You may have a difficult time deciding which type of home mortgage is the best for your needs. The world of home finance offers so many variables and options that it’s often hard to keep them straight. The following may help you better understand the differences and find a home loan that’s right for you. Fixed-Rate Mortgages are very popular because the interest rate and monthly payments are constant. Fixed loans are generally amortized over ten, fifteen, twenty or thirty years. Property taxes and homeowners insurance may increase, but generally your monthly payments will be very stable. During the early amortization period, a large percentage of the monthly payment is used for paying the interest. As the loan is paid down, more of the monthly payment is applied to principal. A typical 30 year fixed rate mortgage takes 22.5 years of level payments to pay half of the original loan amount. You may also opt for “biweekly” mortgages, which shorten the loan by making a payment every two weeks. (Since there are 52 weeks in a year, you make 26 payments, or 13 “months” worth, every year.)
Adjustable Rate Mortgage (ARM) is a loan which allows for the adjustment of its interest rate according to the terms of the note and as market interest rates change. With this type of mortgage loan program the interest rate and payments may be adjusted as frequently as every month. The purpose of the program is to allow mortgage interest rates to fluctuate with market conditions. The initial interest rate for an ARM is usually lower than that of a fixed rate mortgage, where the interest rate remains the same during the life of the loan. A lower rate means lower payments, which might help you qualify for a larger loan. Also if you do not plan to keep your home for more than a few years, the possibility of rate increases isn’t as much of a factor. But no one has a crystal ball to predict the fluctuation of interest rates, so it is somewhat of a gamble. FHA Mortgage Loan is insured by the Federal Housing Administration. FHA is part of the U.S.
Department of Housing and Urban Development (HUD), one of its chief purposes is to help people obtain financing to buy their homes. The FHA doesn’t make the loans, but insures loans made by banks, savings and loans, mortgage companies, credit unions and other approved institutions. FHA does not originate loans. FHA insures the mortgage and pays the lender if the homebuyer defaults on the loan, or fails to repay the loan. Almost anyone who has a satisfactory credit record, enough cash to close the loan, and sufficient steady income to make monthly mortgage payments can be approved for an FHA-insured mortgage. There is no upper age limit and no certain income level required, although individual mortgage amounts are limited by law.
VA Mortgage Loan is similar to the FHA mortgage. The U.S. Department of Veterans Affairs guarantees loans made by institutional lenders to eligible veterans. The guarantee helps protect the lender in the event of the borrower’s default. The VA Loan was initiated in 1944 through the Servicemen’s Readjustment Act, more commonly known as the GI Bill of Rights. The GI Bill was signed into law by President Franklin D. Roosevelt and provided veterans with a federally guaranteed home loan with no down payment. This feature was designed to provide housing and assistance for veterans and their families, and the dream of home ownership became a reality for millions of veterans. VA will guarantee a maximum of 25 percent of a home loan amount up to $104,250, which limits the maximum loan amount to $417,000. Generally, the reasonable value of the property or the purchase price, whichever is less, plus the funding fee may be borrowed. All veterans must qualify, for they are not automatically eligible for the program.
Interest-Only Mortgage is really an interest-only option that works with various mortgage types. This option has regular payments, typically monthly, for a fixed period of time; however, payments consist of one hundred percent interest. No principal is paid during the interest-only period. When that period ends, the borrower is obligated to make payments of principal and interest. Because the time remaining in the loan term to repay the principal is shorter than it would have been, payments will adjust upward, sometimes substantially. The appeal of interest-only payments is savings. When principal is not being paid, monthly payments are dramatically lower. On the risk side is potential for loss. If the need to sell arises and the property value has stayed flat or declined, a borrower might be in a position where the mortgage loan balance is higher than the market value of the property. Balloon Mortgage Loan generally has a short term, commonly anywhere from 3-7 years. During that term, borrowers make regular equal payments of principal – the amount of money borrowed – plus interest. At the end of the loan term, a “balloon” payment is due for the entire loan balance. Options for handling the balloon payment include paying off the balance when due or refinancing before the payment comes due. Balloon mortgages are usually offered at lower interest rates than other fixed-rate loans. In addition, payments are calculated using a period longer than the term of the loan. As a result, balloon loans offer affordability for short-term circumstances. Borrowers do need to plan ahead so they are not caught unprepared when the balloon payment is due.
Choosing a type of mortgage is not the only decision you must face. Several other criteria are listed below.
