3-6-3 Rule: Slang Term For How Banks Used to Operate

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

What Is the 3-6-3 Rule?

The 3-6-3 rule is a slang term that refers to an unofficial practice in the banking industry in the 1950s, 1960s, and 1970s that was the result of non-competitive and simplistic conditions in the industry.

The 3-6-3 rule describes how bankers would supposedly give 3% interest on their depositors’ accounts, lend the depositors money at 6% interest, and then be playing golf by 3 p.m. In the 1950s, 1960s, and 1970s, a huge part of a bank’s business was lending out money at a higher interest rate than what it was paying out to its depositors (as a result of tighter regulations during this time period).

Key Takeaways

  • The 3-6-3 rule is a slang term that refers to an unofficial practice in the banking industry, specifically in the 1950s, 1960s, and 1970s, which was the result of non-competitive and simplistic conditions in the industry.
  • The 3-6-3 rule describes how bankers would supposedly give 3% interest on their depositors’ accounts, lend the depositors money at 6% interest, and then be playing golf by 3 p.m.
  • After the Great Depression, the government implemented tighter banking regulations, which made it more difficult for banks to compete with each other and limited the scope of the services they could provide clients; as a whole, the banking industry became stagnant.

Understanding the 3-6-3 Rule

After the Great Depression, the government implemented tighter banking regulations. This was partially due to the problems–namely corruption and a lack of regulation–that the banking industry faced leading up the economic downturn that precipitated the Great Depression. One result of these regulations is that it controlled the rates at which banks could lend and borrow money. This made it difficult for banks to compete with each other and limited the scope of the services they could provide clients. As a whole, the banking industry became more stagnant.

With the loosening of banking regulations and the widespread adoption of information technology in the decades after the 1970s, banks now operate in a much more competitive and complex manner. For example, banks may now provide a greater range of services, including retail and commercial banking services, investment management, and wealth management.

For banks that provide retail banking services, individual customers often use local branches of much larger commercial banks. Retail banks will generally offer savings and checking accounts, mortgages, personal loans, debit/credit cards, and certificates of deposit (CDs) to their clients. In retail banking, the focus is on the individual consumer (as opposed to any larger-sized clients, such as an endowment).

Banks that provide investment management for their clientele typically manage collective investments (such as pension funds) as well as overseeing the assets of individual customers. Banks that work with collective assets may also offer a wide range of traditional and alternative products that may not be available to the average retail investor, such as IPO opportunities and hedge funds.

For banks that offer wealth management services, they may cater to both high net worth and ultra-high net worth individuals. Financial advisors at these banks typically work with clients to develop tailored financial solutions to meet their needs. Financial advisors may also provide specialized services, such as investment management, income tax preparation, and estate planning. Most financial advisors aim to attain the Chartered Financial Analyst (CFA) designation, which measures their competency and integrity in the field of investment management.

[ad_2]

Source link

Continue Reading No Comments

80-10-10 Mortgage

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

What Is an 80-10-10 Mortgage?

An 80-10-10 mortgage is a loan where first and second mortgages are obtained simultaneously. The first mortgage lien is taken with an 80% loan-to-value (LTV) ratio, meaning that it is 80% of the home’s cost; the second mortgage lien has a 10% LTV ratio, and the borrower makes a 10% down payment.

This arrangement can be contrasted with the traditional single mortgage with a down payment amount of 20%.

The 80-10-10 mortgage is a type of piggyback mortgage.

Key Takeaways

  • An 80-10-10 mortgage is structured with two mortgages: the first being a fixed-rate loan at 80% of the home’s cost; the second being 10% as a home equity loan; and the remaining 10% as a cash down payment.
  • This type of mortgage scheme reduces the down payment of a home without having to pay private mortgage insurance (PMI), helping borrowers obtain a home more easily with the up-front costs.
  • However, borrowers will face relatively larger monthly mortgage payments and may see higher payments due on the adjustable loan if interest rates increase.

Understanding an 80-10-10 Mortgage

​​​​​​​When a prospective homeowner buys a home with less than the standard 20% down payment, they are required to pay private mortgage insurance (PMI). PMI is insurance that protects the financial institution lending the money against the risk of the borrower defaulting on a loan. An 80-10-10 mortgage is frequently used by borrowers to avoid paying PMI, which would make a homeowner’s monthly payment higher.

In general, 80-10-10 mortgages tend to be popular at times when home prices are accelerating. As homes become less affordable, making a 20% down payment of cash might be difficult for an individual. Piggyback mortgages allow buyers to borrow more money than their down payment might suggest.

