fixed-pay period. They would only have to put 10 percent down and can go with a stated-income, full-asset document type. Because their incomes will vary monthly, they will be able to make the minimum payment when they both have slow months and pay more toward the principal during the months when things heat up. They begin house-hunting.

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MTA mortgages provide choice and flexibility, which can make them a great product to fit many borrower situations. When used in the right manner, MTAs benefit several kinds of borrowers.


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