A mortgage is nothing more than a loan obtained to close the gap between the cash down payment and the purchase price of a home.
What is included in a monthly mortgage payment?
Most loans have 4 parts: (i) principal, which is the repayment of the amount you actually borrowed; (ii) interest, which is payment to the lender as compensation for the money you've borrowed; (iii) homeowners insurance, which is a monthly amount to insure the property against loss from fire, smoke, theft, and other hazards required by most lenders; and (iv) property taxes, which are the annual city/county taxes assessed on your property, divided by the number of mortgage payments you make in a year.
What factors affect mortgage payments?
The size of the mortgage payment will be determined by the amount of your down payment, the size of the
mortgage loan, the interest rate, the length of the repayment term and the payment schedule of the loan.
How does buying compare to renting?
Buying and renting are very different propositions. The primary advantage to renting is that you are generally free of most maintenance responsibilities and have the freedom to move without too much effort at the end of your lease period. However, by renting you lose the opportunity to build equity to increase your net worth, take advantage of available tax benefits and protect yourself against rent increases. Also, there is a very real personal satisfaction that results from owning a home -- something that is all yours and reflects your personal style.
Do all borrowers receive a tax break from owning a home?
There isn't an automatic tax credit for owning a home. However, homeowners are entitled to deduct the interest paid on a mortgage and, in some circumstances, the points paid to secure the mortgage. It is possible that the tax break may not be worth much if you buy a low-priced home. It is a good idea to hire an accountant to provide advice on the availability of various tax breaks from home ownership.
Should I use a mortgage broker or deal directly with the bank?
The advantage to using a mortgage broker is that mortgage brokers generally work with hundreds of different lenders and have access to hundreds of different loan programs. Consequently, mortgage brokers will generally have a greater ability to find a loan or lender that offers a program ideally suited to your unique needs.
You usually don't pay brokers (the bank does) and they're a good source of information. Additionally, a broker can be an enormous help in filling out the application and leading you through the loan process.
Dealing directly with a bank offers fewer options, but may sometimes be the easiest solution for a borrower, particularly if the bank is one with which the borrower has a prior relationship.
How much home can I afford?
In evaluating whether or not to approve a potential borrower, lenders focus on the three "C's" - credit (your personal credit history), collateral (the market value of the property used as security for the loan) and capacity (your financial ability to repay the loan). If one or more of these areas is inadequate, your loan may become nonconforming in nature. A nonconforming loan may require a slightly higher interest rate to adjust for the added risk associated with the loan.
Lenders use two primary qualifying ratios to determine how much a borrower can reasonably afford. The first ratio, the "front ratio," measures the total housing costs against the borrower's gross income. Generally speaking, to qualify for a conventional loan, most lenders limit the front ratio to 28%. For example, annual Income of $30,000 equals gross monthly income of $2,500. At 28%, the maximum monthly housing payment would be $700 ($2,500 x .28). The second ratio, the "back end" ratio, measures the borrower's total long-term debt (i.e., revolving debt, installment loans of longer than 11 months and housing costs) against the borrower's gross income. For most conventional loans, the back end ratio should equal no greater than 33% to 36% of the borrower's gross monthly income.
These ratios vary among lenders and most lenders will "stretch" the ratios for certain borrowers (e.g., for those with extremely impressive credit scores). Our experienced loan officers will work to find any and all methods by which we can approve a loan submission.
What is Loan to Value (LTV)?
LTV stands for loan to value. The loan to value ratio is the amount of money you borrow compared with the price or appraised value of the home you are purchasing. Each loan has a specific LTV limit. For example, with a 95% LTV loan on a home priced at $50,000, you could borrow up to $47,500 (95% of $50,000) and would pay $2,500 as a down payment.
What are escrow accounts?
Established by your lender, an escrow account is a place to set aside a portion of your monthly mortgage payment to cover annual charges for homeowners insurance, mortgage insurance (if applicable) and property taxes. Escrow accounts are a good idea because they assure money will always be available for these payments. If you utilize an escrow account to pay property tax or homeowners insurance, be certain that you are not penalized for late payments since it is the lender's responsibility to make those payments.
What is the U.S. Department of Housing and Urban Development?
Also known as HUD, the U.S. Department of Housing and Urban Development was established in 1965 to develop national policies and programs to address housing needs in the U.S. One of HUD's primary missions is to create a suitable living environment for all Americans by developing and improving the country's communities and enforcing fair housing laws.
