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Mortgages that didn't exist 5 years ago widen choice


There was a time Vic and Janice Warren were the perfect customers for a conventional mortgage. Solidly middle class and raising a family, they expected to own their home for many years.

With their daughter married and the couple feeling a little footloose, the Warrens were ready for a new type of mortgage. So when they refinanced their 3,300-square-foot home in Rochester Hills, Mich., recently, they chose a type of mortgage they hadn't even heard of a few years ago.

It's a two-step loan known as a 5-25, which carries a lower fixed interest rate for the first five years, then rolls over to a market rate for the remaining 25 years.

The Warrens may take out another mortgage at whatever market rate is available then, or pay off the loan.

"The thing is, I'm 56 years old, and in five years I don't know if we're going to be in the same home," says Vic Warren, vice president of CoreSource, a claims adjustment firm. "We won't need a 3,300-square-foot home for my wife and I to rattle around in."

And, he adds, their mortgage rate was a good deal. The Warrens went from a rate of about 9.75 on the old mortgage to 7 percent on a 5-25 loan. It could have been lower had they not opted to roll closing costs into the loan, which produced a slightly higher rate.

Homeowners once had two basic choices in mortgages. Most borrowers took what their lending institu tion offered -- a conventional 30-year fixed-rate loan. More adventurous borrowers tried an adjustable-rate mortgage.

Today borrowers can pick from a bewildering array of mortgages. There are loans that are part adjustable and part fixed-rate. There are mortgages that carry terms of, say, five or seven years, with an automatic rollover at the end. There are conventional mortgages with 15-year and even 10-year terms.

And all these new products offer initial interest rates anywhere from half a percentage point to nearly two full percentage points below that charged on a conventional 30-year mortgage.

"Our product mix has definitely changed to reflect these new things," says Michael Lubig, manager of the mortgage department for Standard Federal Bank, the state's largest mortgage lender.

"A lot of our customers don't particularly need the 30-year fixed. Even as recently as five years ago, a lot of the product that's out on the street, no one ever heard of," Mr. Lubig said.

Consider Carol and Joseph Kaplan of Bloomfield Hills. When they refinanced their home recently, they chose a hybrid mortgage little known yet in metro Detroit. It's called a 10-1: It carries a fixed interest rate for the first 10 years and a floating rate for the final 20, adjustable once per year.

"I think the appeal is that we probably won't be here in 10 years,so it's a great rate for that period of time," Carol Kaplan says.

Flexibility is the key to all these loans. Most people stay in their homes no more than seven or eight years on average. A loan for a shorter term carries a lower rate than a long-term mortgage. So, many experts ask, if you know you're not going to need a 30-year loan, why take it?

The important point is that these new types of loans have one key advantage over the 30-year fixed. They carry lower interest ZTC rates, so the borrower saves big -- as much as tens of thousands of dollars.

For example, compare the cost of a $60,000 loan taken for 30 years and for 10 years. At a fixed rate of 7.125 percent, the borrower would repay about $152,000 over 30 years. But with a 10-year loan, at a rate of 6.375 percent available now, the borrower would repay $83,000.

A cautionary note: When the term of the loan is shorter, the monthly payments are higher than on a 30-year fixed. In the preceding example, the borrower of the 30-year loan would have monthly payments of $422 per month; the 10-year borrower would pay back $696 per month. For those who can afford that monthly check, the savings can be huge.

With mortgage rates down to lows not seen since the 1960s, a borrower may be able to refinance an older 30-year loan into one of the newer loans at a lower rate with little if any increase in monthly payments.

"A customer's awareness . . . is much higher today than it ever has been," Mr. Lubig says.

So far, these newfangled mortgages have not exactly banished the 30-year conventional loan to oblivion.

Detroit, for example, remains a conservative market. And while the 30-year fixed-rate market is shrinking, it remains the biggest single type of loan written by many lenders -- about one-third of all mortgages.

Fixed-rate loans with shorter terms -- such as 10 or 15 years -- account for a growing slice of the business. And unusual loans like the 5-25 mortgage account for about one of every nine.

The key is to understand all the options and the advantages and drawbacks of each.

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