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How To Shop For A Mortgage
With dozens of competing
lenders and mortgages to choose from, you may think that today's home loan
market is terribly confusing. It really isn't though if you know the basic facts
about financing a house. That's what this brochure is designed to give you.
Let's start with the questions that are probably uppermost in your mind. How Large A Mortgage Can I Get?
That depends upon your
income and the cost of your new house. Lenders use certain guidelines to
determine the mortgage amount that they will lend any one homebuyer. The two
guidelines used are housing expenses and long-term debt. Lenders generally say
that housing expenses (including mortgage payments, insurance, taxes and special
assessments) should not exceed 25 percent to 28 percent of the homeowner's gross
monthly income. For Federal Housing Administration (FHA) loans, this
figure is not t o exceed 29 percent of the homebuyer's gross monthly income.
With loan guaranteed by the Department of Veteran's Affairs (VA), lenders
measure prospective homebuyers with "Residual Income," or the monthly
income minus expenses. The remainder is t hen measured against geographical and
family size data to qualify the borrower. ·
FHA Loans
VA Loans
Conventional Loans
What Types Of Loans Are Available
Although you may see many different types advertised, they all belong to just two families: those mortgages that carry fixed interest rates, and those whose rates change during the course of the loan on a periodic schedule mutually agreed upon by you and your lender. This page does, however, discuss some new loans who are really "cousins" to each family-convertible mortgages.
Fixed Rate Mortgages
You are probably familiar
with a fixed-rate mortgage. Your parents more than likely had one, as did their
patent before them. The major advantage of fixed rate mortgages is that they
present predictable housing costs for the life of the loan. Some fixed-rate
mortgages you will probably hear about are:
When people thought of a
mortgage 10 to 50 years ago, they thought of a 30-year fixed-rate mortgage. This
traditional favorite is not the only choice nowadays because volatile financial
times created a whole new range of selections. However, the 30-year fixed-rate
mortgage may still be the best mortgage for your circumstances. It offers the
lowest monthly payments of fixed-rate loans, while providing for a never-
changing monthly payment schedule. Some lenders offers 25,20, and even 40-year
term mortgages as well. But remember, the longer the term of the loan, the more
total interest you will pay. The 15-year fixed-rate
mortgage allows homeowners to own their homes free and clear in half the time
and for less than half the total interest costs of the traditional 30-year loan.
The loan's term is shortened by the 10 percent to 15 percent higher monthly
payments. Some homebuyers prefer this mortgage because it allows them to own
their home before their children start college. Others prefer it because they
will own their home free and clear before retirement and probable declines in
income. The major disadvantages or the 15-year fixed-rate mortgage are the sometimes higher monthly payments. But if saving on total interest costs and cutting the to free and clear ownership are important to you, the 15-year fixed-rate mortgage is a good option. The bi-weekly mortgage shortens the loan term to 18 to 19 years by requiring a payment for half the monthly amount every two weeks. The bi-weekly payments increase the annual amount paid by about 8 percent and in effect pay 13 monthly payments(26 bi-weekly payments) per year. The shortened loan term decreases the total interest costs substantially. The interest costs for the bi-weekly mortgage are decreased even farther, however, by the application of each payment to the principal upon which the interest is calculated every 14 days. By nibbling away at the principal faster, the homeowner saves additional interest. Remember, however, that you trade lower total interest costs for fewer mortgage interest deductions on your federal income tax. Your ability to qualify for this type of loan is based on a 30-year term, and most lenders who offer this mortgage will allow the homebuyer to convert to a more traditional 30-year loan without penalty. Availability is limited on this mortgage, but it can be worth looking for.
Mortgages That Change
Some newer mortgages afford
homebuyers some the best qualities of the fixed-rate and adjustable rate
mortgages. One new type of loan, often called a Two-Step, Super Seven, or
Premier Mortgage, gives homeowners the predictability of a fixed- rate
and adjustable rate mortgage for a certain time, most often seven or 10 years,
and then the interest rate is adjusted to fit market conditions at that time.
