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Learn About Mortgages
Shopping for the right loan is just as
important as choosing the right house.
Your challenge is to select the loan
terms that are most favorable to your
situation. In selecting the loan that's
right for you, you'll need to
understand:
Basic Components of a Mortgage Loan
A mortgage requires you to pledge your
home as the lender's security for
repayment of your loan. The lender
agrees to hold the title or deed to your
property (or in some states, to hold a
lien on your title or deed) until you
have paid back your loan plus interest.
The following are the basic components
of a mortgage loan:
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Mortgage Amount and Term
The mortgage amount is the amount of
money you borrow from a lender to
pay for your house. The term is the
number of years over which you can
pay back the amount you borrow.
TIP: The length of your
mortgage repayment period will
directly affect your monthly
mortgage payments. The most
popular mortgage term is 30 years.
By extending payment over 30 years,
you keep your monthly housing costs
low. If you can afford higher
monthly payments, you can select a
mortgage term that is shorter. There
are 20-year, 15-year, and even
10-year fixed-rate mortgages
available from most mortgage
lenders. The longer your repayment
period is, the lower your monthly
payments will be, but the total
interest you pay over the life of
the loan will be more.
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Amortization
Over time, you will repay your
mortgage through regular monthly
payments of principal and interest.
During the first few years, most of
your payments will be applied toward
the interest you owe. During the
final years of your loan, your
payment amounts will be applied
primarily to the remaining
principal. This type of repayment
method is called amortization.
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Fixed or Adjustable Interest Rates
Interest rates are usually expressed
as an annual percentage of the
amount borrowed. You can choose a
mortgage with an interest rate that
is fixed for the entire term of the
loan or one that changes throughout.
A fixed-rate loan gives you the
security of knowing that your
interest rate will never change
during the term of the loan. An
adjustable-rate mortgage (called an
ARM) has an interest rate that will
vary during the life of the loan,
with the possibility of both
increases and decreases to the
interest rate and consequently to
your mortgage payments.
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Down Payment
The down payment is the part of the
purchase price the buyer pays in
cash and is not financed with a
mortgage. Your down payment will
reduce the amount you'll need to
borrow. So, the more cash you put
down, the smaller the size of your
loan, and the smaller the amount of
your mortgage payments.
TIP: Lenders often view
mortgages with larger down payments
as more secure because more of your
own money is invested in the
property. However, there are
other loans that require as little
as 3% to 5% of the purchase price
for a down payment. There are also
special programs available with $0
down payment which even allow for
sellers to pay closing costs.
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Closing Costs
The closing is the final step,
during which ownership of the home
is transferred to you. The purpose
of the closing is to make sure the
property is ready and able to be
transferred from the seller. The
closing costs (which vary from state
to state) are usually expressed as a
percentage of the sales price or
loan amount. Typically, costs range
from 3% to 6% of the price of your
home and can include transfer and
recordation fees or taxes, title
insurance, the site survey fee,
attorney fees, loan discount points,
and document preparation fees.
TIP: Sometimes you can
negotiate to have the seller pay
some of your closing costs.
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Discount Points
In the special vocabulary of
mortgage lending, "points" are a
type of fee that lenders charge.
(The full term to describe this fee
is "discount points.") Simply put, a
point is a unit of measure that
means 1% of the loan amount. So, if
you take out a $100,000 loan, one
point equals $1,000. Discount points
represent additional money you can
pay at closing to the lender to get
a lower interest rate on your loan.
TIP: Usually, the longer
you plan to stay in your home, the
more sense it makes to pay discount
points.
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Conforming and Nonconforming Loans
The term "conforming," as opposed to
"nonconforming," is sometimes used
to explain loans that offer terms
and conditions that follow the
guidelines set forth by Fannie Mae
and Freddie Mac. These are the two
private, congressionally chartered
companies that buy mortgage loans
from lenders, thereby ensuring that
mortgage funds are available at all
times in all locations around the
country. The most important
difference between a loan that
conforms to Fannie Mae/Freddie Mac
guidelines and one that doesn't is
its loan limit. If your loan amount
will be for more than the conforming
loan limit, the interest rate on
your mortgage may be higher or you
may have slightly different
underwriting requirements,
particularly in regard to your
required down payment amount. Check
with your lender about this if you
are taking out a large loan amount.
TIP: Nonconforming loans
are sometimes called jumbo loans.
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Fixed-Rate Mortgages
The interest rate may be your main
consideration if you expect to stay
in your house for a long time. With
a fixed-rate mortgage, you can be
sure that your interest rate will
stay the same for the entire life of
your loan. Fixed-rate mortgages are
available in a variety of repayment
terms, with 15, 20, and 30 years the
most common.
30-Year Fixed-Rate: The
easiest fixed-rate loan to qualify
for, the 30-year mortgage, gives you
an excellent opportunity to keep
mortgage payments reasonable by
making monthly payments over a long
period of time. This mortgage loan
may be ideal if you plan to remain
in your home for years and wish to
keep your housing expense low and
use any extra cash for other
purposes. This loan also provides
maximum interest deduction for tax
purposes.
20-Year Fixed-Rate: For those
who want a lower interest rate and
want to own their homes free of debt
sooner, this shorter mortgage
amortizes principal and interest
over just 20 years, saving a
considerable amount of total
interest paid over the life of the
loan.
15-Year Fixed-Rate: This
shorter-term mortgage will save you
a significant amount of interest
over the life of the loan. By paying
off the mortgage more quickly, you
also build up equity in your home
sooner. This may be important if you
are approaching retirement or have
other large expenses to cover, such
as financing your children's
education. However, the monthly
payments you make on a 15-year
mortgage will cost you more than
those you would make on a 30- or
20-year loan.