What is RESPA?
RESPA stands for Real Estate Settlement Procedures Act. RESPA requires lenders to disclose information to potential customers throughout the mortgage process. By doing so, it protects borrowers from abuses by lending institutions. RESPA mandates that lenders fully inform borrowers about all closing costs, lender servicing and escrow account practices in addition to any business relationships between closing service providers and other parties to the transaction.
Do lenders have any responsibilities in addition to RESPA?
Lenders are not allowed to discriminate in any way against potential borrowers. If you believe a lender is refusing to provide his or her services to you on the basis of race, color, nationality, religion, sex, familial status, or disability, contact HUD's Office of Fair Housing at 1-800-669-9777 (or 1-800-927-9275 for the hearing impaired).
Can I pay off my loan ahead of schedule?
Yes. By sending in extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal loan amount. Most lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so.
The simplest way to begin the process of applying for a mortgage is to contact one of our loan professionals at (713) 524-1920 or complete our streamlined application online here. The streamlined application will take you less than 3 minutes to complete and will provide us with the basic information we'll need to assess your ability to secure a mortgage. We provide these pre-qualified services without a charge or obligation.
What does it cost to submit a loan application?
While some lenders charge an application fee to apply for a loan, we will prepare your loan application and provide you a loan pre-approval without charge or obligation.
Can I meet with a loan officer in person?
Absolutely. Our experienced mortgage loan professionals are always willing to discuss your needs and take your application in person at a time and place most convenient for you.
What documents are needed to apply for a mortgage?
The following documentation is generally needed for full-documentation loans:
Social security numbers for all borrowers
Pay stubs for the past two months
W-2 forms for the past two years
Proof of any other income
Most recent two months' bank statements
Proof of other assets (e.g., stocks or bonds)
Tax returns for the past two years
The address and/or sales contract for the property being purchased
Depending on your lender or the particular loan program you choose, you may be required to provide other supporting documentation.
What is the benefit of being pre-qualified?
Borrowers can apply and get accepted a home mortgage before searching (or while searching) for a new home. Particularly in a seller's market, being pre-qualified bolsters a buyer's bargaining position by representing to the seller that the buyer is serious and possesses the ability to close the transaction.
Do I need to choose the property I want to buy before I fill out the application?
No, you can complete a loan application first to determine how much you can borrow.
What happens after I've completed an application?
After your loan application is complete and you've worked with one of our mortgage professionals to choose a loan program that best suits your needs, it will generally take us just a few days to receive a loan approval. Upon approval, and in conjunction with the terms of your purchase agreement, a closing date will be chosen. During the time from approval to closing, we will work with you to gather the necessary documentation to complete the file.
It is not essential to have a good credit to purchase a home. However, a lender will require a higher interest rate, points and/or down payment for individuals with less than excellent credit. Additionally, if you have very poor credit, it may not be possible to obtain a loan from traditional lenders, even with a large down payment and/or at high rates.
What is a credit report?
The credit payment history of any person who has ever applied for a credit card or personal loan is recorded in a file or report. These files or reports are maintained and sold by consumer reporting agencies ("CRAs"). Each report contains detailed information about the income, debt, and credit payment history of the particular consumer.
What is the Fair Credit Reporting Act ("FCRA")?
The FCRA is a set of regulations enforced by the Federal Trade Commission. It is designed to promote accuracy and ensure the privacy of the information used in consumer credit reports.
What rights does the FCRA provide?
Pursuant to the FCRA, you have the following rights:
You have the right to receive a copy of your credit report. The copy of your report must contain all the information in your file at the time of your request.
You have the right to know the name of anyone who received your credit report in the last year for most purposes or in the last two years for employment purposes.
Any company that denies your application must supply the name and address of the CRA it contacted if the denial was based upon information supplied by that CRA.
If you have an application for credit denied because of information supplied by a CRA, you have the right to receive a free copy of your credit report. Your request must be made within 60 days of receiving your denial notice.
You have a right to add a summary explanation to your credit report if a dispute is not resolved to your satisfaction.
Can a borrower purchase a home without a credit history?
Yes. If you prefer to pay debts in cash or are too young to have established credit, there are other ways to prove your eligibility. Our loan professionals can discuss these options with you.
What is credit scoring?