The main advantage associated with this type of loan is that homebuyers often
get a slightly lower than market rate to begin with. The main disadvantage is
that they may see their interest rate go up by as much as six percentage points
at the end of the seven-year period. The lender may also reserve the option to
call the loan due with 30 days notice at that time, making this loan similar to
a balloon mortgage in some cases. Lenders offer this type of
loan in part because research indicates that many homebuyers remain in the home
for seven to 10 years before moving. For this type of homebuyer, the Two-Step or
Super Seven loan present an excellent way of getting a fixed- rate loan at a
better than market price for a fixed-rate loan at a better than market price for
a fixed period of time. Another type of mortgage
that is becoming popular is called a Lender Buy-down, where the homebuyer
gets an initially discounted rate and gradually increases to an agreed-upon
fixed rate over a matter of three years. For example: When the market rate is 10
percent, the fixed rate for the mortgage is set at about 10.5 percent, but the
homebuyer makes monthly payments based on a first year rate of 8.5 percent. The
second year the rate goes up to 9.5 percent, and for the third year through the
remaining life of the loan, the rate is calculated at 10.5 percent. A second
type of lender buy-down, called a Compressed Buy-down, works the same
way, but with the interest rate changing every six months instead of on a yearly
basis. The Lender Buy-down gives
consumers the advantage of lower initial monthly payments for the first two
years of the loan when extra money may be needed for furnishings and, secondly,
the advantage of knowing that, although the interest rate does change during the
first three years of the loan, the interest is fixed from the third year on. Convertible mortgages offer
today's homebuyer the option to change the loan's interest rate after some
period of time or some specified movement in interest rates. Convertible fixed-rate
mortgages are often referred to as the Reduction Option Loan (ROL) or, in
some locations, the Reducing Interest Loan (RIL), or Mortgage (RIM). This
new type of loan offers homeowners the option of getting a loan that , under the
right conditions, can be adjusted to a lower interest rate with a payment of
$100 or $200 or so and a small loan amount-based fee, sometimes as little as
one-fourth of a percentage point. These conditions usually are a prescribed
movement in rates-typically two percent below the initial- during a set time
limit-between months 13 and 59, for example. On a 30-year fixed-rate
mortgage with a reduction option, the homebuyer pays an extra one-fourth to
three-eighths of a percentage point in the interest rate on the mortgage plus a
quarter to three-eighths of 1 percent of the loan amount (points) at the time of
closing. This allows the homeowners to adjust the interest rate on the loan
without having to go through a refinancing, which could cost up to 5 percent or
6 percent of the loan amount, if the rates are right during the prescribed time
limit. On an $80,000 loan, this
means that you could reduce the interest rate on your loan from, say, 10.5
percent to 8.5 percent, and take advantage of the low rates for the rest of the
loan term for $150 instead of up to $4,800, if the rates dropped to that point
during your "window of opportunity" - months 13 through 59. Some
homeowners may find the ROL a good "insurance policy" against the high
costs of refinancing. Others may want the flexibility that refinancing offers -
namely the ability to draw on built-up equity- that is not available with ROLs.
The decision is up to you. Convertible Adjustable
Rate Mortgages (ARMs)
are another new loan product on today's market. It worked like any other ARM,
but it offers homeowners a distinct advantage-it allows them to turn their ARM
into a fixed-rate mortgage after a set period (usually during the second through
fifth years of the loan). A new product developed by
the Federal National Mortgage Association (Fannie
Mae), which buys mortgages from lenders, allows the homeowner to
convert an ARM to either a 15 or 30 year fixed-rate mortgage for a fee of 1
percent of the original loan plus $250, as compared to the 3 percent to 6
percent costs of refinancing. Say, for instance, that you got your convertible
ARM at an initial interest rate of 10.0 percent, and after a year or so, rates
had dropped to 8.0 percent. For the smaller conversion fee, you could adjust
your mortgage to either a 15 or 30 year fixed-rate loan at a new rate that would
be about one-half percent higher than the going market rate, or 8.5 percent.