The first mortgage of an 80-10-10 mortgage is usually always a fixed-rate mortgage. The second mortgage is usually an adjustable-rate mortgage, such as a home equity loan or home equity line of credit (HELOC).

Benefits of an 80-10-10 Mortgage

The second mortgage functions like a credit card, but with a lower interest rate since the equity in the home will back it. As such, it only incurs interest when you use it. This means that you can pay off the home equity loan or HELOC in full or in part and eliminate interest payments on those funds. Moreover, once settled, the HELOC remains. This credit line can act as an emergency pool for other expenses, such as home renovations or even education.

An 80-10-10 loan is a good option for people who are trying to buy a home but have not yet sold their existing home. In that scenario, they would use the HELOC to cover a portion of the down payment on the new home. They would pay off the HELOC when the old home sells.

HELOC interest rates are higher than those for conventional mortgages, which will somewhat offset the savings gained by having an 80% mortgage. If you intend to pay off the HELOC within a few years, this may not be a problem.

When home prices are rising, your equity will increase along with your home’s value. But in a housing market downturn, you could be left dangerously underwater with a home that’s worth less than you owe.

Example of an 80-10-10 Mortgage

The Doe family wants to purchase a home for $300,000, and they have a down payment of $30,000, which is 10% of the total home’s value. With a conventional 90% mortgage, they will need to pay PMI on top of the monthly mortgage payments. Also, a 90% mortgage will generally carry a higher interest rate. 

Instead, the Doe family can take out an 80% mortgage for $240,000, possibly at a lower interest rate, and avoid the need for PMI. At the same time, they would take out a second 10% mortgage of $30,000. This most likely would be a HELOC. The down payment will still be 10%, but the family will avoid PMI costs, get a better interest rate, and thus have lower monthly payments.

[ad_2]

Source link

Continue Reading No Comments

2/28 Adjustable-Rate Mortgage (2/28 ARM)

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

Homebuyers face may choices in types of mortgages, from longer-term fixed rate loans to shorter-term adjustable-rate loans. A 2/28 adjustable-rate mortgage is one type of adjustable rate mortgage that is less common than the traditional 30-year fixed mortgage, but it may suit some buyers’ needs.

A 2/28 mortgage essentially offers a two-year fixed interest rate followed by a floating rate for 28 years. Learn how this type of mortgage works, and more about the pros and cons.

What Is a 2/28 Adjustable-Rate Mortgage (2/28 ARM)?

A 2/28 adjustable-rate mortgage (2/28 ARM) is a type of 30-year home loan that has an initial two-year fixed interest rate period. After this two-year period, the rate floats based on an index rate plus a margin.

The initial teaser rate is typically below the average rate of conventional mortgages, but the adjustable rate can then rise significantly. Since banks don’t make much money on the initial teaser rate, 2/28 ARMs include hefty prepayment penalties during the first two years.

Key Takeaways

  • 2/28 adjustable-rate mortgages (ARMs) offer an introductory fixed rate for two years, after which the interest rate adjusts semiannually for 28 more years.
  • When ARMs adjust, interest rates change based on their marginal rates and the indexes to which they’re tied.
  • Homeowners generally have lower mortgage payments during the introductory period, but are subject to interest rate risk afterward.

Understanding 2/28 Adjustable-Rate Mortgages (2/28 ARMs)

The 2/28 ARMs became popular during the real estate boom of the early 2000s, when soaring prices put conventional mortgage payments out of reach for many buyers.

Other ARM structures exist, such as 5/1, 5/5, and 5/6 ARMs, which feature a five-year introductory period followed by a rate adjustment every five years or every six months, respectively. Notably, 15/15 ARMs adjust once after 15 years and then remain fixed for the remainder of the loan.

Less common are the 2/28 and 3/27 ARMs. With the former, the fixed interest rate applies for only the first two years, followed by 28 years of adjustable rates. With the latter, the fixed rate is for three years, with adjustments in each of the following 27 years. In these cases, rates adjust semiannually.

Example of 2/28 ARM

For example, let’s say you are buying a $350,000 home and providing a down payment of $50,000. You have a $300,000 2/28 ARM mortgage with an initial interest rate of 5% and monthly payments of $1,906. (Total monthly mortgage payments vary when property taxes and insurance costs are factored in. This example assumes $230 per month in property tax and $66 per month in insurance costs.)

With a 2/28 ARM, your interest rate of 5% remains fixed for two years. Then, it can change based on changes in a broader index rate. Let’s say your interest rate then rises to 5.3%. Your total monthly costs would rise to $1,961. Your interest rate would continue to change over the remainder of the loan depending on the broader index. So, the total costs of the loan would be difficult to estimate.