Credit scoring is a system creditors utilize to determine whether to extend credit to a particular borrower. Using a statistical program, creditors compare information about the borrower to the credit performance of consumers with similar profiles. A credit scoring system awards points for each factor that predicts the likelihood of repaying debt and subtracts points for each factor that suggests the likelihood of delinquency on debt.
What are credit bureau scores and how do lenders use them?
A credit bureau score is a number, based upon your credit history, which represents the possibility that you will be able to repay a loan. Lenders use it to determine your ability to qualify for a mortgage loan. The better the score, the better your chances are of getting a loan. Ask your lender for details.
Why is credit scoring used?
Credit scoring is based on real data and statistics, so it usually is more reliable than subjective methods. It treats all applicants objectively. Subjective methods typically rely on criteria that are not systematically tested and can vary when applied by different individuals.
How is a credit scoring model developed?
To develop a model, a creditor selects a random sample of its customers or a sample of similar customers. This sample is analyzed to statistically identify characteristics that relate to creditworthiness. Then, each of these factors is assigned a weight based on how strong a predictor it is of who would be a good credit risk. Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.
Scoring models generally evaluate the following types of information in your credit report:
Have you paid your bills on time? Payment history typically is a significant factor. It is likely that your score will be affected negatively if you have paid bills late, had an account referred to collections or declared bankruptcy;
What is your outstanding debt? Many scoring models evaluate the amount of debt you have as compared to your total credit limits. If the amount you owe is close to your credit limit, that is likely to have a negative effect on your score;
How long is your credit history? Generally, models consider the length of your credit track record. An insufficient credit history may have an effect on your score, but that can be offset by other factors, such as timely payments and low balances;
Have you applied for new credit recently? Under many credit models, having an excessive number of inquiries/requests for credit may negatively impact your score.
In short, though it will take time, paying your bills on time, lowering your outstanding debt relative to your available credit and limiting your inquires for credit will improve your credit score.
How can I correct an error in my credit report?
Under the Fair Credit Reporting Act, both the Credit Reporting Agency ("CRA") and the organization that provided the information to the CRA, such as a bank or credit card company, have responsibility for correcting inaccurate or incomplete information in your report.
If you identify an inaccuracy in your report, write to both the CRA and the information provider. In your letter clearly explain the reasons why you believe the item is inaccurate. Enclose a copy of a recent credit report with the item circled as well as copies of any documents that support your position. Send your letter by certified mail, return receipt requested, so you can document what the CRA received. Keep copies of your dispute letter and enclosures.
CRAs must investigate the items in question, usually within 30 days, unless they consider your dispute frivolous. They also must forward all relevant data you provide about the dispute to the information provider. After the information provider receives notice of a dispute from the CRA, it must investigate and review all relevant information provided by the CRA and report the results to the CRA. Disputed information that cannot be verified must be deleted from your file. If an item is changed or removed, the CRA cannot put the disputed information back in your file unless the information provider verifies its accuracy and completeness and the CRA gives you a written notice that includes the name, address, and phone number of the provider. Also, if you request, the CRA must send notices of corrections to anyone who received your report in the past six months. If an investigation does not resolve your dispute, ask the CRA to include your statement of the dispute in your file and in future reports. Many providers specify an address for disputes. If the provider then reports the item to any CRA, it must include a notice of your dispute.
How can I improve my credit score?
Credit scoring models are complex and often vary among creditors and for different types of credit. If one factor changes, your score may change, but improvement generally depends on how that factor relates to other factors considered by the model. Only the particular creditor can explain what might improve your score under the particular model used to evaluate your credit application. To improve your credit score under most models, concentrate on paying your bills on time, paying down outstanding balances and not taking on new debt.
Traditionally, homebuyers have put down 20% of the purchase price of the home as a down payment. In recent years, there have been more programs offered for individuals without a lot of cash saved or individuals who would rather not tie up their cash in a down payment. These programs allow a buyer to put down less than 20% and, in some circumstances, forego a down payment altogether.
What are options for buyers who can't afford a 20% down payment?
Assuming you can afford (and qualify for) high monthly mortgage payments and have an excellent credit history, you should be able to find a low (0-15%) down payment loan. However, you may have to pay a higher interest rate and loan fees (points) than someone making a larger down payment. Also, the primary lender will require private mortgage insurance if the loan-to-value is greater than 80%.
Don't forget private sources of mortgage money for a down payment--parents, other relatives, friends or even the seller of the house you want to buy. Borrowing money privately is usually the most cost-efficient mortgage of all.
