Financial Advice

Buy & Own a Home

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Understanding Mortgage Types

Today’s homebuyer has many choices. Before committing to a mortgage, talk to a mortgage professional about what is available to you and which loan type makes the most sense for your situation and future plans.

Conventional Loans

Loans under $417,000. Also known as “Conforming” loans. Down payments can be as low as 5% of the purchase price.

Jumbo Loans

These are for loan amounts greater than $417,000. Generally these loans require 20% down.

Tandem Loans

These are actually two loans. The first lien is for 80% of the sales price at market rate for 30 years. The second is a 15-year note for 5% or 10% at a slightly higher rate. Since the first lien is for 80% LTV, no mortgage insurance is required. However, there are credit score requirements to qualify for these loans.

VA Loans

Available for qualifying veterans, these loans are 100% LTV and are guaranteed by the Veteran’s Administration. The one downside: Additional VA fees can create a loan that is well above 100%.

FHA Loans

This is a “first time home buyer” loan based on its low down payment (3.5%) and the ability to use gifts from family and others for that down payment. This loan does carry a high mortgage insurance premium because of the risk associated with the low down payment.

Fixed Rate Mortgages

These loans have an interest rate that is fixed for the term of the loan. Fixed rate mortgages are a good choice when the borrower anticipates interest rates will rise over the life of the loan or wants the certainty of knowing what their payment will be. The downside: Fixed rate loans have higher rates and most people only stay in their homes 5-7 years.

Adjustable Rate Mortgages

ARMs can be conventional or jumbo loans. They have a set interest rate for the first 1, 3, 5, or 7 years. The initial rate is lower than the market rate for fixed rate mortgages. However, after the initial fixed term, these rates can adjust upward or downward depending on the mortgage market at the time. Adjustments are typically capped at a maximum of 2% per year, with a lifetime cap of 5-6%. ARM interest rate changes are tied to changes in an index rate.

Using an index to determine future rate adjustments provides you with assurance that rate adjustments will be based on actual market conditions at the time of the adjustment. The current value of most indices is published weekly in the Wall Street Journal. If the index rate moves up so does your mortgage interest rate, and you will probably have to make a higher monthly payment. On the other hand, if the index rate goes down your monthly payment may decrease.

An often used index for ARM rate adjustment is the US 10-Year Treasury Bond, often known as the “T Bill” or the “Long Bond”.

To determine the interest rate on an ARM, we'll add a pre-disclosed amount to the index called the "margin." If you're still shopping, comparing one lender's margin to another's can be more important than comparing the initial interest rate, since it will be used to calculate the interest rate you will pay in the future.

15-year Mortgages

A 15-year fixed rate mortgage gives you the ability to own your home free and clear in 15 years. And, while the monthly payments are somewhat higher than a 30-year loan, the interest rate on the 15-year mortgage is usually lower. More importantly, you'll pay less than half the total interest cost of the traditional 30-year mortgage.

The 15-year fixed rate mortgage is most popular among younger homebuyers with sufficient income to meet the higher monthly payments to pay off the house before their children start college. They own more of their home faster with this kind of mortgage, and can then begin to consider the cost of higher education for their children without having a mortgage payment to make as well. Other homebuyers, who are more established in their careers, have higher incomes and whose desire is to own their homes before they retire, may also prefer this mortgage.

While you will pay off your mortgage in half the time, and at half the interest expense, remember that your monthly payments will be about 10%-15% higher than with a 30-year loan.

Compare Loans

Loan Type Down Payment Advantages Disadvantages
Conventional 30- Year Fixed Rate 5-15% Down payment is relatively low. Your payment is fixed for 30 years.

Mortgage insurance is required.

You must escrow your taxes and insurance with the lender and must deposit monies equal to 2 months of hazard insurance and 3 months of property taxes at closing.

Conventional 15- Year Fixed Rate 5-15%

Down payment is relatively low.

Your payment is fixed for 15 Years.

The interest rate is generally.5% lower than the 30-year rate.

At the end of 10 years, you would have paid $26,000 more in monthly payments, but your loan balance would be $41,000 lower.

Mortgage insurance is required.

You must escrow your taxes and insurance with the lender and must deposit monies equal to 2 months of hazard insurance and 3 months of property taxes at closing.

Your monthly payment is about 36% higher than on a 30-year mortgage.

VA Loans -0-

No down payment makes this a great way to get into a home.

The seller, in accepting a VA contract, agrees to pay about $900 of your closing costs.

Interest rates are favorable: about the same or just under prevailing conventional rates.

You must satisfy certain requirements in length of continuous military service to be eligible.

There is a VA “funding fee” of 2% of the loan amount that is added to the loan at closing (3% if you have used your VA entitlement previously), so you end up with a 102% mortgage. This is fine as long as the market is good and values are increasing, but can be troublesome in a declining market when you might actually owe more on your home than it is worth when time to sell.

Tandem Loans 5% or 10%

An 80% first lien and a 10%, or 5% second lien allows you to avoid mortgage insurance.

The payment is generally lower than a comparable loan with mortgage insurance.

Since the second lien is for 15 years, you are paying off the principal faster, and can develop equity sooner than you would if spending the money on mortgage insurance.

You must have good credit scores and adequate income to qualify for this type of loan, since the second lien holder has virtually no security.

Jumbo Loans Minimum of 10% Down

Allows you to borrow over the $300,700 level

Interest rates are higher, from 1% to 1.5%

Credit requirements are stiffer.

With less than 20% down, you pay mortgage insurance and escrow with the lender.

Adjustable Rate Mortgages-ARMS Minimum 5%

Fixed to 1, 3, 5 or 7 years, then adjusts annually thereafter.

Initial interest rate is considerably lower than any of the conventional products.

Based on the lower rate, a buyer can qualify for a larger mortgage with the ARM.

If you are with a company that routinely transfers you every 3-5 years, this is an excellent product.

Normal adjustment maximums are set: 2% per year and 5-6% for the life of the loan.

Questions to Ask:

What is the Index?

What is the Margin? (normally 2.75% over the prevailing index rate)

What are the annual and lifetime caps?

Uncertainty is the biggest drawback.

An interest rate that started at 4.5% for the first year could climb to 6.5% the second, 8.5% the third and to 10.5% the fourth.

If your income and other debts are such that you could not withstand a $125 per month increase from Year One to Year Two, or a $262 increase from Year One to Year Three, this is not a good loan for you.