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COFI vs ARM vs Traditional


jq26
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Okay guys, this question is for seasoned mortgage folks! Here's the situation-

Before the end of July 2005, my girlfriend and I will be buying a home in the Philadelphia area. Since my credit is on the rebound, we will be solely using her credit and salary for mortgage purposes, so I will stick with her numbers. Currently she has a 780 middle FICO and makes about 50K. The good thing is she has NO debt, no car payments, nothing. She is pre-approved for a traditional loan for at 220K. She has 30K in cash on hand to put down or put towards closing costs.

The thing is, we are in a unique situation. The goal of this house isn't necessarily to buy it as an investment thorugh paying off the mortgage and through appreciation (I'm of the school of thought that a primary residence is a liability and not an asset). The goal of this house is to get us through the next 5 years comfortably with or without my salary at the lowest cost. Although I make 60K right now, I am attending law school this fall and may or may not have a salary for the next few years, depending if I decide to go at night or during the day. Our broker and my father feel that we'd be great for a COFI loan and both have them on their own properties. The broker offered what I consider to be a great deal- a 3yr fixed 1.95% COFI with no points, after the 3 yrs, the payment can readjust up to 7.5%, predictably higher as cost of funds increase.

I have researched a lot about it, and I see many advantages and only one disadvantage, and even at that, an AVOIDABLE disadvantage.

Advantage:

1) tied to Cost of Funds, a lagging indicator, generally adavntageous in a rising rate environment. The rate is lower and more stable than prime.

2) flexibility- if I return to school full-time, we only have to service the low payment and can allow neg amortization. If I continue to have a salary, we will be squirreling away plenty of cash AND can decide to service the accumulating interest to avoid neg amort.

3) My goal, assuming I go to school at night and continue to make a salary, is to purchase a rental property in 12 months. The rental income and appreciation of this investment made available only due to the lower COFI payment on our mortgage should well outpace any neg amortization on the loan.

4) Should we even allow neg. amort to kick in, we are borrowing from ourselves at an extremely low rate. If we are wise with your budgets and investing, we can create our own yield spread and come out way ahead (not much different from a bank!)

5) When we get married, and our tax brackets jump, we can make a lump sum payment for any accumulated interest and effectively write down her income (assuming COF Index has increased and interest is piling up).

Disadvantage:

1) Neg Amortization. If you buy too much house and purchase non-cash generating assets (cars, furniture, and other sh*t) with the money saved every month, then you can actually suck a bit of equity out of your home and end up upside down. However, to my knowledge, this can be avoided by either servicing the additional debt (effectively rendering this an ARM with a reduced interest rate) or by outpacing any neg amort by accumulating investments of equal or greater value.

I guess, in general, if one can STICK TO a plan and invest wisely, this set up is advantageous. If one does not understand what is going on, then maybe its best to avoid any possibility of neg amortization.

What are your thoughts on these loans? Any suggestions or corrections to the thoughts I posted above? I am admittedly a newbie when it comes to mortgages, but I want to make sure we go into this with a thorough plan. We are both 27 yrs old and trying to set up the best possible scenario going forward.

Thanks so much. Sorry so long-winded!

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Seeing as the future is a little hard to predict, this is just general advice.

1) I would suggest that you find a fixed rate for 5 years type loan, or one that would not for sure jump to 7.5 in 3 years.

2) Do a lot of shopping around. There are homes in the Phil area that are great deals, ie I have a client that purchased a home just now for 269K, and the appraisal shows that the home is actually worth more in the 285K range. Then if you want to sell in 3 years (to escape a 7.5% interest rate) you will at least break even.

3) Consider purchasing a duplex or triplex, then you would have some income, and the loan can be done as an owner occupied loan.

Charles

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Thanks Charles, I'll head that advice.

To clarify, the payment amount, not the mortgae rate, can increase by 7.5%. The rate will still be linked to current cost of funds index. The stability and lagging nature of the COS index leads me to beleive that rate will not reach 4% in the next 5 years.

A duplex or triplex is out of the question at the moment, since I am unable to take ona mortgage at the moment and my fiance is unable to qualify on 50K.

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OK, then you are fine. I have my mother in a loan similar to that, the only difference is that the index is a cost of savings deposit index. It is a neg am, and bothers her a lot that it is. It does not really matter, just will leave us less $ to squander when she dies.

You would have to check with the lender, but some will allow you to use rental income as income rightaway, even though it is just based on a lease agreement.

But, to answer your question, you should be good with that loan. If you are troubled by going neg on it, then while you have funds available, make extra payments towards principal, and as it goes negative, you can keep it positive that way.

Charles

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  • 3 weeks later...

Creditdodger-

that's who we are probably going to do our COSI loan with- World Savings. As of last night, the rate was 3.4% (fixed margin) + the variable 2.06% COS Index. I've heard nothing but good things about this bank.

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That is who my mom is with, World Savings.

She is NOT paying like I asked her to do, how I know.... later.

She started with a 53K loan, payments 172.96

She now has payment of 185.93.

Next year it will go up to 198.87

Her loan is now 52,655, so that is how I know sort of what she has been paying. HOW? Her "real" effective rate was 5.25, so her loan should have gone up to 54,437. Her payments based on her effective rate should have been 292.67, and she paid 172.96, so at the end of the year she should have owed the 54K, but it "kills her" to be going negative, so I am sure that she has been paying the interest only option, or the 30 year option or ?

I have told her to pay the minimum and spend the rest on whatever, but it is not her way.

Now, at the end of the 5th year, we will refinance. And that will bring her payment down to the minimum, otherwise the rate goes to interest only, and at 10 years, the loan is "recast" and payments refigured to pay the note off in the 20 years remaining.

I went into depth here to try to explain the realities of a NegAm loan, if you don't pay at least the interest only amount, you will owe more at the end of the year than what you started out at. In my mom's case, no one cares how much is owed on her home when she dies. In many situations, it does matter.

Now, World Savings has some oddities, so some people (Brokers/LO'S) don't use them. I personally will not do an Option Arm with anyone else. WHY? because with other lenders, when you get to 110% of the initial loan, the loan is converted to a fixed 30 years loan at "prevailing rates". As many of you know, that has no meaning as a real number.

Have a great day.

Charles

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