Master The Fast-Changing Mortgage Rate Game

N E W   Y O R K, August 21, 2003 -- Those rock-bottom mortgage rates aren't so low anymore, and we've just learned that they jumped a full point over the summer to 6.2 percent.

Still, despite the biggest quarter increase in more than 15 years, the buzz among prospective homeowners about mortgage rates is expected to continue into the fall.

As a result of rising interest rates, the refinance boom is beginning to slow down. But, according to an estimate by the Mortgage Bankers Association, U.S. homeowners refinanced their mortgages 25 million times during the past two and a half years, padding their own wallets with between $230 billion and $250 billion.

Although the refinancing market has quieted down, new home purchases continue to roar, and the value of homes continues to increase — forcing many consumers to work harder at getting the most for their money when it comes to financing their homes.

Historically Low Rates

Although mortgage rates have risen since June, it is not too late to take advantage of what are still low rates to refinance your current mortgage or buy a new home.

To put the current interest rates in perspective, a bit of interest rate history may be useful. According to Freddie Mac, the drop in mortgage rates began in mid-2000 when the average rate on a 30-year fixed mortgage dropped to 8.52 percent. In the early 1980s, the average rates were about 17 percent — so the rates in mid-2000 were considered good.

Thereafter, rates dropped steadily and bottomed out in mid-June of this year at an average rate of 5.21 percent on a 30-year fixed mortgage, the lowest rate since Freddie Mac began tracking rates in 1972. Since then, rates have been on the rise, although they dipped slightly again last week from 6.34 percent to the current average rate of 6.24 percent for a 30-year fixed loan.

Interestingly enough, the rate of 6.24 percent is virtually the same as it was at this point last year when rates were at an average of 6.22 percent for the week ended August 15, 2002.

That said, people are shying away from refinancing. The number of owners choosing to refinance declined by half since June, according to the Mortgage Bankers Association. However, if you are part of the 39 percent of homeowners who are still paying an interest rate at least 0.5 percent higher than what you would pay if you refinanced your loan, refinancing may be a good idea.

For example, if you own a $150,000 house and refinance, you will save $900 a year, at a minimum. Anyone who has a loan of 6.7 percent or more should consider refinancing.

Locked Out of Your Rate?

Many people who recently purchased a home have found themselves "locked-out" of the low rate they thought they had "locked in" when they first negotiated their mortgage.

Many mortgage lenders offer to lock-in rates for 30 to 60 days, which protects the borrower if the rates rise prior to closing on their new home. However, there are a few catches.

First, lenders may not accept lock-in guarantees while they are changing rates, which has happened a lot more lately. According to the Mortgage Market Guide, the average rate on a 30-year fixed mortgage has fluctuated as much as 0.25 percent a day at least 10 times since mid-July.

As a result, many mortgage lenders, which used to only update their rates once a day, are now adjusting them multiple times a day, so the rate you receive at 10 a.m. may be different from the rate you lock in at 3 p.m of the same day. In addition, due to high demand in the mortgage business, even if your rate has been locked-in, loans are not always processed within the lock-in window.

The result is that the lock may expire, and the homebuyer may have to re-negotiate a new — and nowadays, higher — rate. As a result, many borrowers are finding that by the time they close on their new home, their monthly mortgage payment is higher than they originally expected.

There are several ways to avoid being locked out.

When locking in a rate, get it in writing. When you hear a certain rate and they say it is locked in, make them put it down so everyone knows it is real.

Once you have locked in your rate, be sure to produce all of the required documents as quickly as possible because every day counts when your rate is only guaranteed for a certain period of time.

When your paperwork is in, closely follow your application during the processing period to ensure everything is moving along as it should, which may involve you touching base with your mortgage broker on a regular basis. If, for some reason, your lock-in period expires prior to your loan closing, try to work with your lender to either extend the lock-in period or split the difference between your original rate and the new rate.

Finally, you may want to consider using the services of a mortgage broker who deals in large volume. Bigger players are often better positioned to negotiate on your behalf should rates go up, or down, before your closing date. In fact, you should try and negotiate with your mortgage broker right up to the day, to insure you are getting the best deal on your mortgage.

Again, nothing prevents you from shopping around, so definitely do your homework.

Interest-Only Mortgages

For those homebuyers who were looking to purchase a home beyond their current means, but shelved the idea when interest rates began to rise, there is another option — an interest-only mortgage.

According to bankrate.com, interest-only mortgages have been around since the 1920s, but abruptly disappeared in the 1930s when homeowners saw the value of their real estate plunge and their employment disappear, making it impossible to make monthly payments. However, this type of loan has made a comeback on the heels of recently rising interest rates. According to the HomeBanc Mortgage Corporation, the nation's leading source of interest-only payment plans, it lent $280 million in interest-only mortgages in July, up 12 percent from June.

Interest-only mortgages allow a borrower to pay interest only — as the name implies — for the first 10 years of a 30-year loan, making the monthly payment lower.

For example, on a 30-year amortizing loan of $200,000 with an interest rate of 6.5 percent, the total monthly payment would be $1,264.14. However, on an interest-only mortgage, you would pay only $1,083.34 per month, freeing up $180.80 which could be used to pay down other debt or to max-out your 401(k).

At the end of 10 years, the loan self-amortizes increasing the payments which ultimately pay the principle down to zero over the next 20 years. In addition to a lower monthly payment, the greatest advantage of the interest-only mortgage is the entire monthly payment can be deducted on your tax bill for the first 10 years of the loan as interest payments are tax-deductible.

Although there are benefits to this type of financing, especially if the money saved is invested wisely, the pitfalls can be far greater than the potential upsides.

First, most interest-only mortgages do not have a fixed rate conversion option. After 10 years, you need to convert to a regular mortgage, which could be at a higher rate. No one knows what mortgage rates will be in 10 years.

Second, if the value of your home declines after 10 years, you will need to make up the difference. For example, if the value of your home at the time of purchase was $200,000 and after 10 years the value declined to $180,000, you would need to make up the $20,000 difference. Third, paying only the interest on a mortgage does not allow you to build any equity in your home-meaning home "ownership" is more like home "leasing." Finally, while an interest-only loan allows a buyer to qualify for a larger mortgage and a more expensive home, biting off more than you can chew is rarely a savvy financial decision.

Overall, I am not a fan of interest-only loans. The only people they make sense for is a borrower who knows their salary will increase, or someone who won't live there very long.

Not So Fast …

The closing costs are a buyer's last line of defense when shopping for a mortgage. Last year, more than $50 billion in fees were collected from those who bought a new home or refinanced an existing property.

It is important to read and understand the Good Faith Estimate document your broker submits during the loan application process. While this is only in "good faith" and is not a final guarantee, it is an excellent means to "window shop" mortgages to determine if your closing costs are in line with other lenders. For example, if the processing fee costs $250 at one lender and $150 at another, but the first lender's deal is better overall, point out the discrepancy and try to negotiate.

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is Good Morning America's personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.