Thinking of buying a new co-op or condo in New York and unsure what type of loan to get? Traditionally, co-op and condo buyers ask for a fixed-rate mortgage—a loan in which the interest rate does not fluctuate throughout the term of repayment. The benefit of this is that it protects the borrower from possible increases of the interest rate, even during times of inflation. The downside is, these loans tend to be more expensive. Fixed-rate mortgages are cookie-cutter loans that cannot be tailored to each borrower. Financial institutions sell fixed-rate mortgages on the secondary market, which some experts see as a disadvantage. How does this work? Financial institutions pool identical mortgages with the same rates and terms. The lender groups the mortgages into a mortgage backed security (MBS) and sells it to an investor. The lender will use the assets from the sale to continue lending out money for mortgages. The U.S. Congress created Fannie Mae and Freddie Mac, the largest mortgage investors who attract the most secondary market investors. This ultimately makes the market more liquid, allowing for further investments and lower interest rates. Not all MBS pools fit into Fannie Mae and Freddie Mac’s guidelines. These MBSs are usually sold onto hedge funds and private investors. The pitfall of this system is that fixed-rate mortgages have to meet certain guidelines so that they can attract investors.
Although fixed-rate mortgages carry fewer risks, there is also an argument for obtaining adjustable-rate mortgage (ARM). An ARM, also known as a variable-rate mortgage, has a fluctuating interest rate. The benefit for borrowers is that the initial loan payments are less than in a fixed-rate mortgage. This allows borrowers to buy larger co-ops and condos then they would normally be able to afford, which ultimately attracts many first time buyers. Generally, it is more beneficial to use ARMs when there is a drop in mortgage rates and it looks like they will remain low for a while. In instances like this, borrowers purchasing a co-op or condo should look for a 5/1 or 7/1 ARM where the low interest rate is fixed for five or seven years, respectively. Because not all co-ops or condos meet the guidelines set by Fannie Mae, financial institutions offer “portfolio lending” which is essentially an adjustable rate mortgage. Quicken Loans maintains that a clear advantage of ARMs, besides their initial low mortgage rates, is that the interest rate is not guaranteed to inflate. For instance, if you obtain a 7/1 ARM, the interest rate will adjust after the first seven years, but it might drop lower.
Unlike fixed-rate mortgages, ARMs give the lender greater flexibility when determining factors such as margins, adjustments, and caps. However, this means borrowers need to pay extra attention to the terms they are agreeing to. It is important to understand how much you are paying every month and what that payment covers. For instance, although very low payments are appealing, make sure they apply to more than the initial interest in order to avoid owing more at closing.
So what are the benefits of ARMS?
Many people question whether co-ops permit purchasers to take out an ARM. Robbie Gendels, the vice president and senior loan officer at the National Cooperative Bank, says “I have never experienced a co-op or condo not approving a purchase or refinance because of the type of mortgage the borrower is taking.” When purchasing the shares of a co-op it is essential to keep in mind that you will require approval from the co-op board and bank. However, certain co-op boards maintain the right to not accept any types of refinancing. When considering what type of loan to obtain, it is imperative to be aware of the advantages and disadvantages of taking an ARM or fixed-rate mortgage. Communicate with your future co-op or condo board, they can share how other owners have financed their property.