Real Estate News

Want to buy a home? Do you have the cash in the bank? If you're like most people, you probably don't. We go to banks and mortgage lenders and borrow the money to buy our homes. What would we do if those banks and mortgage lenders weren't around to sell us the money to buy our homes? The rental market would sure be booming!

In this article, we'll explain how the secret world of mortgages makes home ownership possible for so many people. We'll look at some of those confusing terms you always hear, like "escrow" and "amortization," we'll look at all the fees you pay, and we'll find out what the costs of the loan really are. You may be surprised at what you are actually paying for that modest house in the suburbs!

What is a Mortgage?
According to Webster's, a mortgage is "the pledging of property to a creditor as security for the payment of a debt." In plain terms, it is the legal contract that says if you don't pay the loan back (along with all of the fees and interest that are included with it), then the lender can have your house.

In states following the "title theory," the lender holds the title to your house until the debt is completely paid off, and the lender will sell your house in order to get the money back if you can't make your mortgage payments. In states following the "lien theory," the mortagee holds a lien on your property and can foreclose said lien and sell your property in the event you default under the mortgage.

Your down payment is the lump sum you pay up front that reduces the amount of money you have to finance. You can put as much money down as you want, or you can sometimes pay as little as 3 to 5 percent of the purchase price. The more money you put down, though, the less you have to finance and the lower your monthly payment will be.

Types of Mortgages

There are many types of mortgages you can choose from. Which type you choose usually depends on the length of time you think you'll be in your home or the other financial obligations you have. If you think you'll be there for the long haul, then you may want a fixed rate mortgage with the lowest interest rate you can get.

There may be other considerations, however. What if you have kids who are going to be entering college in 10 years? In that case, you might consider getting an adjustable rate mortgage, or a mortgage with a balloon payment so you can keep your payments low for the first few years in order to save for college. Once the kids are out of college, you can refinance at the current rate. If you don't think you'll be in your home for that long, then you may also want to look at other options.

Fixed-rate Mortgages
This mortgage offers an interest rate that will never change over the entire life of the loan. If you lock in a rate of 7 percent that calculates a payment of $1,247 per month, then you know that in 20 years you'll still be paying $1,247 per month. The only things that will change will be the property tax and any insurance payments that are included in your monthly payment.

The length (known as the term) of your fixed rate mortgage can be 15, 20 or 30 years. These terms have an affect on the various benefits you'll get from your mortgage.

30-year fixed-rate - The 30-year term gives you the maximum tax advantage by having the greatest interest deduction. While the fact that you're paying more interest may not seem like a benefit, you make lower payments with the longer term fixed-rate loan and you get a bigger tax deduction. If you will be staying in your home for many years (especially if you think your income may not increase tremendously), this may be the best option. This type of loan is also the easiest to qualify for.
20-year fixed-rate - You can shorten your mortgage by 10 years and usually get a lower interest rate with the 20-year mortgage. These aren't offered through as many banks and lenders, however, so you may have to shop around to get one. The advantage with the shorter term, besides paying your loan off sooner, is that you'll also have more equity in your home sooner than you will with a 30-year loan. Your payments will be higher, however.
15-year fixed-rate - This loan term has the same benefits as the 20-year term (i.e., quicker pay-off, higher equity, lower interest rate), but you will also have a higher monthly payment

Adjustable-rate Mortgages

Adjustable-rate mortgage
An adjustable-rate mortgage (ARM) has an interest rate that changes based on changing market rates and economic trends. They usually offer an initial interest rate that is two to three percentage points lower than fixed-rate mortgages, but they don't offer the stability or assurance of a known mortgage payment in the years to come. If you don't expect to be in your home for many years, however, an ARM may be just what you need.

