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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.
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 then measured against geographical and family size data to qualify the
borrower.
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Housing expenses = 29% of gross monthly income
Housing Expenses Plus Long-Term Debt = 41% of gross monthly income
- VA
LoansHousing Expenses Plus Long-Term Debt = 41% of gross monthly
income
Residual Income = Varies by location and family size
-
Housing Expenses = 25% - 28% of gross monthly income
Housing Expenses Plus Long-Term Debt = 33% - 36% of gross monthly income
Lenders
usually define long-term debt as monthly expenses extending more than 10 months
into the future. These expenses should not exceed 33 percent to 36 percent of
the homeowner's gross monthly income. VA and FHA mortgage lenders define long-
term debt as monthly income. Your lender will work out these figures for you
when you sit down to discuss the mortgage you want.
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.
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:
- 30-year
fixed-rate mortgages
- 15-year
fixed-rate mortgages
- Bi-weekly
mortgages
- "Convertible"
mortgages
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 further, 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.
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 Buydown,
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 Buydown,
works the same way, but with the interest rate changing every six months instead
of on a yearly basis.
The
Lender Buydown 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
(ROLE) 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 (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:
- Initial
interest rate, which is typically one to three percentage points lower
than that of most fixed-rate mortgages. Lower interest rates also make ARMs
somewhat easier to qualify for. The initial interest rate is tied to certain
economic indicators that dictate in part what the monthly payments will be.
- Adjustment
interval, at the time between changes in the interest rate and/or
monthly payment will be.
- Index,
against which lenders measure the difference between what they are making on
their investment in the mortgage and what they could be making on other
types of investments. The most popular index is based on the rate of return
on a one- year Treasury bill (also called T-bill).
- Margin,
or the additional amount the lender adds to the index to establish the
adjusted interest rate on an ARM. The margin is usually 1.5 percent to 2.5
percent.
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:
- Assumability,
or whether you may transfer the mortgage to a new homebuyer, usually with
the same terms if the new homebuyer qualifies for the loan. ARMs are almost
always assumable.
- Convertibility
allows the borrower to change an ARM to a fixed-rate mortgage, usually at
the end of some predetermined period, locking in a lower interest rate.
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 i s 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.
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, the loans feature low or no down payment terms and 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.
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.
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.
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.
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- 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.
-
- Assuming
a mortgage is simply taking the loan over from the holder (seller) and
becoming liable for the repayment.
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- The
buydown mortgage is one where the seller and/or the home builder
subsidizes 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.
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- 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.
-
- 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.
-
- 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.
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- 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 mean an initial premium payment of $338 to $675
and an extra $15 to $20 a month.
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