How does the size of the down payment affect the mortgage?
The more money you put into your down payment, the lower your mortgage payments will be. Additionally, if you put down enough money, you will not be required to purchase mortgage insurance, which will lower your monthly payment. see Mortgage Insurance
Can I use money from my IRA or 401(k) for the down payment?
Under the 1997 Taxpayer Relief Act, first-time homebuyers can withdraw up to $10,000 penalty free from an individual retirement account (IRA) for a down payment to purchase a principal residence. This $10,000 is a lifetime limit. The law defines a first-time homeowner as someone who hasn't owned a house for the past two years. If a couple is buying a home, both must be first-time homeowners. Ask your tax accountant for more information, or check IRS rules.
Another source of down payment money is a loan against your 401(k) plan. Ask your employer or plan administrator if your plan allows for loans. If it does, the maximum loan amount under the law is the lesser of one-half of your interest in the plan or $50,000. Other conditions, including the maximum term, the minimum loan amount, the interest rate and applicable loan fees, are set by your employer. Any loan must be repaid in a "reasonable amount of time," although the Tax Code doesn't define reasonable. Be certain to find out what happens if you leave your job before fully repaying a loan from your 401(k) plan. If a loan becomes due immediately upon your departure, income tax penalties may apply to the outstanding balance.
Interest is the compensation banks require for the use of their money. The interest rate banks will quote you is generally a percentage per year of the amount of money borrowed.
Interest rates are determined by the bond market and other financial indicators. Rates can change daily and even more than once in the same day if the markets are particularly volatile. Historically, mortgage rates are correlated with federal rates (thus, when the Fed lowers rates, lower mortgage rates will likely follow), though they are also impacted by long-range inflation forecasts.
What are points?
Some mortgage require borrowers to pay "points" on their loans. Points (also called "Discount Points") are up-front interest payments that lenders charge for processing and approving a mortgage. One point is equivalent to one percent of the total loan amount. For example, one point on a $140,000 mortgage would be $1,400. While points are money spent upfront, they can add up to a significant amount of savings over the life of the loan. Additionally, points are generally tax-deductible.
What is the difference between discount points and loan-originated points?
Discount points are prepaid interest, while originated points represent money paid to the originating lender as compensation for preparing the loan and arranging financing.
When does it make sense to pay points?
It makes sense to pay points whenever the savings over time from the lower interest rate will offset the money paid upfront to secure the lower rate. While this decision is unique to each borrower, depending on his/her tax bracket and other uses for the saved money, generally you should consider points if you intend to be in the home for at least five years.
How does the interest rate factor into securing a mortgage?
A lower interest rate will allow you to borrow more money than with a higher rate while maintaining the same monthly payment or, in the alternative, to lower your monthly payment relative to the payment that would result from borrowing the same amount of money at a higher interest rate.
What happens if interest rates decrease and I have a fixed rate loan?
If interest rates drop significantly, you may want to investigate refinancing. see Refinancing
What is the difference between a mortgage rate quoted and the APR?
The Annual Percentage Rate ("APR") is best thought of as the all-in interest rate on the loan. Along with the stated interest rate on the mortgage, the APR reflects the effect that points and closing costs have on the overall rate paid on the loan.
Is the APR an accurate measure of the cost of two different loans?
One method to compare loans with different points is to use the Annual Percentage Rate (APR), which lenders must disclose to borrowers under federal law. The APR can be misleading, however, as its method of calculating the cost of a loan as a yearly rate assumes that the loan will not be paid off until the loan term ends. While most loans are for 30 years, people generally pay off their loans before the loan term ends because they either move or refinance sooner. Also, different lenders have various ways of calculating costs included in the APR, so that a loan for the same dollar amount and number of points may have different APRs with different lenders. Still, the APR is a more accurate measure of the cost of two different loans than a simple stated interest rate.
Mortgage insurance ("MI") protects lenders against some or most of the losses that result from defaults on home mortgages. Generally, mortgage insurance is required only of borrowers making a down payment of less than 20%. Mortgage insurance premiums are generally paid monthly and typically cost less than one-half of one percent of the mortgage loan. Mortgage Insurance is also referred to as Private Mortgage Insurance ("PMI").
How does mortgage insurance work?
Like home or auto insurance, mortgage insurance requires payment of a premium, protects against loss and is utilized only in the event of an emergency. If a borrower can't repay an insured mortgage loan as agreed, the lender may foreclose on the property and file a claim with the mortgage insurer for some or most of the total losses.