There are other variations on this loan available from lenders across the
country. Homebuyers who want the low initial rate of an ARM, and the option and
peace of mind of a fixed mortgage should rates drop, can now have it both ways. Adjustable Rate Mortgages
Adjustable Rate Mortgages (ARMs)
have become on of the most popular and effective tools for helping some
prospective homebuyers achieve their dream of homeownership. Developed during a
time of high interest rates that kept many people out of the housing market, the
ARM offers lower initial rates by sharing the future risk of higher rates
between borrower and lender. ARMs can be an excellent
choice of financing under certain conditions, such as rising income
expectations, high interest rates, and short-term homeownership. But because
payments and interest rates can increase, either steadily or irregularly,
homebuyers considering this kind of mortgage need to have the income to keep up
with all possible rate and/or payment changes. Each ARM has four basic
components:
In addition to the four
basic components, an ARM usually contains certain consumer safeguards such as
interest rate caps, which limit the amount that the interest rate applied to the
payments may move. This prevents the amount of interest the consumer pays from
rising higher than perhaps the homeowner can afford. For instance, a typical ARM
would have a two-percentage point cap over the life of the loan. That means that
a loan with an initial interest rate of 9.75 percent would be able to go no
higher than 14.75 percent over the life of the loan, and it would be able to
move no more than two percentage points per year. Another safeguard found on
some ARMs are monthly payment caps that limit the amount homeowners need to
increase their payments at adjustment time. Monthly payment caps can, however,
sometimes prevent the monthly payments from increasing enough to keep up with
the rise in the interest rate, causing negative amortization, resulting in
higher or more payments for the homeowner later on. Other options you should ask
about when shopping for an ARM are:
An Option For Mature Homeowners
A relative newcomer in the
mortgage market is a Reverse Annuity Mortgage (RAM). For older Americans,
especially retirees living on fixed incomes, the equity in their paid for or
almost paid for home represents a large but liquid asset. The RAM is designed to
help supplement those homeowners' income. The lender who will issue a
RAM appraises the property and makes the loan based on a percentage of its
current value. The homeowner retains ownership, and the property secures the
loan. The lender then pays an annuity to the borrower, usually on a monthly
basis, up to an amount equal to the equity they have in the home. The advantage of such a loan
for older Americans is that of receiving a monthly tax-free income. Under one
plan, this income is available for life or until the house is sold at the
homeowner moves. The schedule of payments depends on the value of the home and
the ages of the owners. There are risks involved, however. If the homeowner
wants to move and buy a new house, there may not be enough equity in the home to
permit such a plan. Or the lender may consider only the current market value of
the home rather than any future appreciation when deciding on the monthly
payments. FHA/VA Mortgages
The
Federal Housing
Administration (FHA) and the Veterans Administration (VA) offer a wide range of
mortgage choices that may appeal to you. These include 30 and 15-year fixed rate
mortgages, as well as ARMs. Insured by these government agencies, these loans
offer low or no down payment terms. They are often assumable by future
purchasers. VA loans are restricted to individuals qualified by military service
or other entitlements, but FHA - insured loans are open to all qualified home
purchasers. Note that there are limits to handle moderate-priced homes anywhere
in the country. Talk to your lender about FHA/VA possibilities. Creative Financing or
Seller-Assisted Mortgages
This type of financing
became popular when interest rates went to very high levels in the early 1980s.
Seller-assisted creative financing usually means the seller of the home helps
with the financing by underwriting all or part of the loan. The advantage of this type
of arrangement is that the mortgage usually carries a lower interest rate with
lower monthly payments. The disadvantage is that the previous homeowner, not an
institution, may hold the deed of trust. If the loan terms call for certain
payment schedules, the buyer may have to seek new financing. Many homebuyers in
recent years have found "creative financing" deals to be fraught with
problems and useful only as short-term alternatives to mortgages from
traditional lenders. One type of mortgage you are
apt to run into with seller financing is the balloon payment mortgage. Balloons,
as they are known, are usually offered as short-term fixed-rate loans. The
balloon payment mortgage gets its name from the payment schedule, which involves
smaller payments for a certain period of time and one large payment for the
entire amount of the outstanding principal. They have terms of 3, 5, and
sometimes 15 years, though payments are usually calculated as though it were a
30-year loan. Sometimes a balloon will be offered as a second mortgage where you
also assume the homeowner's first mortgage. The major disadvantage with a
balloon payment loan is that it may be difficult to save up the money to make
the final large payment (often the entire amount of the principal) while paying
interest on the loan. Some lenders guarantee refinancing, though the interest
rate is usually adjusted when the principal comes due. If you cannot refinance,
you may have to the property if you cannot meet the large payment. Balloons are
an advantage if you plan on living in an appreciating house for a short period
of time and want to pay less while you live there. How Do You Shop Most Effectively
For A Mortgage?
