Because
a new home is probably the largest and most important purchase
you'll every make, our Mortgage Information Desk will provide
you with the information you need to make wise choices.
Mortgage Information Desk: Choosing
a Mortgage
Choosing the right loan requires consumers to review their
financial objectives and ask a host of questions, such as:
- How long do I intend to occupy the house?
- What is my tax bracket?
- How much money do I have for a down payment?
- Is paying the mortgage off early important?
- Can I or should I make extra principal payments?
- Do I want a level payment or a variable payment mortgage?
- Should I finance the closing costs in the interest rate
or the loan amount?
- Is my income projected to remain stable?
These questions are important in the loan selection process
and a loan officer or other financial advisor can help consumers
make informed decisions.
Common Loan Types and General Characteristics
Fixed Rate Fully Amortizing Loans
The most common fixed rate loans are the 15- and 30-year
mortgages. In these types of mortgages, the interest rate
and monthly payments are fixed for the term of the loan.
The payments are calculated so that upon maturity the mortgage
loan is paid in full. 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 mortgage
takes 22.5 years of level payments to pay half of the original
loan amount.
Balloon Loans
Generally, balloon loans have level monthly payments based
upon a 30-year fully amortizing schedule, but mature earlier
than 30 years. The most common balloon loans mature in 5
or 7 years. Sometimes balloon loans have features that allow
borrowers to convert the mortgage at the end of the balloon
period to a fully amortizing loan based upon the outstanding
principal balance and the current interest rates. These
loans are commonly called two-step mortgages. Generally,
the interest rate on balloon loans is lower than 30- and
15-year mortgages resulting in lower initial monthly payments.
However, after the initial balloon period, the interest
rate will adjust based upon the current market conditions.
Adjustable Rate Mortgages (ARMs)
The interest rate on ARMs adjusts periodically based upon
an established index. The monthly payment adjusts at the
same time the interest rate changes when ARMs are fully
amortizing. Some ARMs may have an interest rate adjustment,
but the monthly payment may not adjust; the difference or
"shortfall" in interest may be added to the principal
creating a Negative Amortizing Loan. In essence, the principal
balance on the loan increases rather than decreases unless
additional payments are made. ARMs have several important
elements which are detailed below:
Index: The index is a published interest
rate, such as the 1-year Treasury, 11th District Cost of
Funds, or the London Inter-Bank Rate (LIBOR). The index
is identified in the mortgage note.
Margins: The margin is a spread described
as a percentage, which generally remains fixed during the
loan. The margin is identified in the note and the current
interest rate is based upon the index plus the margin.
Interest Rate: The interest rate is based
upon the published index plus the margin. This is also known
as the fully indexed mortgage interest rate. Refer to the
index quote in the Wall Street Journal.
Periodic Interest Rate Caps: Most ARMs
have caps on the interest rate adjustments depending on
the adjustment period. Generally, a loan with a 6-month
adjustment period will have a cap of 1% while a 1-year will
have a 2% cap. However, there can be many variations of
caps depending on the lender. The periodic interest rate
cap is identified in the mortgage note
Life Cap: The life cap is the maximum
interest rate the ARM may have during its life. The life
cap is identified in the mortgage note.
Teaser Rate: Many times lenders will
offer an introductory rate that is below the fully indexed
rate.
Convertible ARMs: Sometimes lenders may
offer a fixed rate conversion feature on an ARM allowing
borrowers to convert to a fixed rate mortgage sometime in
the future.
FHA Loans: The Federal Housing Administration
(FHA) is sponsored by the U.S. Government and managed by
the Housing and Urban Development (HUD). Most of the mortgage
programs are designed for first time home buyers and low
to moderate income borrowers. FHA offers fixed rate loans
as well as ARMs. The down payment requirements of FHA loans
are generally less than a conventional loan. Maximum loans
can vary based on the metropolitan area and are established
by FHA.
VA loans: The Veterans Administration
(VA) is sponsored and managed by the U.S. Government. The
VA establishes the maximum loan amounts and eligibility
requirements. The major characteristic of a VA loan is that
there is no down payment requirement up to the maximum loan
amount.
State and Local Housing Programs: Many states, counties,
and cities provide low to moderate housing finance programs.
Most of these programs are fixed rate mortgages and have
interest rates lower than the current market.
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