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Adjustable-Rate Mortgages (ARMs)
With an adjustable-rate mortgage
(ARM), the interest rate you pay is
adjusted from time to time to keep
it in line with changing market
rates. When interest rates go down,
so might your mortgage payments; but
keep in mind that your payments
could go up when interest rates are
raised. ARMs are attractive because
they may initially offer a lower
interest rate than fixed-rate
mortgages. Since the monthly
payments on an ARM start out lower
than those of a fixed-rate mortgage
of the same amount, you can qualify
for a larger loan. The chief
drawback, of course, is that your
monthly payments may increase when
interest rates rise. You may want to
consider an ARM if: You are
confident your income will rise
enough in the coming years to
comfortably handle any increase in
payments; You plan to move in a few
years and therefore are not so
concerned about possible interest
rate increases; or You need a lower
initial rate to afford to buy the
home you want. An ARM has two "caps"
or limits on how large an interest
rate increase is permitted. One cap
sets the most that your interest
rate can go up during each
adjustment period, and the other cap
sets the maximum total amount of all
interest adjustments over the life
of the loan. For example, a typical
ARM that adjusts annually may have a
yearly cap of 2%, meaning that the
adjusted interest rate can never be
more than 2% higher than the
previous year. And such an ARM may
have a lifetime rate cap of 6%,
meaning that the interest rate on
your loan will never be more than 6%
over the original rate. So, if you
are looking at an ARM with a current
introductory rate of 5%, a lifetime
cap of 6% tells you that the highest
interest rate you could ever pay
would be 11%.
TIP: Before applying for
an ARM, be sure you know how high
your monthly payments could go - the
"worst-case scenario." Only you
can determine if you would feel
comfortable paying this interest
rate sometime in the future. Your
lender can tell you which ARMs offer
a conversion feature that allows you
to convert from an adjustable rate
to a fixed rate at certain times
during the life of your loan. One
important thing to know when
comparing ARMs is that the interest
rate changes on an ARM are always
tied to a financial index. A
financial index is a published
number or percentage, such as the
average interest rate or yield on
Treasury bills.
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Government Loans and Programs
The Federal Housing Administration
(FHA), the U.S. Department of
Veterans Affairs (VA), and the Rural
Housing Services (RHS) are three
agencies that offer
government-insured loans. To obtain
these loans, you apply through a
lender that is approved to handle
them. All require that the
properties being purchased meet
certain minimum standards. Various
types of government loans include:
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FHA Loans: With FHA insurance,
you can purchase a home with a
very low down payment (from 3%
to 5% of the FHA appraisal value
or the purchase price, whichever
is lower). FHA mortgages have a
maximum loan limit that varies
depending on the average cost of
housing in a given region.
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VA Loans: The VA guarantee
allows qualified veterans to buy
a house costing up to $203,000
with no down payment. Moreover,
the qualification guidelines for
VA loans are more flexible than
those for either FHA or
conventional loans. To determine
whether you are eligible, check
with your nearest regional VA
office.
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RHS Loans: The Rural Housing
Service, a branch of the U.S.
Department of Agriculture,
offers low-interest-rate
homeownership loans with no down
payment requirements to low and
moderate-income persons who live
in rural areas or small towns.
Check with your local RHS office
or a local lender for
eligibility requirements.
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State and Local Loan Programs: A
number of states sponsor
programs to help first-time home
buyers qualify for mortgages.
Local housing agencies also
offer, in some areas, attractive
loan terms, such as low down
payments or low interest rates,
to home buyers who meet
specified income guidelines.
Some state and local programs
may also offer down payment and
closing cost assistance. Check
with your state housing
authority. You can find the
office nearest you online or
look in the government "blue
pages" of your phone book.
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Balloon
Loans
Balloon loans offer lower interest
rates for shorter term financing,
usually five, seven, or 10 years. At
the end of this term, they require
refinancing or paying off the
outstanding balance with a lump-sum
payment. Balloon mortgages may be
suitable if you plan to sell or
refinance your home within a few
years and want a fixed, low monthly
payment. The advantage they offer is
an interest rate that is lower than
that of a fully amortizing
fixed-rate mortgage. For example,
your initial interest rate may be
7.5%, and you would pay that for the
first five, seven, or 10 years
(depending on the term of your
balloon loan). Then, your entire
outstanding loan balance would be
due to the lender or you might have
to pay a fee to refinance your loan
at the prevailing interest rate. Be
sure to ask about all the conditions
for a refinance option at the end of
the balloon term. With some balloon
mortgages, the lender doesn't
guarantee to extend the loan past
the balloon date. If you don't feel
you will be able to meet all the
refinance conditions or think the
balloon term may be up before you
are ready to move, this type of loan
may not be appropriate for you.
Other Affordable Housing Loans
Fannie Mae® offers a variety of low and
moderate-income households mortgage loan
options that help overcome common
barriers to homeownership. Fannie Mae
loans require less cash at closing and
for a down payment, in addition to
flexible underwriting ratios, making it
easier for qualifying individuals to get
into a new home sooner and use more of
their monthly income toward housing
costs than permitted by other mortgage
loans.
The Minnesota Housing Finance Agency
offers low rate financing to first time
homebuyers. With assistance from
Rural Development, loans can be obtained
with $0 downpayment. This is a
very popular program in rural Minnesota.
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Contact us today
for all your
Real Estate needs.
(320) 599-4917
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