A Guide to Mortgages
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You'll spend more on your mortgage than you ever will on your house. Your home loan could be the biggest purchase you ever make. Doesn't it make sense to choose it carefully?
Here's an overview of the different types of home loans. Happy hunting!
Fixed Rate: Fixed-rate loans dominate the market more than ever right now, and for good reason: They're cheaper than they've been in three decades. The percentage difference between variable-rate and fixed-rate loans has narrowed, too, and the spread usually isn't enough to justify giving up all those years of fixed-rate security.
Long-term, fixed-rate loans are good for people who can comfortably qualify for the loan they want and who expect to stay in their homes for many years. But how long do you pay? Many baby boomers are now refinancing mortgages with 15-year fixed-rate loans, assuming they'll make their last payments by retirement.
For example, if you borrow $150,000, you could pay it off at 6.75 percent in 30 years at $973 a month, with total interest costs of $200,243. Or you could borrow the same amount at 6.5 percent for 15 years and pay $1,307 a month, with total interest costs of just $85,199.
Adjustable-Rate Mortgage: Borrowers who are willing to sacrifice the long-term security of a fixed-rate loan can get a lower interest rate and start with lower payments if they take an adjustable-rate mortgage (ARM). That's a particular benefit for two types of borrowers: those who expect to move within five years, and those who may want the slightly lower rate to help them qualify for the loan that puts them into the house of their dreams.
ARM borrowers, however, sacrifice simplicity. The interest rates on these mortgages rise and fall along with market interest rates, and if you're not careful, you can find your monthly payment rising higher than you can afford. Several variables determine whether an ARM is a good deal. Here are the most important ones:
- Your Index: Interest rates on ARMs are linked to several common money-related indexes that lenders use. Most common is the rate on one-year Treasury securities, but many mortgage lenders offer their customers choices. Two popular options are the often-lower (but more volatile) London InterBank Offering Rate (LIBOR) and the slightly higher but less volatile Cost of Funds Index for Western banks in the Federal Reserve's 11th District. The Wall Street Journal prints most of these rates; ask your lender where else you can look up such figures. There's no clear-cut winner; choose the index that offers you the best rate with the least volatility. You might have to accept a little more volatility if you want to get the lowest rate.
Your Frequency: How soon and how often will your rate adjust? If you expect rates to rise, you'd rather have a slower adjustment period and a longer stretch of time before it starts adjusting. Most common today are ARMs that adjust every year; you also can find those that adjust every three or even every five years.
Your Rate Cap: Most ARMs carry limits on how high their rates can be adjusted at any one time and on how high they can go overall. To evaluate an ARM, assume skyrocketing interest rates, just to make sure you can afford the bad news. A typical structure today includes a 2-percentage-point cap on annual increases, with a 6-percentage-point cap over the life of the loan. If you start with a 6 percent loan, for example, it could go up in 2 percent increments per year to 8 percent, 10 percent, and 12 percent. Once it hits 12 percent, it could go no higher. Of course, that rate would be lofty enough to double your interest.
What if you have a steady income but little down-payment cash? Enter Fannie Mae, the nation's largest source of home mortgage funds. It buys mortgage loans and creates new products designed to keep money flowing into the mortgage market.
Fannie Mae's "Flexible 97" mortgage allows borrowers to limit their down payment to 3 percent of the cost of their home, and -- unlike most lending plans -- to get that 3 percent as a gift from parents, employers, or other family members.
This is just one of many loans on the market today aimed at putting buyers into homes. Borrowers who have cash flow but little or no savings, savings but no cash flow, poor credit ratings, and other special situations can find their own best mortgages by checking the following types of loans:
Balloon Mortgages: These loans often carry monthly payments as low as those of 30-year mortgages, but they'll usually come due for payoff in five or seven years.
These can be great loans for homeowners who know they won't be staying put, but who like the certainty of a fixed rate. They're risky for someone who stays in a home beyond the term of the loan, because then the homeowner will need to find a replacement mortgage, move, or make that big balloon payment.
Hybrids: When you cross a balloon mortgage with a fixed- or adjustable-rate mortgage, you get a hybrid. These loans stay fixed for five or seven years, then convert to either fixed-rate or variable-rate mortgages. They have lower rates than fixed-rate mortgages but carry the risk of having the last 25 years of the loan being an unknown.
Again, they're good for people who like fixed payments, who need wiggle room on the rate to qualify for the loan, or who expect to move before the fixed part of the loan expires.
Low-Doc and No-Doc: "Doc" stands for documentation. If you're self-employed or have a complicated financial situation, you might shoot for one of these loans, especially if you're in a hurry to get into a particular house or if your income is rising rapidly.
Instead of asking for tax returns, business statements, and other paperwork a borrower might be expected to provide, low-doc lenders are willing to make the loan fast and easy. But it comes at a price -- maybe one-half percent more, or even a full percentage point.
These loans are for borrowers with good credit ratings who are shopping for loans worth 75 percent or less of the home's value and are willing to pay higher rates in exchange for quick-and-easy approval.