Hybrid Mortgage combines features of both fixed-rate and adjustable-rate mortgages. A hybrid mortgage loan may start with a rate that is fixed for a period of time. When that fixed-rate period expires, the loan then converts to an ARM. The initial rate for a hybrid mortgage loan is typically lower than prevailing fixed rates. The lower rate enables more buying power up front. On the risk side is the uncertainty of how high interest rates will be when the fixed-rate period expires.
Lending Institution are used When you’re looking for a home loan, you might work with an officer at a bank or other lending institution, or you might choose to work with a mortgage broker. The loan officers at a bank, credit union or other lending institution are employees who work to sell and process mortgages originated by their employer. They often have a wide variety of loans types to draw from, but all originate from that specific lender.
Mortgage Brokers are professionals who are paid a fee to bring together lenders and borrowers. The mortgage broker working to secure your loan is earning a fee for that transaction—and the better deal they achieve for a lender, the more they are paid. Don’t be too anxious to disclose the interest rate you would be willing to accept, let them tell you what terms they can secure. Shop around to make sure the terms are reasonable.
There should be little difference between obtaining a loan from a broker or a local lending institution. Maybe none, but you should be aware of the differences between the two positions. A mortgage broker may find you a lender in another part of the country. The loan office will likely be able to offer more personal service while your loan is being processed and once you are an established customer.
Discount Points are fees paid to a lender at closing in order to lower your mortgage interest rate. While buying points is sometimes a good decision, many times the purchase costs you more than it saves. The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000. Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 5.5 percent rate would be lowered to 5.375 percent if you purchase one point. Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan. Whether or not paying points makes sense for you depends in part on how long you plan to keep the loan.
Helpful Mortgage Terms
Adjustable Rate Mortgage is a loan with a rate that adjusts to market conditions. The rate of adjustment will be stated in the contract.
Adjustment Index is a guide lenders use to change ARM interest rates during the life of a mortgage. The specific index to which your ARM is tied to will be listed in the mortgage contract.
Annual Cap is a limit on how high the interest rate on an ARM can rise in a single year. Annual caps are specified in the better ARM programs.
Annual Percentage Rate Equals the true cost of a loan including financing charges and fees.
Amortization is the process that reduces the amount owned in a loan. It can be made in a lump sum or periodic installments.
Appraisal Value is estimating the property’s worth which is based on comparable properties. Appraisals that are completed by certified professionals, and are used by lenders to verify the home’s value and justify the mortgage commitment.
Appreciation is the increase in the property’s value, either by improvement in the market or improvements made by the owner.
Balloon Mortgage is a loan that acts like a fixed rate but is due in three, five or ten years. At that point you must pay the outstanding balance in one lump sum.
Buydown is the process of buying a lower interest rate by paying more points at closing.
Conventional Mortgage is a loan that is under $ 240,000 and meets Fannie Mae and Freddie Mac standards, the largest purchasers of home mortgages on the secondary market.
Convertible Mortgage is an ARM with the option to convert to a fixed rate mortgage as specified in the contract.
FHA Loans are issued by FHA approved lenders. The FHA insures its loans so that borrowers can get them with only 3 to 5% down payment. The FHA has certain criteria to qualify for these loans.
Fixed-rate Mortgages are self amortizing loans with a constant rate of interest. These loans are commonly for 10, 15. 20 or 30 year periods.
Interest Rate is what the lender charges for the use of their money. Expressed as an annual percentage of the amount borrowed before financing expenses.
Initial Interest Rate is what lenders charge on an ARM until the first adjustment is made. This rate is usually much lower than fixed rate mortgages.
Jumbo Mortgages are loans greater than $ 227,150 with an interest rate that is a quarter percentage higher than conventional loans.
Lifetime Cap is the same as an annual cap except there is limit on how high the interest rate can increase over the entire life of the mortgage.
Loan Commitment is a promise by the lender to provide the agreed amount of money stated on the mortgage to close on a home. The commitment also states the interest rate, term of loan, and usually expires within 60 days.
Loan Servicing is the institution that handles the administrative processing of your loan such as billing and collecting payments.
Loan-to-Value Ratio is the proportional relationship of the mortgage loan to the value of a home, expressed as a percentage.
How much do you qualify for based on typical lender requirements? Generally, the lender will require that your monthly payments not exceed 28% of your gross monthly income. Lets take a look at how a lender would typically determine your ability to meet monthly house payments.
First, determine your gross monthly income from all sources. Then multiply that amount by 28% to determine an approximate allowable monthly payment. This payment includes principal, interest, taxes and insurance. From this amount subtract taxes and insurance to arrive at your allowable principal and interest payment. You can obtain your property taxes from the local township office and you can contact your insurance agent for homeowner rates.
