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, if you know the basic facts about
financing a house. That's what this article 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 they will lend any one home buyer. 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 to exceed 29 percent of the home
buyer's gross monthly income. With loan guaranteed by the Department
of Veteran's Affairs (VA), lenders measure prospective home buyers
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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FHA Loans
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VA Loans
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Conventional Loans
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.Your lender will compute these figures for you when
you discuss the mortgage you want.
Although you may see many different types
advertised, they all belong to two families: 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 article 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 parent
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 offer 20,25, and even 40-year term mortgages as well.
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 home buyers 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.
Some newer mortgages afford home buyers some
the best qualities of the fixed-rate and adjustable rate mortgages. One
new type of loan, often called a Two-Step 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 home buyers
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 home buyers remain in the home for
seven to 10 years before moving. For this type of home buyer, the
Two-Step loan presents an excellent way of getting 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 a Lender Buydown, where the home buyer 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 home buyer 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 home
buyer 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 type of loan offers homeowners the option of getting a loan, 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 home buyer 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
(CARMs) are another loan product on today's market. It works 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 product developed by the Federal
National Mortgage Association (Fannie Mae-FNMA), 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. Home buyers 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 one of the most popular and effective tools for helping some
prospective home buyers achieve their dream of home ownership. 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.
There are several things to compare when
looking at different ARM products. If you are thinking about getting an
adjustable rate mortgage, make sure you inform yourself on how they
adjust and what it is based on.
One of the best things to use for a good
comparison is the start rate. A low start rate is always nice to have.
Just make sure you are looking at the whole picture because that nice
low rate won’t stay there for very long. They usually adjust every 6
months or every year.
ARMs can be an excellent choice of financing
under certain conditions, such as rising income expectations, high
interest rates, and short-term home ownership. Because payments and
interest rates can increase, either steadily or irregularly, home buyers
considering this kind of mortgage need their income to keep up with all
possible rate and/or payment changes. Each ARM has four basic
components:
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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.
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Adjustment interval, the time
between changes in the interest rate and/or monthly payment will be.
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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).
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Margin, 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.
It is the index plus the margin that will
determine what the interest rate will eventually be.
The Index
An ARM’s interest rate goes up and down
according to a nationally published index. The lender has no control
over the index and cannot arbitrarily adjust your rate. Your rate is
determined by the index.
The index is what the lender uses as a
reference for what it might cost to take in money that it can then lend.
Take the CD Index as an example. If a lender is currently paying 5% to
depositors for Certificates of Deposit it must then make up that cost
when it takes those funds and lends them out.
The index on an adjustable rate mortgage
will change during the time that you have the loan. So whatever the
index is at when you initially get your loan you can be sure that it
will change during the time you have your loan. An index can go up or
down depending on the current market conditions. There are several
different indexes and they are tied to different market indicators that
will change differently.
Treasury Bills
This ARM index is officially called "The
weekly average yield on U.S. Treasury securities adjusted to a constant
maturity of 1 year." It is based on the interest rate that the
government pays on some of its debt. This index is used on the majority
of ARM loans. The Treasury Bill index tends to be fast moving, which
means that when market conditions in interest rates change, they will
react to that change very quickly. This can be a good thing if rates are
going down, and not so good if rates are going up.
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