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Mortgage
Guide
Shopping
for the right loan is just as important as choosing the right
house. Your challenge is to select the loan terms that
are most favorable to your situation. In selecting the
loan that's right for you, you'll need to understand:
Basic
Components of a Mortgage Loan
A mortgage requires
you to pledge your home as the lender's security for repayment
of your loan. The lender agrees to hold the title or deed
to your property (or in some states, to hold a lien on your
title or deed) until you have paid back your loan plus interest.
The following are the
basic components of a mortgage loan:
Mortgage Amount
and Term
The mortgage amount is the amount of money you borrow from
a lender to pay for your house. The term is the number
of years over which you can pay back the amount you borrow.
TIP: The length of
your mortgage repayment period will directly affect your monthly
mortgage payments.
The most popular mortgage
term is 30 years. By extending payment over 30 years, you
keep your monthly housing costs low. If you can afford higher
monthly payments, you can select a mortgage term that is shorter.
There are 20-year, 15-year, and even 10-year fixed-rate mortgages
available from most mortgage lenders. The longer your repayment
period is, the lower your monthly payments will be, but the
total interest you pay over the life of the loan will be more.
Amortization
Over time, you will repay your mortgage through regular
monthly payments of principal and interest. During the
first few years, most of your payments will be applied toward
the interest you owe. During the final years of your loan,
your payment amounts will be applied primarily to the remaining
principal. This type of repayment method is called amortization.
Fixed or Adjustable
Interest Rates
Interest rates are usually expressed as an annual percentage
of the amount borrowed. You can choose a mortgage with
an interest rate that is fixed for the entire term of the
loan or one that changes throughout. A fixed-rate loan
gives you the security of knowing that your interest rate
will never change during the term of the loan. An adjustable-rate
mortgage (called an ARM) has an interest rate that will
vary during the life of the loan, with the possibility
of both increases and decreases to the interest rate and consequently
to your mortgage payments.
Down Payment
The down payment is the part of the purchase price the buyer
pays in cash and is not financed with a mortgage. Your
down payment will reduce the amount you'll need to borrow.
So, the more cash you put down, the smaller the size of your
loan, and the smaller the amount of your mortgage payments.
TIP: Lenders
often view mortgages with larger down payments as more secure
because more of your own money is invested in the property.
However, there are other loans that require as little as 3%
to 5% of the purchase price for a down payment.
Closing Costs
The closing (or, in some parts of the country, settlement)
is the final step, during which ownership of the home is transferred
to you. The purpose of the closing is to make sure the property
is ready and able to be transferred from the seller. The closing
costs (which vary from state to state) are usually expressed
as a percentage of the sales price or loan amount.
Typically, costs range from 3% to 6% of the price of your
home and can include transfer and recordation taxes, title
insurance, the site survey fee, attorney fees, loan discount
points, and document preparation fees.
TIP: Sometimes
you can negotiate to have the seller pay some of your
closing costs.
Discount Points
In the special vocabulary of mortgage lending, "points"
are a type of fee that lenders charge. (The full term
to describe this fee is "discount points.") Simply put, a
point is a unit of measure that means 1% of the loan amount.
So, if you take out a $100,000 loan, one point equals $1,000.
Discount points represent additional money you can pay
at closing to the lender to get a lower interest rate on your
loan. Usually, for each point on a 30-year loan, your
interest rate is reduced by about 1/8th (or .125) of a percentage
point.
TIP: Usually,
the longer you plan to stay in your home, the more sense it
makes to pay discount points.
Conforming and Nonconforming
Loans
The term "conforming," as opposed to "nonconforming," is sometimes
used to explain loans that offer terms and conditions that
follow the guidelines set forth by Fannie Mae and Freddie
Mac. These are the two private, congressionally chartered
companies that buy mortgage loans from lenders, thereby ensuring
that mortgage funds are available at all times in all locations
around the country.
The most important
difference between a loan that conforms to Fannie Mae/Freddie
Mac guidelines and one that doesn't is its loan limit.
