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Different types of mortgages:
There are many, many different types of mortgages. But there are two most common
types of mortgages - fixed rate and adjustable rate (ARM).
Fixed Rate Mortgage - These are also called
conventional mortgages because they have been around since the 1930's.
With this type of mortgage
your borrowing costs and monthly payments remain the same for the term of
the loan, no matter what happens to market interest rates. This
predetermined expense is one of a fixed-rate loan’s most attractive
features, since you always know exactly what your mortgage will cost you.
If interest rates rise, a fixed-rate mortgage works in your favor. But if
market rates drop, you can refinance (take out a new mortgage and pay off
your current mortgage) to get a lower rate and reduce your mortgage
costs. Fixed-rate mortgages, which are available in 15-, 20-, and 30-year
terms, are more common than adjustable-rate mortgages except in periods
when interest rates are high.
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What is
Private Mortgage Insurance?
Private mortgage
insurance (also called PMI) is insurance provided by a mortgage
insurance company to protect a lender in the event of default on a
loan. PMI is generally required when you put less than 20% down on
a mortgage. You pay for mortgage insurance on a monthly basis in
addition to the principal and interest payments that are made on a
loan. The lender then transfers the PMI payments to the insurance
company.
The bank must drop the PMI once you have built
up more than 22% in equity. Stay on top of this and make sure they
drop it when they are supposed to. If your property appreciates
you effectively have more equity in your home. If this happens you
should ask your lender if they will drop the PMI requirement based
on the new value. In order for them to drop the PMI they will most
likely require an appraisal which will cost you around $250.
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Adjustable Rate Mortgage or ARM - ARMs started out in the 1980's
(when interest rates were very high) to help more buyers qualify for
mortgages. Unlike a fixed-rate mortgage,
where interest rate remains the same for the term of the loan, the
interest rate on an ARM is adjusted, or changed, during its term. The
initial rate on an ARM is usually lower than the rate on a fixed-rate
mortgage for the same term, which means it may be easier to qualify for
an ARM. You take the risk, however, that interest rates may rise,
increasing the cost of your mortgage. The bank is willing to give a lower
mortgage interest rate because it is "protected" from higher interest
rates in the future. Of course, it's also possible that the rates may
drop, decreasing your payments.
The rate adjustments, which are based on changes in one of the publicly
reported indexes that reflect market interest rates, occur at preset
times, typically once a year but sometimes every three, five, or seven
years. Lenders determine the new rate using two measures:
1. The index - This is often a published figure, like the rate on
one-year U.S. Treasury securities. Be sure to ckeck the index because
some fluctuate more and change more rapidly than others.
2. The margin - This is a hundredths of a percentage point added
to the index to determine the new rate.
Annual and Lifetime caps:
Typically, rate changes on ARMs are capped, meaning there is a limit
on the amount the interest rate can change. The annual cap
limits the rate change each year (2 percentage points is most common),
while lifetime cap limits the change (usually 6 percent)
over the life of the loan which helps
protect you in the case of a rapid or sustained increase in market rates.
These are important details in an adjustable rate mortgage. The
adjustment period is key to the loan. How often they adjust the payment
is important because you want the longest adjustable period. Most decent ARMs have an adjustment period of one year, so your monthly payments
remain the same for a year, then increase or decrease the next year. Be
very weary of the word "discount" when looking at ARMs as this means that
the loan will most likely have a shorter adjustment period which will
lead to a higher cost in the long run. This is similar to introductory
rates on a credit card.
If you plan to be in a house for only 3-5 years, an ARM allows
you to pay lower monthly payments for those 3-5 years than a fixed interest rate
mortgage. If interest rates drop, an ARM provides a way to participate in these
lower rates without having to refinance your house. This can save you cost of
refinancing.
However, certain ARMs allow negative amortization, which means
additional interest could accumulate on the outstanding balance if market rates
rose higher than the cap. For example if interest rates rates rise 4% one year,
but your annual cap is 1%, you owe the 3% difference. The additional interest is
added to the amount of your loan. You should avoid adjustable rate mortgages with negative
amortization!
More Mortgage options:
There are many types of mortgages which are much less
common than Fixed rate or adjustable rate mortgages. Some of theses mortgage
types are described here.
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What are Jumbo Loans?