In comparison, if you had a 30-fixed mortgage on the same loan with 5% interest, you would pay $1,906 per month and you can expect to pay $279,987 in total interest if you did not pay the loan off early.

Risks of 2/28 ARMs

The risk with an adjustable-rate mortgages like an 2/28 ARM is the potential for the rate to increase. After two years, the rate is adjusted every six months, typically upward, by a margin above an index rate, such as the federal funds rate or the Secured Overnight Financing Rate (SOFR). 2/28 ARMs have some built-in safety features, such as a lifetime interest rate cap and limits on how much the rate can change with each period. But even with caps, homeowners can face significant payment spikes in volatile markets.

During the boom, many homeowners failed to understand how a seemingly small rate increase could dramatically boost their monthly payment. And even many of those who were fully aware of the risks viewed 2/28 ARMs as a short-term financing vehicle. The idea was to take advantage of the low teaser rate, then refinance after two years to either a conventional mortgage. Or, if their credit was not good enough, they would refinance to a new adjustable mortgage. Amid spiking real estate prices, this strategy kicked the debt further down the road. To many, this made a certain amount of sense since, after all, the borrower’s home equity was rising fast.

But with the market collapse in 2008, home values plummeted. Many owners with 2/28 ARMs found were unable to refinance, make their payments, or sell their homes for the value of the outstanding loan. The rash of foreclosures led to stricter loan standards. Today, banks more carefully evaluate a borrower’s ability to make adjustable-rate payments.

2/28 ARM vs. Fixed Rate Mortgage

Adjustable-rate mortgages like a 2/28 ARM work differently than fixed-rate mortgages and this difference is important to understand for planning your long-term finances.

An adjustable rate mortgage will have an interest rate that can change. That means your monthly payments can change and the overall total interest you will pay is unpredictable. Because the interest can change, you will need to prepare for the possibility that you will have to make higher monthly payments.

In contrast, interest on a fixed-rate mortgage does not change. You can plan for the same monthly payment for the life of the loan. A 2/28 ARM offers the fixed rate for only the first two years, after which the rate can adjust.

Is a 2/28 Adjustable-Rate Mortgage Right for You?

A 2/28 adjustable-rate mortgage has advantages and disadvantages that make it ideal for some buyers but not for others. Weigh the pros and cons with your own financial situation to determine if this type of mortgage is right for you.

You may benefit from a 2/28 ARM if you need a lower monthly payment at the beginning of your mortgage and if you believe you will be able to make higher monthly payments in the future. However if you can afford a higher monthly payment, you may save more money in total interest costs with other loan options, such as a 15-year fixed-rate loan.

What are the Disadvantages of an Adjustable-Rate Mortgage?

An adjustable-rate mortgage can provide lower monthly payments at the beginning of the loan, but borrowers need to prepare for the potential that their payments can increase. If the interest rate increases, then monthly costs and total borrowing costs increase.

What is a 5/1 ARM with a 30-year Term?

With a 5/1 adjustable-rate mortgage (ARM), your interest rate is fixed, or remains the same, for the first five years. Then, it adjusts once a year. When these mortgages have a 30-year term, that means you will have a fixed interest rate for five years and an adjustable rate for the next 25 years. These loans are also known as 5/1 hybrid adjustable-rate mortgages.

Can You Pay off an ARM Loan Early?

Whether you can pay off an adjustable-rate mortgage (ARM) early depends on the terms of your loan. With some ARMs, you may face a prepayment penalty if you pay the loan off early, including if you sell the home or refinance the loan.

[ad_2]

Source link

Continue Reading No Comments

3/27 Adjustable-Rate Mortgage (ARM)

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

A 3/27 adjustable-rate mortgage (ARM) is a 30-year loan that carries a fixed interest rate for the first three years, then a variable rate for the remaining 27 years. Borrowers often use a 3/27 ARM as a short-term financing vehicle that they can later refinance into a mortgage with more favorable terms.

Key Takeaways

  • A 3/27 adjustable-rate mortgage (ARM) is a 30-year mortgage with a three-year fixed interest rate period.
  • The fixed interest rate is generally lower than the current rates on 30-year conventional mortgages.
  • After three years, and for the remaining 27 years of the loan, the interest rate will float based on an index, such as the yield on one-year U.S. Treasury bills.
  • Because their monthly payments can rise significantly once the interest rate adjusts, borrowers should plan carefully before taking out a 3/27 ARM to make sure it will still be affordable.