Who provides mortgage insurance?
There are a handful of privately owned companies that provide mortgage insurance. These companies establish guidelines for lenders that detail the types of loans they will insure and the lenders, in turn, use the guidelines to determine borrower eligibility.
Do I have to pay mortgage insurance on the life of the loan?
With the exception of some government and older loans, you can drop PMI once the equity in your house reaches 20% and you've made timely mortgage payments.
Locks
What is a Lock-In?
A lock-in (also called a "rate-lock," "rate commitment," or simply, a "lock") is a lender's promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed.
When can I lock in an interest rate?
A loan can be locked after a property is chosen and a loan application is completed. Generally rates are locked 30 to 60 days in advance of closing, but lock periods can range from 7 to 120 days.
Are borrowers charged for locks?
Lenders will likely charge you a slightly higher interest rate on the loan for the luxury of locking the rate, though this up charge will vary among lenders and may depend upon the length of the lock-in period.
When should I lock?
The decision of when to lock your loan is similar to the decision of whether to choose a fixed-rate mortgage or an ARM. Essentially, your decision will depend on your view of the future (i.e., do you think interest rates will rise or fall in the near term) and your willingness to shoulder risk. While the lock will protect you against rate increases while you are waiting to close, it may prevent you from taking advantage of a price decrease during that time.
What happens if my lock period expires?
If your lock-in period expires, you might lose the interest rate and the number of points you had locked in. Most lenders will then offer the loan based on the prevailing interest rate and points, which may now be higher due to market conditions.
A general rule of thumb is that refinancing is worthwhile if the current interest rate on your mortgage is at least 2 percentage points higher than the prevailing market rate and you intend to be in the property for at least eighteen months. Naturally, if you will be in the property for a longer period of time and/or the drop in your interest rate will be greater, refinancing may still be a sound strategy.
Refinancing an ARM
In deciding whether to refinance an ARM you should consider the following questions:
Is the next interest rate adjustment on your existing loan likely to increase your monthly payments substantially?
Will the new interest rate on your ARM be two or three percentage points higher than the prevailing rates being offered for either fixed-rate loans or other ARMs?
If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term?
If the answer to any or all these questions is "yes," refinancing may be a wise choice.
On the day of closing (also called Settlement), closing costs are paid to various service providers by buyers and sellers of real estate. Among other items, closing costs generally include a loan origination fee, discount points, appraisal fee, title search and insurance, survey, taxes, deed recording fee and a credit report charge.
How much are closing costs?
Typically, closing costs will equal 2 to 6 percent of the purchase price of the property, with the closing costs of higher price homes being less in percentage terms (though higher in absolute dollars) since some of the closing costs are fixed amounts.
Explanation and estimate of closing costs
Because costs may vary significantly from area to area and from lender to lender, the following are estimates only. Your actual closing costs may be higher or lower than the ranges indicated below.
Application fee. This charge is imposed by a lender to cover the initial cost of processing your loan request and checking your credit report and generally costs
$200 - $350.
Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company, that insures the policy holder in a specific amount for any loss caused by discrepancies in the title to the property.
Lender's Attorney's Review Fees. The lender will generally charge you for fees paid to the lawyer or company that conducts the closing for the lender. You may also be required to pay for other legal services relating to your loan, which are provided to the lender. Additionally, you may want to retain your own attorney to represent you at all stages of the transaction.
Loan Origination Fee. The origination fee is charged for the lender's work in evaluating and preparing your mortgage loan. This fee generally costs 1% of the loan amount but may be higher for lower-priced homes.
Loan Points. Points are prepaid finance charges imposed by the lender at closing to lower the stated interest rate on the mortgage note. One point equals one percent of the loan amount.
Appraisal Fee. This fee pays for an appraisal, which is a supportable and defensible estimate or opinion of the value of the property. A standard residential appraisal typically costs $300 - $400.
Escrow fees. These fees cover document and fund handling and range from several hundred to more than a thousand dollars depending on the home's price.
Homeowners insurance. You are required to have insurance before you close on the property and some lenders may require you to pay the first year's premium at closing. The cost of homeowners insurance varies widely according to property price, geographic region and insurer.
Prepaid loan interest. Your lender can charge up to 30 days interest to cover the time from the date your loan is funded until the date you make your first mortgage payment.
