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Mortgage Basics FAQ
Get an overview of types of loans
and terms and tips on how to afford a mortgage and down
payment. What's
Many entities, including banks, credit unions, savings and
loans, insurance companies and mortgage bankers make home
loans. Lenders and terms change frequently as new companies
appear, old ones merge and market conditions fluctuate. To get
the best deal, it's a good idea to compare loans and fees with
at least a half a dozen lenders. Because many types of home
loans are standardized to comply with rules established by the
Federal National Mortgage
Association (Fannie Mae) and other quasi-governmental
corporations that purchase loans from lenders, comparison
shopping is not difficult. Be sure to ask for the same size,
type, and length of mortgage -- such as a 30-year fixed term
mortgage for $300,000 -- so you're comparing apples to apples.
Fortunately, mortgage rates and fees are usually published
in the real estate sections of metropolitan newspapers, and
are increasingly available on online mortgage websites. You
can also work with a loan broker, who is someone who
specializes in matching house buyers and appropriate mortgage
lenders, normally collecting a fee from the lender.
Be sure to check out government-subsidized mortgages, which
have no down payment and low down payment plans.
(See What kinds of government
loans are available to homebuyers? below.) Also,
ask banks and other private lenders about any "first-time
buyer" programs that offer low down payment plans and flexible
qualifying guidelines to low- and moderate-income buyers with
good credit.
Finally, don't forget private sources of mortgage money --
parents, other relatives, friends or even the seller of the
house you want to buy. Borrowing money privately is usually
the most cost-efficient mortgage of all.
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Assuming you can afford (and qualify for) high monthly
mortgage payments and have an excellent credit history, you
should be able to find a low (10% to15%) down payment loan.
However, you may have to pay a higher interest rate and loan
fees (points) than someone making a larger down payment.
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Private mortgage insurance (PMI) policies are designed to
reimburse a mortgage lender up to a certain amount if you
default on your loan and the foreclosure sale is less than the
amount you owe the lender -- that is, the amount of your
mortgage loan plus the costs of the foreclosure sale. Most
lenders require PMI on loans where the borrower makes a down
payment of less than 20%. Premiums are usually paid monthly
and typically cost less than one-half of one percent of the
mortgage loan. With the exception of some government and older
loans, you can drop PMI once your equity in the house reaches
22% and you've made timely mortgage payments. Ask your lender
for details on the cost of PMI and requirements for canceling
it.
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Under the 1997 Taxpayer Relief Act, first-time homebuyers
can withdraw up to $10,000 penalty free from an individual
retirement account (IRA) for a down payment to purchase a
principal residence (though you might have to pay income tax
on the amount withdrawn.) This $10,000 is a lifetime limit --
and the money must be used within 120 days of the date you
receive it. The law defines a first-time homeowner as someone
who hasn't owned a house for the past two years. If a couple
is buying a home, both must be first-time homeowners. Ask your
tax accountant for more information, or check IRS rules at
www.irs.gov.
Another source of down payment money is a loan against your
401(k) plan. Ask your employer or plan administrator if your
plan allows loans. If it does, the maximum loan amount under
the law is the one-half of your vested balance in the plan or
$50,000, whichever is less. (If, however, you have less than
$20,000 in your plan, your limit is the amount of your vested
balance, but no more than $10,000.) Other conditions,
including the maximum term, the minimum loan amount, the
interest rate and applicable loan fees, are set by your
employer. Any loan must be repaid in a "reasonable amount of
time," although the Tax Code doesn't define what is
reasonable. Be sure to find out what happens if you leave your
job before fully repaying a loan from your 401(k) plan. If a
loan becomes due immediately on your departure, income tax
penalties may apply to the outstanding balance -- but you can
usually avoid this hassle by repaying the loan before you
leave the job.
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Several federal, state and local government financing
programs are available to homebuyers. The two main federal
programs are:
VA Loans. U.S. Department of Veterans Affairs (VA)
loans are available to men and women who are now in the
military and to veterans with other than dishonorable
discharges who meet specific eligibility rules, most of which
relate to length of service. The VA doesn't make mortgage
loans but guarantees part of the house loan you get from a
bank, savings and loan or other private lender. If you
default, the VA pays the lender the amount guaranteed and you
in turn will owe the VA. This guarantee makes it easier for
veterans to get favorable loan terms with a low down payment.
For more information, check the VA's Website at
www.va.gov or contact a
regional VA office for advice.
FHA Loans. The Federal Housing Administration (FHA),
an agency of the Department of Housing and Urban Development
(HUD), insures loans made to all U.S. citizens and permanent
residents who meet financial qualification rules. Under its
most popular program, if the buyer defaults and the lender
forecloses, the FHA pays 100% of the amount insured. This loan
insurance lets qualified people buy affordable houses. The
major attraction of an FHA-insured loan is that it requires a
low down payment, usually about 3% to 5%. For more information
on FHA loan programs, contact a regional office of HUD or
check the FHA website at
www.hud.gov.
For information on other government loans, contact your
state and local housing offices. They often have programs
available for first-time homebuyers who are purchasing
modestly-priced properties. To find your state housing office,
check U.S. State Resources on FindLaw (http://guide.lp.findlaw.com/11stategov/).