Loans that are in excess of an amount set by the Federal National Mortgage
Association (Fannie Mae). This amount is presently set at $252,700 for a single-family home,
or $323,400 for a two-family home in the continental US, in Hawaii and Alaska,
the amount is $379,050 for a single-family home or $485,100 for a two-family
home. Most commercial lenders agree to use these guidelines, which are set by
the Federal National Mortgage Association (Fannie Mae). Jumbo loans have higher
interest rates and fewer financing options, and are also called non-conforming
loans.
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Hybrid mortgage - This is a combination of fixed-rate
and ARM. Most most common ones are 3/1, 5/1, and 7/1 loans. It has a low fixed rate for the first
3, 5 or 7 years, then adjusts
yearly for the remaining 27, 25 or 23 years. Two-step mortgage of
5/25 and 7/23 from Fannie Mae do the same thing. The lower rate means it's easier to
qualify for a mortgage, since the monthly payments are lower. These mortgages are ideal
for first-time buyers and if you have a job that demands that you relocate
often. Your monthly loan payments are lower for those first years than a regular
30-year fixed loan, and when it is time to adjust to the higher rate, you can do
so at no cost. The new rate that you get after 5 or 7 years though can be high,
which is when most people decide to move.
Balloon Mortgage - A balloon style mortgage is a fixed
rate mortgage. The interest rate on this type of mortgage is generally very low.
Lower that the current going rate for a fixed rate mortgage. This interest and
payment plan lasts a specified period of time, say 5 or 10 years. At that point
the entire remaining amount of the mortgage becomes due in full. You might
choose a balloon mortgage if you anticipate refinancing at the end of the term,
if you'll have enough money to pay off the loan in a lump sum, or — less wisely
— if you can afford to buy only because of the comparatively smaller monthly
payments that may be available with a balloon mortgage. Sometimes, this type of
loan is arranged as "interest only," which means you pay only the interest on
the loan and owe the entire principal at the end of the loan term.
Biweekly mortgage - With a regular mortgage, you make twelve monthly
payments per year. With biweekly mortgage, you make payments every two weeks (to
total 26 in a year), or the equivalent of 13 payments per year. This allows you
to pay down the principal faster. Thus, substantially reducing the life of the
mortgage and the interest payable over the life of the mortgage. The problem
with this type of mortgage is that you are stuck into biweekly schedule, you
have to make those payments or face default. It's better to get a conventional
mortgage and prepay principal at your own pace and schedule.
No Document Mortgages (or Non Conforming Loans) -
A no documentation mortgage is a mortgage which does not require any
documentation of income, verification from employers and does not require tax
returns for a couple a years. If you can find a lender willing to give this type
of loan, prepare to pay BIG interest rates.
You will have to put down a larger down payment amount (25%-30%) and pay more
points at closing than other types of loans. This should be the loan of last resort!
How to choose the right mortgage:
As you can see there are variety of mortgages. If you are
planning to stay in your home for only 5 to 7 years, there is no reason for you
to get a 30 year fixed-rate loan. You'll save thousands by getting some form of
ARM or an hybrid loan, such as a 5/1 or a 7/1. If you are going to be there
longer than that, then a fixed-rate loan is probably a good idea. If you can
afford a 15 year loan instead of a 30 year loan, go with 15 year mortgage.
You'll save more than half the interest on a 30 year loan for the same amount.
Another factor to consider when choosing a loan is points and
fees. Should you pay them to get the lower interest rate or should you go with
no points, no-cost loan with a slightly higher interest rate? To find out if you
should pay points, add up the total cost of points and fees, then figure out how
much you'll save each month with the lower rate and divide it. That'll give you
how many months before it's paid off. After that the rest is savings in your
pocket. For example, lets say your total cost of your points and fees are $4,000
and if you can save $80 every month with the lower rate. It would take you 50
months to($4,000 % $100) break even. So if you are planning to stay for longer
than 50 months, you should pay the points and fees.
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What is included in a mortgage
payment?
Your monthly mortgage payment includes principal
and interest. And depending on the amount of down payment, you may
be required to have and escrow to pay property taxes as part of
your mortgage. The lender will usually hold the amounts you prepay
to cover property taxes in an interest bearing account until they
are due. If you put less than 20% in down payment on a home, the
lender will most likely require you to have an escrow.
Most lenders will also require you to keep
homeowners insurance and flood insurance in escrow to protect
their investment. This way they always know that you have the
insurance to protect the property that they are lending you money
on.
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0 to 5%
down payment with FHA & VA loans?
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