Loans & Mortgages
Sound advice for financing your home
Making wise financial decisions
Most people shop for a home before they shop for a mortgage. But, really, first you need to know how much of a mortgage you can afford, and then look for a home that can qualify for the mortgage you can afford. Consequently, it’s best to pre-qualify for a home mortgage before you start looking seriously at houses, let alone make an offer on one.
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 circumstances. Here’s a quick overview of two common types of mortgage loans:
Types of Loans
Your monthly payment—a combination of principal and interest—remains the same throughout the life of the loan and cannot be changed. 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.
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 have a cap on how high the rate can go. If interest rates go down, the ARM goes down as well, which eliminates the hassle and costs of refinancing to take advantage of lower rates. People choose the ARM because it allows them to purchase a home they may not otherwise be able to afford. The drawback is that if your income doesn’t increase as you expect, or the value of your home decreases, you may be in a position where you can’t afford your mortgage, and selling the home at a loss may not cover your mortgage obligations.
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. That can add up to a lot of money, especially for a first-time home buyer. Fortunately, Private Mortgage Insurance (PMI) purchased by the home buyer which protects the lender in the event of a default on the loan. PMI enables you to put 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 (also variously referred to “loan-origination fees,” “discount fees,” or “buy-down charges”) 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.
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 costs you $1500. Like annual mortgage interest, points are 100% tax deductible in the year that you pay them.