How a 3/27 ARM Works

Adjustable-rate mortgages (ARMs) are a type of home loan in which the interest rate applied to the outstanding balance varies throughout the life of the loan. With an ARM, the initial interest rate is fixed for a period of time. After that, the rate resets periodically, at yearly, semiannual, or even monthly intervals.

ARMs differ from fixed-rate mortgages, the other primary mortgage type, which charge a set rate of interest that remains the same for the entirety of the loan.

3/27 ARMs are a kind of hybrid. For the first three years, they have a fixed interest rate, which is generally lower than the current rates on 30-year conventional mortgages. But after that, and for the remaining 27 years of the loan, their interest rate will fluctuate based on a benchmark index, such as the yield on one-year U.S. Treasury bills.

The lender also adds a margin on top of the index to set the interest rate that the borrower will actually pay. The total is known as the fully indexed interest rate. This rate is often substantially higher than the initial three-year fixed interest rate, although 3/27 ARMs usually have caps on how quickly they can increase.

Typically, the interest rate on a 3/27 ARM won’t increase more than 2% per adjustment period, which can occur every six or 12 months. That means the rate can increase by two full percentage points (not 2% of the current interest rate). So, for example, the rate might go from 4% to 6% in a single adjustment period.

There might also be a life-of-the-loan cap set at 5% or more. In that case, the interest rate on a mortgage that started at 4% might go no higher than 9%, regardless of what happens with the index on which it is based.

3/27 ARM Example

Say a borrower takes out a $250,000 3/27 ARM at an initial fixed rate of 3.5%. For the first three years, their monthly mortgage payment will be $1,123.

Then let’s assume that after three years, the benchmark interest rate is 3% and the bank’s margin is 2.5%. That adds up to a fully indexed rate of 5.5%.

If the borrower still has the 3/27 ARM and hasn’t refinanced into a different mortgage, their monthly payment will now be $1,483, an increase of $360.

To avoid payment shock when the interest rate begins to adjust, borrowers with 3/27 ARMs should aim to refinance the mortgage within the first three years.

Risks of a 3/27 ARM

The most serious risks for borrowers with a 3/27 mortgage are that they won’t be able to refinance their loan before the adjustable rate kicks in and that interest rates will have shot up in the meantime. That could happen if their credit score is too low, if their home has fallen in value, or simply if market forces have caused interest rates to rise across the board.

In that event, they would be stuck with the adjustable rate, which could mean considerably higher monthly payments, as in the example above.

ARM Prepayment Penalties

Borrowers should also be aware that ARMs, including 3/27 mortgages, may carry prepayment penalties, which can make refinancing costly and defeat the purpose of taking out an ARM with the intention of switching to a different loan in a few years.

The Consumer Financial Protection Bureau (CFPB) suggests that borrowers check the lender’s Truth in Lending Act disclosure for any prepayment penalties before they sign a contract.

“Remember, many aspects of the loan are negotiable,” the CFPB notes. “Ask for a loan that does not have a prepayment penalty if that is important to you. If you don’t like the terms of a loan and the lender won’t negotiate, you can always shop around for a different lender with terms that better suit your needs.”

Is a 3/27 ARM a Good Investment?

A 3/27 ARM could be a good choice for you if you’re looking for a loan with relatively low monthly payments for the first several years. That could make buying a home more affordable if your budget is already stretched or could give you some extra cash to spend on home repairs, furnishings, or other purposes, compared with a more expensive loan.

However, you’ll want to be reasonably certain that you’ll be in a good position to refinance by the end of the initial three-year period. That means, for example, that you’ll have a strong credit score and a reliable source of income at that point.

A 3/27 ARM is not a good idea if there’s a strong possibility that you won’t be able to refinance (or sell the home) during those first three years and the new, adjustable-rate payments would be too much for you.

FAQs

What is a 3/27 adjustable-rate mortgage (ARM)?

A 3/27 adjustable-rate mortgage (ARM) charges a fixed interest rate for the first three years, followed by a variable interest rate for the remaining 27 years. Because it combines the features of a fixed-rate mortgage and an adjustable-rate mortgage, it is sometimes referred to as a hybrid ARM.

What are the advantages of a 3/27 ARM?

A 3/27 ARM is likely to have a low interest rate for the first three years. But that rate can rise substantially starting in the fourth year.

Is a 3/27 ARM right for me?

If you plan to sell the home or refinance it within the first three years, then a 3/27 ARM might make sense for you. However, look for a 3/27 ARM without any prepayment penalties. Otherwise, a prepayment penalty could make it very costly to get out of the mortgage.

[ad_2]

Source link

Continue Reading No Comments