Now, while shopping for your mortgage, you probably have discovered the current interest rate. Use the chart below; find the column, which applies to that rate. Follow the number down until you find the number that is closest to your principal and interest payment. To the left of that you will find the loan amount for which you probably qualify. If you intend to apply for a 90% loan, divide the loan amount by .90 to calculate the price of the house that would require this monthly payment.
Broker vs. Bank
There are two primary ways to finance a mortgage, those being through a mortgage broker and through a bank. While the differences may be minor, depending upon your current situation, it may be worth it to know a bit more about each potential option. In essence, the brokers work as intermediaries between banks and lenders and on the wholesale end to source financing. On the other hand, the traditional banks and credit unions work directly with homeowners to provide retail financing. There are pros and cons for both choices, some key highlights are listed below.
Mortgage Brokers: Pros and Cons
Brokers have the ability to work with an assortment of lenders to identify loans for clients, however they do not lend money directly. As mentioned, this is the role of the lender. The lender may be an actual mortgage bank that specializes in only dealing mortgages or it could be a large commercial/community or a credit union. A positive feature of working with a broker is that that they have a variety of loans from which they can choose, thus you should request from you broker a list of his or her best options from which you can originate financing. And because they are not restricted to only one bank, they are able to leverage their connections within the industry to help find a program that may be unique to your particular needs.
One of the biggest advantages of working with a broker is that they know the industry, as it is their profession. While the normal person may only obtain a loan once or twice in a lifetime, a broker does this every day, thus they understand all of the trends and are aware of what institutions are offering the best rates. Additionally, they will handle all of the paperwork necessary to interact with these institutions, saving you time and some stress. One potential downside are the fees associated with paying a broker, as brokers typically receive payment from the lender and others charge generous fees to the borrower. Additionally, some brokers may only want to send your business to lenders with whom they have long relationships and may be disposed to source the mortgage from the financial institutions that will pay them the highest commissions.
Bank: Pros and Cons
If you are regular customer of a bank with multiple accounts, a credit card, and an auto loan, then there is a good chance that you will receive special terms on your home loan. Essentially, the longer and more extensive your relationship with the institution is, the better the terms should be, since you have proven not to be a credit risk. However, if you do not have a solid working history with a particular bank you may have to shop around, which takes time and effort. The entire process of comparing particular rates, terms, and understanding the finer points of the deal can be lengthy and somewhat confusing as the nuances of examining the mortgage products individually can be a bit overwhelming to some. Additionally, when compared to a broker, banks have fewer options available and are typically more conservative when lending to a new customer.
ARMs vs. Fixed Rate
Depending upon your unique situation, you may wonder which would be the better mortgage option for you to choose, the adjustable-rate mortgage (ARM) or fixed rate? While each financing option may have its benefits and downsides, the low upfront costs of ARMS can be very tempting, but at the same time include a level of uncertainty. The fixed rate, on the other hand, offers payment predictability, but can be a bit more expensive. Here are some quick pros and cons associated with each option:
- Lower rates and subsequent payments earlier on in the loan.
- Allows the borrower to take advantage of falling rates without having to refinance.
- Inexpensive method for borrowers to finance who don’t plan on staying in one location for too long.
- Payments and interest rate are lower than fixed rate, which will allow you to save more money and potentially buy a bigger home in the future.
- Payments can rise quickly and sharply over the life of a loan. For example, a 4% ARM can go to 9% in three years, depending upon rising interests rates.
- On negative amortization loans, you can end up having to pay more money than you did at closing because of the payment schedule. You should be careful with this option, as the lender may offer you this choice in order to make a minimum payment that doesn’t cover the interest owed. The unpaid interest will be added to the amount borrowed, which increases over time.
- ARMs can be very technical and difficult to fully comprehend, as the lender has more to work with e.g. caps, adjustment indexes, margins, etc., thus it is easy to become confused and fooled by unethical mortgage companies.
Fixed Rate: Pros
- Payments will remain constant throughout the life of the line, and there are no financial pitfalls that will surprise you, even if inflation spikes.
- Straight forward and relatively easy to understand.
- Provides predictability in your budget, if your credit is strong and you plan to stay in your new home for a while, this type of mortgage is typically the best.
Fixed Rate: Cons
- In times when interest rates are falling, you will have to refinance. This entails additional closing costs, time spent at the bank, and more paperwork.
- In times of high interest rates, can be relatively expensive for some borrowers due to the fact that there is no interest rate discount and early-on payments.
- At times, it can be somewhat more difficult to get a fixed rate loan than an ARM loan for potential buyers who do not have a solid credit score.