Soon-To-Be Homesellers: Your Most Effective Mortgage Strategy

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Mortgage planning is about recognizing the right home loan product for the right homeowner at the right time. 

It's a challenge because not only do products change, but homeowners' lives change and the times change, too.

However, change is good because new mortgage landscapes means new mortgage planning opportunities for people that are paying attention.

• The U.S. economy in a recession
• Mortgage money is getting scarcer
• Homes are sitting on the market longer than in years past

And, for all of the talk that the mortgage market is dead, many Americans are quietly going about their business, using the economic situation to their advantage.

One group especially poised to take advantage of the economy is homeowners that plan to sell their homes in 2008 or early-2009. 

For these folks, a rarely-used mortgage product could be their new best friend.

Meet the 1-year Adjustable Rate Mortgage.

If you're selling your home prior to Summer 2009, switching your current home loan into a 1-year ARM could save a lot of money without increasing your home loan financing risk.

First, a brief tutorial on the 1-year ARM; many homeowners don't even know that the products exists. 

A 1-year ARM is an adjustable rate mortgage whose interest rate resets on every anniversary of its inception. 

This is different from a 3-year ARM whose interest rate remains fixed for 3 years, and then adjusts annually; or a 5-year ARM whose interest rate remains fixed for 5 years, and then adjusts annually.

The 1-year ARM is the original ARM, financing homes long before the 3-year and 5-year "hybrids" were ever created.

Over the past decade, though, 1-year ARMs have not be popular with homeowners.  This is because interest rates on 1-year ARM have been very close to interest rates on 3-year ARM.  Homeowners passed over the 1-year product because the extra adjustable-rate risk didn't make up for the minor savings of the product.

But, as the economy starting sinking late-2007, interest rates on 1-year ARMs began to fall hard because 1-year ARM interest rates are highly responsive to U.S. economic projections 12 months hence.  Homeowners planning to sell their homes soon would do well to pay attention to this relationship. 

For all of its warts as a part of a long-term mortgage plan, the 1-year ARM is perfectly suited for a short-term one when economic forecasts are bleak.

1-year ARMs suit soon-to-be home sellers on two fronts:

1. Lower rates = lower payments.  Homeowners save money each month and that is always good
2. Lower payments make it easier to qualifying for a new home loan if a non-contingent offer is required

Now, one common objection to the 1-year ARM is "what happens when the one year is up?  What happens to my rate?".

Like any other ARM, the 1-year ARM adjusts according to clearly defined rules set forth in the mortgage documents.  One common rule with a 1-year ARM is that the rate can't move more than 2% per annual adjustment. 

Considering how conforming 1-year ARM interest rates are hovering near 3.000%, the rules tell us that even after the first adjustment, the highest the 1-year ARM interest rate can go is to 5.000%.

5.000% is less than what most homeowners are paying against their mortgage.

But just saving money isn't enough.  It can't cost much to do the remortgage. either.  Soon-to-be home sellers should insist on a "no cost" loan when pursuing the 1-year ARM strategy.

About "no cost" loans -- there's no such thing.  A "no cost" loan is just like any other loan except with a higher interest rate.  The higher rate allows the lenders to absorb the costs that go with a home refinance. 

But "no cost" does mean "nothing out of pocket" and no increase to the loan balance.  That makes "no cost" home loans terrific for soon-to-be home sellers because they:

1. Preserve 100% of the homeowner's home equity
2. Preserve 100% of the homeowner's savings account balance

Borrowing additional equity or paying closing costs could quickly defeat the purpose of switching to a 1-year ARM so that's why we treat this strategy as a "No Cost or No Go" proposition.

And with one major caveat. 

"No cost" loans usually carry provisions stating that if the loan is paid off within 120 days, the lender reserves the right recapture the absorbed costs from the "no cost" remortgage. Therefore, it's important to plan ahead.

Five months ought to do it. 

• 30 days for a lender to underwrite and approve a home loan
• 120 days for the "recapture" period to end

Once the 1-year ARM has funded, it's safe to the list the home for sale -- just be careful to not go under contract and "close" the sale while the 120 day recapture is still in effect.  Otherwise, additional monies could be due at closing.

30-year mortgages carry high interest rates because they hedge the bank's risk for an extended period of time.  The 1-year ARM is the opposite -- almost all of the risk is shifted to the homeowner.

Homeowners that plan ahead can take advantage of the weak economy and how it's impacting mortgage rates.  If you know you'll be sold within a year, switching to a 1-year ARM could be a cost-effective and profitable mortgage planning strategy.

Moving from a $300,000 30-year fixed mortgage at 6.000% to a 1-year ARM at 3.500% saves $450 monthly. 

That's $5,400 annually -- a pretty big deal.