Fannie Mae and Freddie Mac will purchase loans only up to
a certain loan limit (currently$ 252,700.00).
If your loan amount
will be for more than the conforming loan limit, the interest
rate on your mortgage may be higher or you may have slightly
different underwriting requirements, particularly in regard
to your required down payment amount. Check with your
lender about this if you are taking out a large loan amount.
TIP: Nonconforming
loans are sometimes called jumbo loans.
Fixed-Rate
Mortgages
The interest rate may
be your main consideration if you expect to stay in your house
for a long time. With a fixed-rate mortgage, you can be
sure that your interest rate will stay the same for the entire
life of your loan. Fixed-rate mortgages are available
in a variety of repayment terms, with 15, 20, and 30 years
the most common.
30-Year Fixed-Rate:
The easiest fixed-rate loan to qualify for, the 30-year mortgage,
gives you an excellent opportunity to keep mortgage payments
reasonable by making monthly payments over a long period of
time. This mortgage loan may be ideal if you plan to remain
in your home for years and wish to keep your housing expense
low and use any extra cash for other purposes. This loan also
provides maximum interest deduction for tax purposes.
20-Year Fixed-Rate:
For those who want a lower interest rate and want to own their
homes free of debt sooner, this shorter mortgage amortizes
principal and interest over just 20 years, saving a considerable
amount of total interest paid over the life of the loan.
15-Year Fixed-Rate:
This shorter-term mortgage will save you a significant amount
of interest over the life of the loan. By paying off the mortgage
more quickly, you also build up equity in your home sooner.
This may be important if you are approaching retirement or
have other large expenses to cover, such as financing your
children's education. However, the monthly payments you make
on a 15-year mortgage will cost you more than those you would
make on a 30- or 20-year loan.
Adjustable-Rate
Mortgages (ARMs)
With an adjustable-rate
mortgage (ARM), the interest rate you pay is adjusted from
time to time to keep it in line with changing market rates.
When interest rates go down, so might your mortgage payments;
but keep in mind that your payments could go up when interest
rates are raised.
ARMs are attractive
because they may initially offer a lower interest rate
than fixed-rate mortgages. Since the monthly payments
on an ARM start out lower than those of a fixed-rate mortgage
of the same amount, you can qualify for a larger loan.
The chief drawback, of course, is that your monthly payments
may increase when interest rates rise.
You may want to consider
an ARM if:
- You are confident
your income will rise enough in the coming years to
comfortably handle any increase in payments;
- You plan to move
in a few years and therefore are not so concerned about
possible interest rate increases; or
- You need a lower
initial rate to afford to buy the home you want.
An ARM has two "caps"
or limits on how large an interest rate increase is permitted.
One cap sets the most that your interest rate can go up
during each adjustment period, and the other cap sets the
maximum total amount of all interest adjustments over the
life of the loan.
For example, a typical
ARM that adjusts annually may have a yearly cap of 2%, meaning
that the adjusted interest rate can never be more than 2%
higher than the previous year. And such an ARM may have a
lifetime rate cap of 6%, meaning that the interest rate on
your loan will never be more than 6% over the original rate.
So, if you are looking at an ARM with a current introductory
rate of 5%, a lifetime cap of 6% tells you that the highest
interest rate you could ever pay would be 11%.
TIP: Before
applying for an ARM, be sure you know how high your monthly
payments could go - the "worst-case scenario." Only
you can determine if you would feel comfortable paying this
interest rate sometime in the future.
Your lender can tell
you which ARMs offer a conversion feature that allows
you to convert from an adjustable rate to a fixed rate at
certain times during the life of your loan.
One important thing
to know when comparing ARMs is that the interest rate changes
on an ARM are always tied to a financial index. A financial
index is a published number or percentage, such as the average
interest rate or yield on Treasury bills.
The following are the
most common types of ARMs:
- CD-Indexed ARMs
(Certificate of Deposit): After an initial six-month
period, the initial rate and payments adjust every six months.