There are several ways.
First, talk with your real estate agent or broker. Real estate professionals are
normally in the best position to learn about financing opportunities in the
marketplace. Lenders regularly call agents to alert them to financing packages.
And, of course, agents are highly motivated to obtain financing for their
buyers. Without a suitable loan, the sale can't proceed, and agents won't get
their sales commission on the house. Second, look for rate
surveys published by your local newspaper. Many American papers now include
brief tables on interest rates and mortgage availability in their real estate or
business section. They can help guide you to sources you have not thought about.
Third, look in the Yellow
Pages under "Mortgages," and shop for quotes by telephone. Call five
to 10 different lenders for rates and terms on fixed and adjustable loans. Finally, if your area is
covered by one of the many commercial computerized mortgage shopping services,
give it a try. You may find, however, that the computer services have only a
selection of local lenders on their listings. How Do We Evaluate Different
Loans?
One important method is by
bearing in mind that mortgage packages consist of more than interest rates. They
consist of a quoted rate, plus discount points (pre-paid interest assessed by
the lender at settlement, or the meeting when the property legally changes
hands) and other fees, plus a full range of terms including adjustable versus
fixed-rates, low down payment versus high down payment, the presence or absence
of prepayment penalties, and many other features noted earlier in this brochure.
One way to evaluate rates,
however, is by examining the Annual Percentage Rate (APR). The APR can
help you compare different types of mortgages. It indicates the "effective
rate of interest" paid per year. The figure includes discount points and
other charges and spreads them out over the life of the loan. While the APR
provides you with a common point for comparison, look at the whole product
before deciding which mortgage to get. Pick the one with the rate, payment
schedule and other terms t hat suit your situation best. Terms You Should Know
Acceleration
Clause If
you miss a monthly payment, an acceleration clause allows the lender to speed up
the rate at which your loan comes due or even to demand immediate payment of the
entire outstanding balance of the loan. Assumable
Assuming
a mortgage is simply taking the loan over from the holder (seller) and becoming
liable for the repayment. Buy-down
The
buy-down mortgage is one where the seller and/or the homebuilder subsidize the
mortgage by lowering the interest rate during the first few years of the loan.
While the lower initial payment and interest rate make this kind of loan easier
to qualify, the payments may increase when the subsidy expires. Closing
Costs/Settlement Costs/Escrow Closing
costs ate the costs associated with settlement; the meeting where the buyer and
seller (or their agents) sit down to fill out the papers and make the exchanges
that allow the property to legally change hands. Closing costs include appraisal
fees, title search and insurance, survey, tax adjustments, deed recording fees,
credit report and points, among others. Due-on
Sale Clause A
clause or provision in a mortgage or deed of trust that allows the lender to
demand immediate payment of the balance of the mortgage at the time of sale. Negative
Amortization This
occurs when your monthly payments are not large enough to pay all the interest
due on the loan. This unpaid interest is added to unpaid balance of the loan.
The danger of negative amortization is that the homebuyer could end up owing
more than the original amount of the loan. Private
Mortgage Insurance In
the event that you do not have a 20 percent down payment, lenders will allow a
smaller down payment-as low as 5 percent in some cases. With the smaller down
payment loans, however, borrowers are usually required to carry private mortgage
insurance. Private
mortgage insurance will require additional premium payment of 0.5 percent to 1.0
percent of your mortgage amount plus an additional monthly fee depending on your
loan's structure. On a $75,000 house with a 10 percent down payment, this would
mea n an initial premium payment of $338 to $675 and an extra $15 to $20 a
month.
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Send
mail to randy@randydurham.com
with questions, comments or requests for info. Copyright © 1999-2008 Randy Durham ,LLC
Licensed in TN & GA (423) 664-1900
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