I actually wrote this almost 2 years to the day at Rain City Guide. A recent track-back brought this past article back to my attention. Since I'm taking a short break from blogging and mortgage this week, I thought I'd share this oldy-but-goodie with you.
Unless you have a long term fixed rate mortgage, you should develop an exit strategy. An exit strategy is a well thought plan on how you’re [photopress:airplaneexit.jpg,thumb,alignright]going to leave your current mortgage. Every time you board an airplane, the Stewardess reviews the “exit strategy”. They’re not planning on an actual emergency landing, they are simply preparing you for a worse case scenario and informing you where the exits are and what you need to do in that event.
You should have a plan if your current mortgage is:
- Any type of adjustable rate mortgage (ARMs)
- Option ARMs (negative amortization a.k.a. deferred interest)
- Any balloon mortgages (recently common with subprime mortgages such as 2/28 or 3/36)
Having a plan (being prepared) does not mean waiting until you receive a notice from your mortgage company that your mortgage payment is hiking because your fixed period on your ARM is over. You need an exit strategy because once fixed period is over and your mortgage adjusts, odds are that your new mortgage payment will not be desirable or affordable.
You need to start developing your plan well in advance. Here’s what I recommend:
- Find the Note for your mortgage (deed of trust) and determine what your new rate may be using the worse case scenario. If you have an ARM, you can figure this out by adding the first cap to your interest rate. For example, if you currently have a 5/1 ARM with a note rate of 5% and the first adjustment rate cap is 5% (5/2/5 is a common cap structure), your new rate could be 10%. If the first adjustment cap is 2% (2/2/6 is another possibility); your new rate could be 7%. If your ARM has an interest only feature and will also be converting to amortized payments (some have longer interest only terms beyond the fixed rate period), you’re in for a double whammo if you’re keeping the mortgage.
- Determine what your worse case payment may be. Your new payment will be amortized over the remaining term of the mortgage. Use an amortization schedule to see what your mortgage balance will be at 60 months (using the 5/1 ARM scenario) and figure your payment based on the maximum possible rate amortized for 300 months. This new payment does not include taxes and insurance. In fact, anyone with an adjustable rate mortgage, regardless how long the remaining fixed term is, should contact their LO to determine what their “worse case payment” may be when their mortgage’s fixed period is over.
- While you have your Note out, review it to see if you have a prepayment penalty and when the term is over. It’s possible that you may or may not want to wait for this to expire depending on your personal circumstances. Even if you have a prepayment penalty, don’t stop preparing your exit strategy.
- Visit www.annualcreditreport.com and review your credit report. You don’t need to sign up for all the credit bureaus extra stuff. In fact, I recommend that you just use one of the bureaus to pull your information for review and select another bureau in 4 months and the last bureau in 8 months so that you are constantly reviewing your credit information.
- If you’re satisfied with the Loan Originator you worked with, contact them and ask them to review this information with you. Most Mortgage Professionals will provide Annual Reviews for their clients which includes assessing their current mortgage, examining their credit report and reviewing goals (including if you’re planning on retaining your current home and/or mortgage).
Of course selling your home is another way to exit your mortgage. In this case, I recommend that you price your home correctly. I’m noticing more “new price” signs on listings in my neighborhood of West Seattle (I guess “new price” sounds more fresh than the old “price reduced” signs). If you wait too long to work on your exit strategy, you may have to sell if you’re not able to refinance due to not being in the posititon to qualify for a new mortgage (this is why I strongly recommend meeting with your Mortgage Professional ASAP).
You cannot start too soon in preparing your exit plan. The more time you allow yourself (at least 12-24 months in advance of a rate change), the more improvements you can make to your credit scores, assets, employment and home equity. Avoid a rough landing and meet with your Mortgage Professional to work on your strategy to be in the best possible position when it’s time for you to exit your mortgage.
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