How often your interest rate adjusts is determined by the terms of the loan. You may choose a six-month ARM, a one-year ARM, a two-year ARM, or some other term. There is usually an initial period of time during which the rate won't change. This might be anywhere from six months to several years. For example, a 5/1 year ARM would mean the initial interest rate would stay the same for the first five years and then would adjust each year beginning with the sixth year. A 3/3 year ARM would mean the initial interest rate would stay the same for the first three years and then would adjust every three years beginning with the fourth year.
There will also be caps, or limits to how high your interest rate can go over the life of the loan and how much it may change with each adjustment. Interim or periodic caps dictate how much the interest rate may rise with each adjustment. For example, the terms of the loan may be that the rate can go up as high as one percentage point each year depending on the market. Lifetime caps specify how high the rate can go over the life of the loan. For example, the terms of the loan might specify that the rate cannot go up by more than a total of six percentage points.
The interest rates for ARMs can be tied to one-year U.S. Treasury bills, certificates of deposit (CDs), the London Inter-Bank Offer Rate (LIBOR), or other indexes. When mortgage lenders come up with their rates for ARMs, they look at the index and add a margin of two to four percentage points. Being "tied" to these index rates means that when those rates go up, your interest goes up with it. The flip side is that if they go down, your rate also goes down. Try this ARM calculator to see how your payments might change with an adjustable rate mortgage.

Balloon Mortgage A balloon mortgage offers an initial interest rate that is lower than fixed-rate mortgages. It keeps this low fixed rate for five to seven years and then requires a "balloon" payment. The balloon payment is the final payment of the loan and pays off the entire balance.

Monthly payments are low because the payments for those first five to seven years are amortized at a low interest rate over the total length of the loan. If you plan on either selling your home, paying it off, or refinancing it before the balloon payment is due, then this type of mortgage is good deal.

Veterans Administration Loans
VA loans are designed for qualified veterans and offer more relaxed standards for qualification than either FHA loans or traditional loans. As of 2002, loans can be for amounts up to $240,000 and require no down payment.

Like FHA loans, these loans are not made by the Veterans Administration, but are simply guaranteed by the Administration.

Federal Housing Loans

Federal Housing Administration Loans
Government housing loans help lower the costs of mortgages so that more people can afford to own their own home. There are three government agencies that insure mortgages. The Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development, the Veterans Administration (VA), and the Rural Housing Service (RHS), which is a branch of the U.S. Department of Agriculture. Only approved lenders can offer these loans, and there will be required standards that the property has to meet in order to qualify.

The FHA offers a mortgage financing program that insures home loans. The FHA doesn't make the loans itself; rather, it serves as an insurance policy for lenders. Because the financial requirements for FHA loans are relaxed compared to traditional commercial loans, more people are able to afford to buy homes.

FHA insurance makes lenders more willing to work with someone who might not completely fit their usual loan qualification requirements. FHA requirements reduce the debt-to-income ratio from 28/36, which is the traditional loan requirement, to 29/41 for FHA loans (we'll discuss how this ratio works a bit later). FHA loans also require a low down payment of 5 percent or less, and allow 100 percent of the money used for the down payment and closing costs to come from a family member. Traditional loans won't allow you to borrow the money used for those payments.

There are maximum loan limits with FHA loans. These limits vary by state or region. Visit the FHA Web page to find the limit for your area.

Rural Housing Service Loans
If you live in a rural area or small town, you may qualify for a low-interest loan through the Rural Housing Service. RHS offers both guaranteed loans through approved lenders and direct loans that are government funded. These loans enable low-income families to get loans for homes.

Reverse Mortgages
Reverse mortgages pay you money as long as you live in your home. These loans are designed for people age 62 and older who own their homes and need an inflow of cash.

The loan is against the equity and isn't paid off until you sell or move out of your home. Until then, you receive regular payments in the amount set up in the terms of the loan.

Reverse mortgages are offered by state and local governments as well as banks and mortgage lenders. Shop carefully for these loans because interest rates and fees tend to be higher than in traditional mortgages. The AARP Web site offers additional information about reverse mortgages.

Conventional vs. Jumbo Loans A conventional loan is one that falls under the loan limit set by Fannie Mae or Freddie Mac. These limits change annually based on the single-family home price survey done by the Federal Housing Finance Board each October. As of 2002, a conventional loan can be up to $300,700.

Loans that are above that limit are called jumbo loans. Because jumbo loans don't offer the same Fannie Mae- and Freddie Mac-backed safety to investors as conventional loans, their interest rates tend to be higher by about 0.25 percent to 0.50 percent. When the conventional loan limit changes, the FHA loan limit usually changes along with it.