Private mortgage insurance. If you put less than 20% down, you may need to buy mortgage insurance and pay a few months to a year's premium in advance.
Property taxes. Property taxes vary widely according to geographic area. In many areas around Houston, they will run approximately 2.89% of the appraised value of the property. The appraised value of the property is often, but not always, less than its market value. If you utilize available homestead exemptions, taxes will be lowered considerably further. See Property Tax Exemptions
Property Survey. A survey is a pictorial depiction of land and the improvements on it. It shows the boundary lines of the property, buildings, sheds, easements, etc. A survey will generally cost $150 to $300.
Home Inspection Fees. It is always wise to have an inspection performed on a property you're purchasing. A standard residential inspection will generally cost $175 to $350.
Recording, courier, and notary fees. These fees cover various administrative costs incurred by the lender and will generally cost less than a few hundred dollars.
What happens at Closing?
At closing, you will sit at a table with your real estate agent, the agent for the seller and a closing agent from the title company. The closing agent will have a stack of papers for you and the seller to sign. While he or she will give you a basic explanation of each paper, you may want to take the time to read each one and/or consult with your agent to make sure you know exactly what you're signing. Don't hesitate to ask questions.
You'll present your paid homeowners insurance policy or a binder and receipt showing that the premium has been paid. The closing agent will then list the money you owe the seller (remainder of down payment, prepaid taxes, etc.) and the money the seller owes you (unpaid taxes and prepaid rent, if applicable). The seller will provide proof of any inspection, warranties, etc.
After all the paperwork is signed, the seller will give you the title to the house in the form of a signed deed. You'll pay the lender's agent all closing costs and, in turn, he or she will provide you with a settlement statement of all the items for which you have paid. The deed and mortgage will then be recorded in the state Registry of Deeds, and you will be a homeowner.
What is the usual time frame to close a loan?
Most loans can close within 30 days. In most circumstances, we provide pre-approval of a loan (subject to certain conditions) within 24-48 hours.
Given the large number and variety of loan products and programs, we are generally able to find a lender and a loan program to accommodate the needs/desires of any particular borrower. You should ask yourself a few preliminary questions to help narrow your search among the many loan options available. Do you expect your finances to change over the next few years? Are you planning to live in this home for a long period of time? Are you comfortable with the idea of a changing mortgage payment amount? Do you wish to be free of mortgage debt as your children approach college age or as you prepare for retirement?
Bear in mind that choosing the particular lender and loan product for each borrower is a difficult and unique decision that is best made through consultation with a trustworthy and experienced mortgage loan professional.
Two fundamentally different types of mortgages exist, which differ with respect to how their interest rate is determined -- fixed-rate mortgages and adjustable-rate mortgages. Most borrowers choose a fixed-rate mortgage in which the interest rate stays the same for the term of the mortgage. The advantage of a fixed-rate mortgage is that you will always know exactly how much the mortgage payment will be.
Alternatively, there is the Adjustable Rate Mortgage (ARM). The interest rate and payment of an ARM may fluctuate up or down as often as once or twice a year or even as frequently as every month. Generally, these fluctuations are tied to a financial index, such as the U.S. Treasury Securities Index. In most circumstances, the initial interest rate on an ARM will be lower than a fixed-rate mortgage in order to compensate the borrower for sharing some of the lender's risk. To avoid constant and drastic changes, ARMs typically regulate (cap) how much and how often the interest rate and/or payments can change in a year and over the life of the loan. A number of variations are available for adjustable rate mortgages, including hybrids that change from a fixed to an adjustable rate after a period of years.
The interest rate on an ARM is primarily determined by what's happening overall to interest rates. When interest rates are on the rise, odds are that your ARM will experience increasing rates, thus increasing the size of your mortgage payment. Conversely, when interest rates fall, ARM interest rates and payments generally fall.
Basic Features of an ARM:
The Adjustment Period: With most ARMs the adjustment period occurs every one, three or five years, resulting in a change in your interest rate and monthly payment at such time.
The Index: Most lenders tie ARM interest rate changes to changes in an index rate. These indexes usually go up and down with the general movement of interest rates, making your monthly payment amount rise or fall accordingly.
The Margin: To determine the interest rate on an ARM, lenders add to the index rate a few percentage points (the margin) to the index. The amount of the margin can differ from one lender to another, but it is usually constant over the life of the loan.
