Managing Money : Adjustable Mortgage Good for Shorter Stay
QUESTION: I am in the market for a home loan and am getting more confused by the day. Is there a formula for evaluating which type of mortgage--fixed or adjustable--I should choose, given the length of time I will hold the property, possible rate increases, points, closing costs and other relevant data? I plan on owning my house for two to five years.--J. D.
ANSWER: No wonder you’re confused. There’s a dizzying array of choices on the mortgage market today that can confound even a sophisticated home buyer, let alone the first-time buyer. However, there are a few basic rules of thumb that you can use to determine what type of mortgage best suits your circumstances.
If interest rates are low--and you think they are likely to start rising--you’re probably better off selecting a fixed-rate loan to lock in the lower rate. You might also favor a fixed-rate mortgage if your tolerance for risk is quite low; interest rate uncertainity can make you a nervous wreck if you’re easily worried about your mortgage payment increasing. You might also prefer a fixed rate if your household income fluctuates greatly from year to year. Knowing that you can make the monthly payments on your lowest possible income level is a great source of security.
Adjustable-rate mortgages have become increasingly popular for a variety of reasons. And because you plan to own your new home for no more than five years, you should strongly consider this choice. At inception, interest rates on adjustable mortgages are typically lower than those for fixed-rate mortgages. For example, according to the U.S. League of Savings Institutions, the national average for fixed-rate mortgages is currently running about 10.5%; the rate for adjustable mortgages is about 7.9%. However, you should be aware that adjustable mortgages will follow a rise in interest rates. Typically, though, the increase is limited to a maximum of 2 percentage points per year and a total of about 5 to 7 percentage points over the entire life of the loan.
The adjustable rate is particularly attractive for a person planning a relatively short ownership because of the typical 2-point ceiling on increases in a single year. Given the 2.6-point spread between the two rates cited above, you can see that the adjustable rate would be lower for both the first and second years of the loan, even under the 2-point maximum allowable rate increase. And even if the rate were increased another 2 points in the third year of the loan, you would still be ahead of the game in terms of overall dollars spent on interest.
By the fourth year, however, your accumulated interest payments on the adjustable mortgage would be greater than on the fixed-rate loan if the adjustable rate were increased again by another 2 points. However, by then, you might have sold the house!
Another factor to consider if you’re interested in a quick turnaround is that adjustable mortgages are generally more easily assumed by a buyer than fixed-rate loans. Typically, adjustable mortgages have a built-in provision specifying the conditions under which the loan may be assumed. Lenders generally do not permit fixed-rate mortgages to be assumed by a buyer.
Furthermore, savings and loan executives say the loan points and fees charged for adjustable-rate mortgages are often significantly lower than those for fixed-rate mortgages. This has been particularly true in California because local savings and loans have been especially aggressive in promoting adjustable-rate mortgages. In addition, executives say competition for mortgage loan business is particularly keen in California. However, these special promotions vary, so you should check with a variety of lenders before selecting either your mortgage instrument or the institution from which you want to get your loan.
If you plan on owning your home for more than five years, you could consider another possibility: the convertible adjustable-rate mortgage. This hybrid loan, which now accounts for about one-third of the new mortgages made in California, allows you to convert your adjustable-rate loan to a fixed rate mortgage at only a fraction of the cost of a normal refinancing. The benefit: You can take advantage of the lower introductory rates of an adjustable mortgage and then switch to a fixed-rate loan if rates should drop. However, in some cases, the borrower is charged an up-front premium for the option to convert. In other cases, the fixed rate you get on the conversion is often higher than the prevailing rates for a regular refinancing.
Q: The Internal Revenue Service requires me to list my military disability as “non-taxable income” but does not require me to add it to my gross income for the purposes of taxation. What I am wondering is what “legal” income I must enter when applying for special programs available to senior citizens. Is it my gross income as entered on my income tax statement, or is it this gross income plus the excluded non-taxable income, such as the military disability?--S. W.
A: The apparent sincerity of your question warmed the hearts of several bureaucrats at the Los Angeles Office on Aging and the state Department of Aging. However, it appears that your willingness to fess up to your full income is not necessary.
According to a spokesman for the state Department of Aging, only a very few senior citizen programs and services use household income to determine eligibility. For most services--including legal, nutrition, transportation and ombudsman programs--age is the only qualification; you must be at least 60 years old to be eligible for these services.
Although age is the single most important requirement, some programs still ask applicants to reveal their household incomes when they apply for services. In most cases, the Department of Aging spokesman said, this question is for informational purposes only and is not used to determine eligibility. In such instances, the spokesman said, the governmental agency is trying to determine how many of its clients are eligible for, or are receiving, Medi-Cal health care services. In these cases, the spokesman advises that you divulge your entire household income, including any non-taxable payments.
While household income is not an eligibility factor for the vast majority of senior citizen programs, there are still a handful of services, including the Adult Day Health Care program, that charge a sliding-scale fee based on the recipient’s income. In these cases, the department spokesman said, applicants should list “all sources” of household income, regardless of whether the federal government considers them taxable. After all, you did want to pay your fair share, didn’t you?
Last week’s column item on Social Security benefits for divorced spouses contained an error regarding benefits for disabled ex-spouses. A disabled former spouse may collect on the Social Security benefits of his or her ex-spouse at age 50 only if the former spouse has died. If the ex-spouse is alive, 62 is the minimum age at which a former spouse may start collecting benefits. If the ex-spouse is dead, a surviving and able-bodied former spouse may start collecting benefits at age 60.
Remember, a divorced spouse is entitled to receive Social Security benefits accumulated by an ex-husband or wife only if they had been married for at least 10 years. For more information about ex-spouse benefits, get the Social Security Administration’s pamphlet No. 05-10084, titled “Survivors’ Benefits.”