These ARMs typically come with a per-adjustment cap of 1%
and a lifetime rate cap of 6%.
- Treasury-Indexed
ARMs: These are tied to the weekly average yield of
U.S. Treasury Securities adjusted to a constant maturity
of six months, one year, or three years. Likewise, the interest
rate on your ARM will adjust once every six months, once
each year, or once every three years, depending on the schedule
you choose. Per-adjustment caps and lifetime rate caps also
vary.
- Cost of Funds-Indexed
ARMs: Indexed to the actual costs that a particular
group of institutions pays to borrow money, the most popular
of this type is the COFi for the 11th Federal Home Loan
Bank District. COFi ARMs can adjust every month, every six
months, or every year, and the per-adjustment caps and lifetime
rate caps vary.
- LIBOR-Based ARMs:
The London Interbank Offered Rate is the interest rate at
which international banks lend and borrow funds in the London
Interbank market. The six-month LIBOR ARM typically has
a per-adjustment period cap of 1% and is offered with either
a 5% or a 6% lifetime rate cap.
- Initial Fixed-Period
ARMs: As protection against rapid interest rate increases
in the early years of your loan, interest rates for these
ARMs don't adjust until several years after you take out
the loan. You can choose from three, five, seven, or 10-year
fixed terms. At the end of your chosen fixed-rate period,
your interest rate would adjust every year.
Government
Loans and Programs
The Federal Housing
Administration (FHA), the U.S. Department of Veterans
Affairs (VA), and the Rural Housing Services (RHS)
are three agencies that offer government-insured loans. To
obtain these loans, you apply through a lender that is approved
to handle them. All require that the properties being purchased
meet certain minimum standards.
Various types of government
loans include:
- FHA Loans:
With FHA insurance, you can purchase a home with a very
low down payment (from 3% to 5% of the FHA appraisal
value or the purchase price, whichever is lower). FHA mortgages
have a maximum loan limit that varies depending on the average
cost of housing in a given region.
- VA Loans:
The VA guarantee allows qualified veterans to buy a house
costing up to $203,000 with no down payment. Moreover,
the qualification guidelines for VA loans are more flexible
than those for either FHA or conventional loans. To determine
whether you are eligible, check with your nearest regional
VA office.
- RHS Loans:
The Rural Housing Service, a branch of the U.S. Department
of Agriculture, offers low-interest-rate homeownership loans
with no down payment requirements to low and moderate-income
persons who live in rural areas or small towns. Check with
your local RHS office
or a local lender for eligibility requirements.
- State and Local
Loan Programs: A number of states sponsor programs to
help first-time home buyers qualify for mortgages. Local
housing agencies also offer, in some areas, attractive loan
terms, such as low down payments or low interest rates,
to home buyers who meet specified income guidelines. Some
state and local programs may also offer down payment and
closing cost assistance. Check with your state housing authority.
You can find the office nearest you online
or look in the government "blue pages" of your phone book.
Balloon
Loans
Balloon loans offer
lower interest rates for shorter term financing, usually
five, seven, or 10 years. At the end of this term, they
require refinancing or paying off the outstanding balance
with a lump-sum payment. Balloon mortgages may be suitable
if you plan to sell or refinance your home within a few years
and want a fixed, low monthly payment.
The advantage they
offer is an interest rate that is lower than that of a
fully amortizing fixed-rate mortgage. For example, your
initial interest rate may be 7.5%, and you would pay that
for the first five, seven, or 10 years (depending on the term
of your balloon loan). Then, your entire outstanding loan
balance would be due to the lender or you might have to pay
a fee to refinance your loan at the prevailing interest rate.
Be sure to ask about
all the conditions for a refinance option at the end of the
balloon term. With some balloon mortgages, the lender doesn't
guarantee to extend the loan past the balloon date. If you don't
feel you will be able to meet all the refinance conditions or
think the balloon term may be up before you are ready to move,
this type of loan may not be appropriate for you.
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