Since interest rates and mortgage options change often, your choice of a fixed or adjustable rate mortgage should depend (i) on the interest rates and mortgage options available when you're buying a house, (ii) your view of the future (generally, high inflation will mean ARM rates will go up and lower inflation means that they will fall) and (iii) how comfortable you are bearing some risk. When mortgage rates are low, most borrowers appreciate the comfort and safety of locking in a fixed-rate. As rates move higher, many borrowers express more willingness to shoulder the risk of an ARM in the hopes of having a lower overall interest rate. Additionally, the lower initial interest rate of an ARM may allow you to qualify for a larger purchase than you would be able to qualify for otherwise.
Should I choose a 15-Year or a 30-Year mortgage?
A 30-year mortgage offers lower mortgage payments than a 15-year mortgage, which may be important to you if you are concerned with your ability to have the cash flow to support the mortgage. Also, the 30-year mortgage provides greater tax deductions since more interest is paid on the mortgage. However, since more interest is paid on the mortgage, the 30-year mortgage is a more "costly" option than the 15-year mortgage. Additionally, on a 15-year mortgage equity is built more quickly since early payments pay a greater portion of the principal balance of the loan than on a 30-year mortgage.
What types of loan programs are available through the government?
For certain qualified buyers, there are several government mortgage programs available, such as VA loans and FHA-insured loans. While these loans may be the right choice for a particular borrower's circumstances, there are many similar loan products available through conventional lenders.
VA Loans
U.S. Department of Veterans Affairs (VA) loans are available to men and women who are now in the military and to veterans (without a dishonorable discharge) who meet specific eligibility rules, most of which relate to length of service. The VA doesn't make mortgage loans, but guarantees part of the house loan made by a lender. If a borrower defaults, the VA pays the lender the amount guaranteed. Consequently, this guarantee makes it easier for veterans to receive favorable loan terms with a low down payment.
FHA Loans
Now an agency within [HUD], the Federal Housing Administration was established in 1934 to advance opportunities for Americans to own homes. By providing private lenders with mortgage insurance, the FHA gives them the security they need to lend to first-time buyers who might not be able to qualify for conventional loans. Anyone who (i) meets the credit requirements, (ii) can afford the mortgage payments and cash investment and (iii) plans to use the mortgaged property as a primary residence may apply for an FHA-insured loan. However, there are limits on FHA loans that often make them unsuitable for many borrowers.
What is a hybrid loan?
A hybrid loan is a cross between a fixed-rate loan and an ARM. Often these loans begin as fixed-rate loans for up to 10 years and then convert to ARMs.
What is a balloon mortgage?
A balloon mortgage generally offers a low rate for an initial period (usually 5, 7, or 10 years) after which time the balance is due or may be refinanced.
What is a two-step mortgage?
A loan in which the interest rate adjusts only once and remains the same thereafter for the life of the loan.
What is an interest-only loan?
Interest-only loans are an effective method of increasing your home purchasing power or maximizing your flexibility to control cash flow. You can save significant amounts of cash for investment, savings, or other expenditures during the first ten years of your loan. Additionally, this is also a solid strategy to maximize tax deductibility, with more funds available for paying down higher cost, nondeductible consumer debt.
What is a negative amortization loan?
While most adjustable rate mortgages (ARMs) adjust the payment when the interest rate changes, negative amortization ARMs have a fixed payment option even when the interest rate increases. Therefore it is possible that the total loan balance may actually grow over time.
What is a no income verification mortgage?
The No Income Verification mortgage or NIV is generally used by people with good credit histories who do not wish to document their incomes. The income is stated but not verified, thereby making this program ideal for the self-employed borrower with complicated tax returns and financial statements.
How do I structure a high-LTV loan to avoid PMI?
You can take out a second mortgage at the same time as the first and avoid PMI by having the primary lender loan 80 percent of the purchase price and the secondary lender lend some fraction of the balance. The secondary loan will carry a higher interest rate than the primary mortgage because of its increased risk (i.e., in the event of a default on the loan, the primary mortgage will be paid off first from the proceeds on the sale of the home). Though most borrowers are attracted by the ability to avoid PMI, you should be careful with this approach because a loan of this type may turn out to be more expensive than one with PMI. If you are trying to choose between the two loan programs, compare the additional interest expense of the two loans with the PMI payments. Remember, you can request cancellation of PMI when your loan-to-value reaches 80 percent so the PMI payments won't last forever.
