SUBMITTED: Monday, January 24, 2005
POSTED: Monday, January 24, 2005
The loan you refer to is the Pick-A-Pay loan. The 1.95% rate is the "minimum payment" rate, not the interest rate. There are actually 4 monthly payment rates on your statement each month:
Minimum Payment - based on the introductory 1.95% (allows borrower to free up cashflow to pay down other, high interest debt such as credit cards and student loans, or invest in 401K, IRA, etc.) This payment will not always cover the Interest due for the month and will accrue deferred interest, raising the principle balance of the loan.
Interest Only Payment - This payment will cover only the interest due for the month at the loan's "Fully Indexed Rate". In your case, the rate on the loan is 4.85%. The "Fully Indexed Rate" is the sum of the Index your loan is based on (most likely CODI or COSI index) plus the "margin" or profit margin the bank charges for loaning you the money.
Fully Amortized Payment - This is the full 30 year Principle and Interest payment. This is the payment necessary to fully pay off your mortgage within the 30 year term at the current interest rate.
15 Year Payment - This is the payment amount necessary to pay off the mortgage in 15 years.
Yours is a very common misconception regarding this loan. This is easily the most difficult loan in America to explain and understand. Many of the largest lenders offer a version of this loan and the versions are basically the same, as is the purpose.
The purpose of the 1.95% payment rate is to increase the cashflow of the borrower by offering the option of paying a much lower monthly payment when necessary. The actual interest rate on the loan is never 1.95%, it is always the index plus margin. The index changes once per month, but the margin never changes over the life of the loan (the index is not controlled by the bank, the margin is but is set at the loan's inception and never changed).
Yes, there will be deferred interest added to the loan principle balance when the minimum payment is made. Think of it this way... A typical loan amount in the San Francisco Bay Area is $400,000 with a 30 year term. With an interest rate of 4.85, the 30 year payment would be $2110.77. The 1.95% payment rate would be $1468.50. The Interest Only payment would be $1616.67. If you chose to make the minimum payment, you would free up $642.27 for that month to spend elsewhere. Since the interest due for that month was $1616.67, your principle balance would increase by $148.17. The $642.27 that you saved by choosing the minimum payment could be used to pay down high interest rate credit cards, student loans, it could be invested in a 401K, IRA, Money Market account, used for a vacation, whatever. Over a year, that comes to about $7700 that can be used for whatever you want. During that year, your mortgage principle balance will increase only around $1800 if you make the minimum payment every month. Now, taking into account the appreciation rate of homes in the Bay Area (around 15% per year or more), the value of your home at the end of that year would be about $460,000, a $60,000 gain. Now the deferred interest doesn't seem so significant, does it?
+$7700
Increased Cashflow
+$60,000 Appreciation
-$1800
Deferred Interest
=
+$65,900 Positive Gain in ONE YEAR
And remember... Mortgage interest is TAX DEDUCTIBLE. I know I sound like a salesman (I am), but I really believe in this loan. Especially in the Bay Area market, where values continue to rise in the 15-30% per year range. Even if the market falls apart and there is ZERO appreciation (unlikely in the near future), the net gain of cashflow against deferred interest would be $5900. Better to pay 4.85% on that $1800 on your home loan than to pay $7700 at 15-21% to a credit card company.
If you were to refinance this loan in 3 years, including deferred interest of $10,000 (unlikely amount, but for argument's sake), you would be financing $410,000. Your home, had it been worth $400,000, even with only 10% appreciation per year, would now be worth around $530,000. You would be able to refi the original loan amount and even take tens of thousands of dollars worth of equity out in CASH. You would have also been able to spend over $20,000 in those 3 years on whatever you wanted due to the smaller minimum payment.
As for the minimum payment in years 2 and 3... There is a payment cap of 7.5% per year. That's not 7.5% as an interest rate, but 7.5% of the last year's payment. For instance: If your minimum payment in year 1 was $1000, then your payment in year 2 could NOT be more than $1075. Year 3 cannot be more than $1155.63. Year 4 $1242.30. This payment amount will increase until it equals the Fully Indexed rate (the 30 year Principle and Interest payment). This usually occurs in year 5 or 6. I don't know who told you about the 2.95 and 3.95 in years 2 and 3, but that is incorrect, as World has never offered such a program.
I'm not writing this to sell anything to anyone. What I hope I have done is help you to realize that you weren't ripped off and you did get a very good loan. I know that ARM loans are difficult to understand, but they are better than fixed rate loans in many ways.
World Savings is by far the most Ethical, Honest, and Upstanding company I have ever known, and I am proud to work for them. Due to the complex nature of adjustable mortgages, there will always be Real Estate agents, Mortgage Loan Brokers, Loan Agents, and even World employees who do not understand the products well enough to explain them clearly to the public. That is too bad, because feelings of being "scammed" and "ripped off" are common when the borrower doesn't truly understand the loan they are in.