Frantic competition is helping to foster a wider variety of mortgage offerings and some new-style lenders.
The garden variety 30-year fixed-rate mortgage with up-front costs continues to be the favorite of most lenders and borrowers. But the hot mortgage market has created niches where borrowers can look for a different kind of deal. Here's a look at portable mortgages, no-cost mortgages and some new style ARMs-only lenders.
The portable mortgage
Internet lender E-Trade Mortgage last month introduced what it calls "Mortgage on the Move," a deal that allows borrowers the one-time option of carrying over the terms of their home loan to a new residence.
The portable mortgage gives the borrower a way to hedge against interest rate increases. The option comes with a higher interest rate. Thursday, a creditworthy borrower could get the portable mortgage at about 0.4 of a percentage point above the lender's rate for a normal 30-year mortgage.
The portable mortgage, so far unique to E-Trade, makes sense only in the current prolonged trough in mortgage rates, which are as low as they've been in about 45 years. Once rates begin to rise substantially, customers aren't going to be inclined to pay the premium to lock in terms through their next move.
Robert Bernabe, head of retail lending at E-Trade, says the mortgage will be available as long as it continues to make sense for customers seeking protection from an upswing in interest rates.
At origination, the portable mortgage looks like a regular 30-year fixed rate loan. But here's what happens when a borrower moves:
• If the borrower downsizes, the monthly payment is recalculated to amortize the new balance over the remainder of the 30-year term of the loan. That ensures the monthly payment won't increase.
• If the borrower upgrades, and more money is needed, E-Trade is committed to issuing a second mortgage on the new house. The deal calls for the second mortgage to be issued at prevailing rates for a first mortgage at the time the new home is purchased.
First mortgages typically carry interest rates two percentage points or more below second mortgages.
The portable mortgage is available only for purchases, not refinances. They're limited to 80% of the appraised value of the home.
Who could benefit: Borrowers who expect interest rates to rise and who are fairly certain they'll be moving in the next several years.
What to watch out for: The protection afforded by the portable mortgage comes at a price. Even if you know you'll be buying another house, the extra cost could be wasted money if interest rates are reasonably low when you make your next purchase.
The no-cost mortgage
All mortgages have closing costs. But lenders and borrowers have options in deciding how they'll be handled — by a customer's cash at settlement, by adding to the loan balance or by a higher interest rate charged to the borrower.
One hot option these days is the so-called no-cost mortgage. It simply means that the lender covers closing costs in return for the borrower paying a premium interest rate.
Skip Dyer, manager at DNJ Mortgage in Cary, N.C., explains the economics of the deal this way:
A borrower who would normally qualify for a 5.5% interest rate agrees to pay 5.75% to avoid payment of closing costs. The higher interest rate allows the lender to sell the mortgage to investors in the secondary market at a premium. A $300,000 mortgage at the elevated interest rate might bring the lender a premium equal to 1% of the loan, or $3,000.
It is the lender's so-called "yield spread premium" from the secondary mortgage market that allows a lender to cover closing costs in a no-cost mortgage deal.
Bob Walters, vice president at Quicken Loans, says no-cost deals generally work for lenders on loans of $110,000 or more.
If you go that route, your higher interest rate should eliminate charges for administrative fees, credit reports, appraisals, title insurance, settlement services and the like. It probably won't eliminate payments to the lender for daily interest charges, or for advance payments for property taxes and homeowners insurance.
Who could benefit: Refinancers who can improve on their current interest rate or home buyers short on cash.
What to watch for: Lenders' marketing claims are confusing. When a lender promises, for example, "no out of pocket costs," it doesn't mean you're getting a no-cost mortgage. It just means closing costs are being rolled into your loan balance. Keep in mind that you're paying a premium interest rate for sidestepping normal closing costs. If you plan to have the mortgage for a long time — say, eight years or more — you're likely to be money ahead by paying the closing costs up-front.
ARMs only
At least two big lenders have given up entirely on the notion of fixed-rate mortgages. Dutch-owned ING Direct and New Mexico-based Thornburg Mortgage make only adjustable-rate loans. ING Direct offers initial fixed-rate periods of up to seven years; Thornburg, up to 10.
From a borrower's point of view, their logic is hard to fault. Thirty-year and 15-year fixed rate mortgages give the borrower certainty about future house payments, but the certainty comes at a price. Their interest rates are higher than mortgages that adjust periodically to reflect market conditions.
Most estimates peg the average tenure in a home at about six years. The result: Most fixed-rate borrowers are paying a premium price for long-term financial security they're not around to enjoy.
"Our consistent message is that if six years is the average, don't get a 30-year fixed rate mortgage," says Thornburg President Ron Chicaferro.
ING Direct Vice President David Lewis says customers are almost always financially ahead by accepting some risk for future interest rate increases.
A company review of data back to 1979 suggests interest rates "just haven't been volatile enough" to justify the cost of locking in an interest rate for the long term.
Another company study showed that borrowers who in 2002 paid off 30-year, fixed rate mortgages that were five years old paid $7.5 billion more than they would have had they taken out a mortgage that allowed rate adjustments after five years.
Who could benefit: Anyone who is fairly certain to move in the next 10 years. For those who don't want to gamble entirely on short-term movements of interest rates, experts recommend balancing expected tenure in the house with a mortgage carrying an initial fixed period to match. Example: Someone expecting to be in a house seven years should look for an ARM with a fixed rate for the first seven years.
What to watch out for: Averages aside, many homeowners will be around long enough to reap the rewards of a long-term fixed rate. And even if your future in the house is uncertain, the predictability and peace of mind of a fixed rate is worth something.
