What is a mortgage?
A mortgage, is a loan, against your Home and land used as security; if you don’t pay back the loan, the lender forecloses on your home. The loan is secured by a lien against the property (your house and land). The lender doesn't own the house, you do. They just have the lien with your house as their collateral (i.e. the security).
When you are looking for a home loan, there are two important items to consider: what can you actually afford, and what can you actually borrow.
A lender looks at your income vs. your debt, as well as your savings and credit history. They're also going to look at the value of the house you want to buy, and the interest rate of the loan you'll be getting. And then they arrive at a loan amount their firm can approve.
So many kinds of mortgages?
Ask yourself a question: What is your goal? Are you going to be living in the home for 2 or 3 years? Is this the home your going to live in for 12 years? or is this the dream home for retirement? These questions will help you to determine the best type of loan to get.
Why does my length of time in the house matter?
It matters for two reasons: It will determine which type of loan is better for you, and it will dictate whether you look hardest at interest rates or at points.
If you are going to stay in your house and plan to pay off your mortgage over its lifetime, you can get a fixed rate loan where the payments will not change.
But if you know you won't be in the house long, you then can consider getting a lower interest rate on an ARM or maybe an Interest Only loan, if your in an area of high home appreciation. You'll also have the option of a hybrid ARM that is fixed for, say, five years, and then adjusts annually.
The lender may charge points, and required third parties charge for their services, which increases the cost of the loan. If you sell your home in a few years and have paid points to get a better interest rate, you may not recoup the cost of those fees. And your equity in the house will be minimal, but you are betting the home will appreciate enough to cover the fees, or that the money you save in interest will balance out the additional cost of the loan. (If you stay in the house longer than you expect, you take the risk that you can't afford the higher payments as the interest rates adjust, or you risk not being able to refinance.)
There's no free loan: You can choose between higher rates with lower points, or lower rates with higher points. The key is to compare different types of loans to see what works for your needs.
Where can I find today’s rates?
Lenders and your local bank will have the latest rates for each type of loan. Shop around for rates in your city to see who is offering the best deal locally. But be sure you are comparing the exact same loan; look at the points as well as the interest rate. It's a good idea to have each lender give you a Good Faith Estimate to show you all charges for the loan and what will be charged at close of escrow.
Why are some rates shown as a percentage and as an APR too?
The Annual Percentage Rate is what you will actually end up paying in addition to the principal. It wraps up the interest, points and fees in an effective annual rate. (When a lender quotes you a rate, it will be for interest only, so ask to see the APR.) As above, when you are using the APR to compare loans, make sure you are comparing apples to apples. You need the same loan from different lenders to make the comparison work.
What is amortization?
It is a true measure of what you are paying per year against your loan. A loan has a life ? whether it's 15, 30 ? even 50 years. You pay in installments, and the principal decreases (except in the case of interest-only loans or negative amortization until the loan is paid off by the end of the term. The payments are evenly spread over the life of the loan, with the interest payments the majority of the payment at the beginning, and then principal paid off toward the end of the term. Pay attention to the amortization schedule, which shows the payments for the life of the loan including interest.
ARM rates are tied to an index. What's an index?
An ARM loan's interest rate is determined by an index, which adjusts periodically, plus a pre-set margin (e.g., LIBOR plus 2). In general, you want to understand this because some indexes change faster than others. The more change, the more fluctuation in the ARM. Most buyers want to choose an ARM based on a stable index (especially if you suspect the economy is less than booming), or at least consider it along with all the other aspects of the loan. Ask your lender to fill you in on how the index works for your loan.
Some popular indexes include:
- T-Bills, the federal government's treasury bill index; the most commonly used
- LIBOR (London Interbank Offered Rate Index), based on international rates
- COFI (11th District Cost of Funds Index), based on a moving average of rates
- Prime Lending Rate
What else should I watch out for?
Prepayment penalties. Think it's a good thing to pay off a loan? Well, it might be, but certain lenders charge a penalty if you do. Penalties apply for a specific period of time, usually 1, 2, or 3 years after the loan is originated. How much is the penalty? Could be six months of interest or 2 percent of the principal remaining on the loan, but it varies.
You might wonder why would I get a loan with a prepayment penalty, but some lenders offer very low interest rates in exchange. Also, some borrowers agree to loans with penalties if they have bad credit and it's the only way they can get the loan. You need to ask if the prepayment penalty is hard or soft? A Soft prepayment penalty allows you certain conditions to sell the home without the penalty but if you were to refinance then the prepayment penalty would come into play. Discuss all the options with your mortgage consultant.
What's a traditional vs. non-traditional loan?
Non-traditional loans include:
- Interest only loans mean the buyer pays no principal and only interest for a period of time. Payments are low because the buyer is not paying anything down on the principal, though he can if he wants (though few do). If this is a short-term loan, buyers can benefit from the reduced payments ? it enables them to borrow more in the loan amount. But it all depends on the length of the interest-only period; the shorter the better.
- Payment-option ARMs let the buyer choose from a selection of payments: negative amortization [link to negative amortization glossary page], interest only, or fully amortized. The buyer has to be careful not to pile up an even higher debt by always choosing the lowest payment.
- Zero-down loans do not require a down payment, so the loan amount, as a percentage of the purchase price, is usually higher than the Fannie Mae guidelines; if the borrower gets a second mortgage to cover the amount above the guidelines, it's called a "piggyback loan" or a "purchase money second mortgage." Ditto if the borrower does not have enough for a down payment, and gets two mortgages instead.
Traditional loans are those where the principal and interest are paid in an agreed-upon payment schedule, with a down payment that fits within the usual parameters. Fixed and conventional ARM loans fall into that description.
What's mortgage insurance? Do I need it?
If you are making a down payment of less than 20 percent, you will most likely have to get Private Mortgage Insurance (or PMI). It ensures that the lender is guaranteed, by the mortgage insurer, 80 percent of the loan if you default. The insurance premium amount varies by the loan to value of the house and type of loan. Another option is to get a second mortgage to use for part of the down payment. For example, you can get an 80/10/10 loan (80 percent loan, 10 percent second mortgage, and 10 percent down) or a variation thereof and avoid paying PMI.
Government loan programs, such as FHA or VA loans, are backed by the government rather than PMI.