When it comes to getting a mortgage loan, homebuyers have
fewer options than they did even a couple of years ago. In the days of the real
estate boom, lenders were much more willing to float exotic loans based on
risky terms, but recently they have returned to safe and sensible home
financing.
Homebuyers hoping to jump into the mortgage market will find
three basic types of loans, for the most part.
Fixed-interest
mortgage
With a fixed-rate home loan, your interest rate remains the
same for the life of the loan and the payment is split into equal monthly
payments for the duration. In other words, it is amortized over the life of the
loan.
The interest payments are front-loaded, however, so that
during the first few years of the loan term, only a small portion of the
payment pays off the principal. To see an example of an amortization schedule,
plug in some hypothetical numbers in Bankrate's mortgage calculator.
Most commonly taken as a 30-year loan, fixed-rate mortgages
can be shorter in duration or, more rarely, longer.
"Fixed-rate home loans can be 10 years, 15 years or 20,
but most popular is the 30-year because that makes your payment the
lowest," says Floyd Walters, owner of BWA Mortgage in La Canada
Flintridge, Calif.
During the height of the real estate bubble, news broke
about even longer loan terms, with some mortgages being offered for a long as
50 years. Those may have been more of an urban myth than reality, says Walters.
"To be honest, I never saw a real offering for a
50-year mortgage. I did see just a few lenders offering a 40-year
mortgage," he says.
An extremely long mortgage term offers few advantages to
consumers.
"On a fully amortized 30-year fixed-rate loan at 5.25
percent for $250,000, the payments would be $1,380 per month. Take that same
loan out another 10 years to a 40-year note and the payments drop but only to
$1,247 per month. You save $133 per month but it adds 10 years to your note
with a net cost of an additional $100,000 or so," Walters says.
Adjustable-rate
mortgage
Unlike a fixed-rate home loan, which sports a static
interest rate over the life of the loan, the interest rate on an
adjustable-rate mortgage, or ARM, changes every year.
ARMs come in various permutations. For instance, a hybrid
ARM features aspects of both adjustable and fixed-rate mortgages.
"Hybrid mortgages can be anything from a three-year,
five-year, seven-year or 10-year fixed interest rate period," says Mark
Klein, president of Pacific Coast Lending in Agoura Hills, Calif. After the
fixed-rate period, the loan is amortized over the balance of the term with a
rate that adjusts annually.
Conversely a one-year ARM has no fixed-rate period. Though
they are still available, they're not widely offered, says Walters.
"It's hard to believe there are very many people taking
a one-year. I haven't done one for years and years. It's just not a product
that feels right," he says.
One circumstance when they might be appropriate would be in
a high fixed-rate environment.
"If I could take a one-year ARM that was 1 or 2
percentage points below what I could get as a fixed-rate mortgage, and if I
could get some interest rate caps built in, I would analyze it. If we were in a
high fixed-rate environment, it might appear more attractive," Walters
says.
Unlike a plain-vanilla fixed-rate mortgage, ARMs come with
more jargon than most people would care to know. But it's vital to understand
the index on which the rates are based, the margin amount and any interest rate
caps (provisions in the contract that limit rate increases).
Index -- An index is a published measure of the
cost of money. Lenders price home loans based on the index to which the loan
will be tied. There are several different indexes lenders use to
calculate the rate on ARMs. Some commonly used indexes are the one-year
Treasury Constant Maturity, the London Interbank Offered Rate, or Libor,
or the 11th District Cost of Funds Index, or COFI.
After the initial fixed-interest period, the rate will
adjust based on predetermined agreements in your note.
"The lender will say, 'We will fix your interest rate
at 4 percent for the next five years. At the end of five years, we will go out
and find the value of one-year Treasury bills and add a margin to that and we
will fix your interest rate on the loan for a year at a time based on that
(index and margin),'" says Walters.
Margin -- The margin is a set amount that will
be added to the index to determine the interest rate.
Cap -- The interest rate will adjust regularly,
but there is a limit to the amount it can change. Typically, there will be a
cap on the initial interest rate reset that is higher than all of the
subsequent rate adjustments, and a cap on the amount the rate can change over
the life of the loan.
"On the first adjustment with a lot of lenders, there
is a 5 percent cap on the first reset and then it goes to 2 percent a year
every year, with a lifetime cap of 5 percent over the starting interest
rate," says Walters.
Interest-only loan
For those buyers who need a rock-bottom payment for several
years, the interest-only mortgage product, as its name implies, allows them the
option of paying only the interest for the first few years of the loan.
"You can pay principal if you wish; interest-only is an
option," says Walters.
Interest-only loans are structured like an adjustable-rate
mortgage.
"The most common one is the five-year fixed 30-year
loan," says Klein. "The payment and interest rate are fixed for five
years and the payment could be based on only the interest payment, so you're
not paying down the principal. When it resets your payments can go up pretty
significantly, even if the interest rate doesn't change that much."
An interest-only loan may be appropriate for homebuyers who
believe their income will increase in the coming years -- for instance, young
families or a professional just starting out at the bottom of a potentially
lucrative field such as law or medicine.
"Who they are not good for is someone who is stretching
every dollar to get into a house and whose income is going to be relatively
flat," says Walters.
No matter what kind of loan gets you into a home, do your
homework beforehand and make sure there are no details about the mortgage loan
you don't understand.
Source: http://www.bankrate.com/finance/mortgages/3-types-of-mortgage-loans-for-home-buyers-1.aspx#ixzz31ocFLslY
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