Most people shop for a home before they shop for a mortgage.
But contrary as it may seem, that’s out of order. When you know how much you can
borrow, you’ll know how much you can spend on a house. Having this piece of information
in place will take a lot of hassle and heartache out of shopping for a new home, so
it’s best to pre-qualify for a home mortgage before you hit the open houses.
TYPES OF LOANS:
— With a fixed rate loan, your monthly payment—a combination of principal and interest—remains
the same throughout the life of the loan, no matter what happens with the economy and interest rates. The stability of a fixed rate loan is attractive, but there’s
a tradeoff. You’ll pay a slightly higher interest rate for a fixed rate loan than for an adjustable rate loan.
Fixed rate mortgages are usually offered in 30- and 15-year
terms. A 30-year mortgage will cost less per month, but you will pay more in interest over the life of the loan. If you can afford the monthly payments of a 15-year loan,
you will own your home in half the time and pay thousands of dollars less in interest.
Keep in mind, however, that while a shorter term loan will save
you money in total costs, you’ll have a smaller income tax deduction for mortgage interest. Another disadvantage to a fixed rate loan is that you will need to refinance
to take advantage of falling interest rates.. Refinancing involves additional paperwork and costs.
Adjustable Rate —
An adjustable rate mortgage (ARM) begins with a lower rate for a specified number of
months, which then fluctuates according to an index, such as the performance of the
30-year Treasury Bill rates or the LIBOR. Rates may increase every year, but most ARMs
designate a cap on how high the rate can go.
Even though they may qualify for a fixed rate loan, many people
choose the ARM because it allows them to purchase a home they may not otherwise be able
to afford. They expect their income to increase in the future to cover the growing size
of their mortgage payments.
An ARM also allows you to enjoy falling interest rates without
having to refinance. The new lower rate is simply reflected in lower premiums.
Mortgages come in many variations, with a number of different options, so you
should consult a lending professional to help you choose the right loan for your personal
How Much Down Payment Do You Need?
The rule of thumb for down payments used to be 20% of the appraised value of a home,
which meant homebuyers needed to put $20,000 cash down on the purchase of a $ 100,000
home. That’s a lot of money, especially for a first-time home-buyer.
Fortunately, the landscape has changed with the advent of Private Mortgage Insurance (PMI). PMI is insurance purchased by the home-buyer that protects the lender in the event of a default on the loan. This enables buyers with less than 20% down to qualify for a mortgage, because it eliminates risk for the lender. The downside is that PMI is expensive — for example: in most cases, buyers can discontinue paying on PMI when their equity in their home reaches 20%.
What Are Points?
Points are fees that lenders charge up front in exchange for a lower interest rate over
the life of the loan. You can usually expect to reduce your interest rate by ¼
to 1/8 of a percent for every point you pay. They are also referred to as “loan-origination
fees", “discount fees", or “buy-down charges".
One point is equal to 1% of your loan amount. So,
if you’re borrowing $150,000 and have to pay one point in fees, it will cost you
$1500. Like annual mortgage interest, points are 100% tax deductible in the year that
you pay them.
As you might suspect, there’s a way to figure
out whether it’s worth it to pay points or to take a loan at a higher interest
rate. Use our handy calculator to do the math: