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The Winners In The Mortgage Mess

If there is a takeaway from the financial crisis of the past five years, it’s this: take financial mass media with a grain of salt. Journalists exist to get the ‘story’ and that story has been to talk about all the problems in the economy. Prominent in this discussion has been the poor housing market.

When the crisis was developing early, we heard about all those explosive adjustable rate mortgages (ARMS) that would eventually catch homeowners by surprise. These fancy mortgages which were common towards the end of the bubble are in fact time bombs because the loan terms weren’t based upon typical criteria of a down payment plus a payment schedule to pay the interest and principal back. They were manipulated mortgages with lower payments (for a period) that masked the actual costs in the expectation that a future mortgage would be bought with better terms.

We don’t here much about ARMs anymore because anyone who had an ARM under normal mortgage terms is absolutely a winner in this crisis today. This doesn’t make for a good story.

A 2% Mortgage!

I know all about this because I have a mortgage on an investment property that is an ARM. When I got the mortgage, the FED has just ended it’s easing cycle from the last recession that ended about 2003.

At that time, the mortgage was quoted about 3.5%, 1 year ARM (this means that the payment was calculated on a 30 year amortization, adjusting once per year). Before the current crisis started, the mortgage had ended up at about 5.5% in 2007.

Fast forward to today, the mortgage is now at 2 7/8%.

As if that weren’t enough, there is a strong likelihood that it will adjust even lower later this year! Here’s why.

First, How ARMs Are Calculated

My ARM interest rate is calculated off of an average weekly price for the 1 year U.S Treasury Note. In the bond market, a 1 year Treasury Note is very short term. Short term interest rates have been kept low by the policy of the Federal Reserve.

And it that wasn’t enough, the crisis in Europe is causing many large investors to seek flight to safety. The U.S Treasury is one of a few large debt markets that still is seen as safe. (I don’t think this is because we are great fiscal or currency managers – it’s because we control our own currency unlike the European countries who don’t have this luxury).

These factors have forced 1 year Notes to levels that have never been seen before.

What The Future Holds

I get letters from the mortgage company every couple of weeks asking me to refinance. Why? So that I can lock in low rates over the long term. I haven’t taken them up on this offer because the numbers don’t work. We already know that short term interest rates (and Treasury rates) are going to be near zero for at least the end of 2014.

Here’s what an interest rate schedule might look like at this relates to my mortgage:

2012: 2 7/8%

2013: 2 7/8%

2014: 2 7/8%

2015: 3 1/4% ???

2016: ?????

What I can say for sure is that the mortgage can’t go up by more than 2% in any one year. Even if the economy is growing like gangbusters in 2016, it still is likely that my mortgage will be under 5% until the end of 2017. Current 30 year mortgages are @3.75% and 15 year mortgages are @3.2%. These rates will still be available at these levels for a couple of years at least.

All the while I have this low rate, the principal part of my payment has ballooned to over 50% of the mortgage payment. The interest payment is lower than both the principal as well as the property taxes!

My intuition tells me that the increase in the principal paid over the next 5 years will make the potential higher refinance costs less of an issue. I haven’t done the calculations yet (will get around to it).

Anyway, I still have a few years to ponder a refinace anyway because we know that rates aren’t going anywhere.

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