Start by looking at your state's home page. You'll probably
find the listing for your state's housing office.
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With a fixed rate mortgage, the interest rate and the
amount you pay each month remain the same over the entire
mortgage term, traditionally 15 or 30 years. A number of
variations are available, including five- and seven-year fixed
rate loans with balloon payments at the end.
With an adjustable rate mortgage (ARM), the interest rate
fluctuates according to the interest rates in the economy.
Initial interest rates of ARMs are typically offered at a
discounted interest rate that is lower than the
rate for fixed rate mortgages. Over time, when initial
discounts are filtered out, ARM rates will fluctuate as
general interest rates go up and down. Different ARMs are tied
to different financial indexes, some of which fluctuate up or
down more quickly than others. To avoid constant and drastic
changes, ARMs typically regulate (cap) how much and how often
the interest rate and/or payments can change in a year and
over the life of the loan. A number of variations are
available for adjustable rate mortgages, including hybrids
that change from a fixed to an adjustable rate after a period
of years.
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It depends. Because interest rates and mortgage options
change often, your choice of a fixed or adjustable rate
mortgage should depend on:
- the interest rates and mortgage options available when
you're buying a house
- your view of the future (generally, high inflation will
mean ARM rates will go up and lower inflation means that
they will fall), and
- how willing you are to take a risk.
When mortgage rates are low, a fixed rate mortgage is the
best bet for most buyers. Over the next five, ten or thirty
years, interest rates are more apt to go up than further down.
Even if rates could go a little lower in the short run, an
ARM's teaser rate will adjust up soon and you won't gain much
if you plan to stay in the house more than a few years (the
broker can tell you your break-even point). In the long run,
ARMs are likely to go up, meaning most buyers will be best off
to lock in a favorable fixed rate now and not take the risk of
much higher rates later.
Keep in mind that lenders not only lend money to purchase
homes; they also lend money to refinance homes. For example,
if you take out a fixed rate loan now, and several years from
now interest rates have dropped, refinancing will probably be
an option.
There are several downsides to refinancing. Unless you can
negotiate a low-cost refi, you may have to pay the same fees
and points as for an original mortgage. This means you may
reduce your monthly payment right away but not actually begin
to save money on the refi for several years. (Again, your
broker can tell you when you will break even.) So, if you
think you will be moving again soon, it may not make sense to
refinance.
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You can save real money if you carefully shop for a
mortgage. Everything else being equal, even a one-quarter
percentage point difference in interest rates can mean savings
of thousands of dollars over the life of a mortgage.
In addition to comparing interest rates, there are a
variety of fees -- and fee amounts -- associated with getting
a mortgage, including loan application fees, credit check
fees, private mortgage insurance (if you're making a low down
payment) and points. Since points comprise the largest part of
lender fees, it's important to understand how they work: One
point is 1% of the loan principal. Thus, your fee for
borrowing $250,000 at two points is $5,000. There is normally
a direct relationship between the number of points lenders
charge and the interest rates they quote for the same type of
mortgage, such as a fixed rate. The more points you pay, the
lower your rate of interest, and vice versa.
| Comparing
Loans by Annual Percentage Rate |
| One method to compare loans with
different points is to use the Annual Percentage
Rate (APR), which lenders must disclose to borrowers
under federal law. The APR can be misleading,
however, as its method of calculating the cost of a
loan as a yearly rate assumes that the loan will not
be paid off until the loan term ends. While most
loans are for 30 years, people generally pay off
their loans before the loan term ends because they
either move or refinance sooner. Also, different
lenders have various ways of calculating costs
included in the APR, so that a loan for the same
dollar amount and number of points may have
different APRs with different lenders. |
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Before comparing points to interest, factor in how long you
plan to own your house. The longer you live in your house (or
pay on the mortgage), the better off you'll be, paying more
points up front in return for a lower interest rate. On the
other hand, if you think you'll sell or refinance your house
within two or three years, we strongly recommend that you
obtain a loan with as few points as possible.
A good loan officer or loan broker can walk you through all
options and trade-offs such as higher fees or points for a
lower interest rate.
Many online services provide mortgage rate information,
though they tend to assume you want a "standard" loan and
omit information on other available loans. Nevertheless, they
offer a great way to start your research and get a sense of
market rates, points and terms, as well as useful advice on
choosing a mortgage. And even if you are considering a loan
you found via more traditional approaches, you can check the
Internet to see if you have been offered the best terms.
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Ten Strategies for Buying an Affordable House
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To find a good house at a
comparatively reasonable price, learn about the
housing market and what you can afford, make some
sensible compromises as to size and amenities and,
above all, be patient. Here are some proven
strategies to meet these goals:
- Buy a fixer-upper cheap.
- Buy a small house (with remodeling potential)
and add on later.
- Buy a house at an estate or probate sale.
- Buy a house subject to foreclosure (when a
homeowner defaults on the mortgage).
- Buy a shared equity house, pooling resources
with someone other than a spouse or partner.
- Rent out a room or two in the house.
- Buy a duplex, triplex or house with an in-law
unit that you can rent out for more income.
- Lease a house you can't afford now with an
option to buy later.
- Buy a limited equity house built by a
nonprofit organization.
- Buy a house at an auction.
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