Home Buying For Dummies

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In the market for a home, but don't know where to start? Not to worry! From financing, mortgages, and credit scores to closing the deal, bestselling real estate authors Eric Tyson and Ray Brown walk you step by step through the entire home-buying process.
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In the market for a home, but don't know where to start? Not to worry! From financing, mortgages, and credit scores to closing the deal, bestselling real estate authors Eric Tyson and Ray Brown walk you step by step through the entire home-buying process.
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Product Details

  • ISBN-13: 9780470453650
  • Publisher: Wiley
  • Publication date: 5/11/2009
  • Series: For Dummies Series
  • Edition number: 4
  • Pages: 408
  • Product dimensions: 7.30 (w) x 9.20 (h) x 1.40 (d)

Meet the Author

Eric Tyson is a syndicated personal financial writer, lecturer, and counselor. He is dedicated to teaching people to manage their personal finances better. Eric is a former management consultant to Fortune 500 financial service firms. Over the past two decades, he has successfully invested in securities as well as in real estate and has started and managed several businesses. He holds a bachelor's degree in economics at Yale and an M.B.A. at the Stanford Graduate School of Business.
An accomplished freelance personal finance writer, Eric is the author of five other national best-sellers in the...For Dummies series: Home Buying (co-author), Personal Finance, Investing, Mutual Funds, and Taxes (co-author). His work has been featured and praised in hundreds of national and local publications, including Newsweek, Kiplinger's, The Wall Street Journal, Money, Los Angeles Times, Chicago Tribune, and on NBC's Today Show, PBS's Nightly Business Report, CNN, The Oprah Winfrey Show, ABC, CNBC, Bloomberg Business Radio, CBS National Radio, and National Public Radio.
Eric has counseled thousands of clients on a variety of personal finance, investment, real estate, and mortgage quandaries and questions. In addition to maintaining a financial counseling practice, he is a popular speaker on important personal finance topics.

Ray Brown, co-author of the national best-seller Home Buying For Dummies, is a veteran real estate broker with more than two decades of hands-on experience. A former vice president and manager for Coldwell Banker Residential Brokerage Company and McGuire Real Estate, and founder of his own real estate firm, the Raymond Brown Company, Ray is currently a writer, radio talk show host, and public speaker on residential real estate topics.
Ray believes that most people are pretty darn smart. When they have problems, it's usually because they don't know the right questions to ask to get the information they need to make good decisions. This book completes Ray's residential real estate trilogy and fulfills his dream of helping folks find their way through the often mystifying process of buying, financing, and selling their homes.
On his way to becoming a real estate guru, Ray worked as the real estate analyst for KGO-TV (ABC's affiliate in San Francisco), a syndicated real estate columnist for The San Francisco Examiner, and he hosts a weekly radio program, Ray Brown on Real Estate, for KNBR. In addition to his work for ABC, Ray has appeared as a real estate expert on CNN, NBC, CBS, and in The Wall Street Journal and Time.

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Table of Contents

Introduction 1
About This Book: The Eric Tyson/Ray Brown Difference 1
Conventions Used in This Book 2
How This Book Is Organized 2
Icons Used in This Book 4
Where to Go from Here 5
Part I Home Economics 7
Chapter 1 Deciding Whether to Buy 9
Weighing the Advantages of Owning versus Renting 10
Ownership advantages 10
Renting advantages 16
Pitfalls of the Rent-versus-Buy Decision 17
Renting because it seems cheaper 18
Fretting too much over job security 18
Buying when you expect to move soon 19
Succumbing to pushy salespeople 19
Ignoring logistics 19
Overbuying 20
Underbuying 20
Buying because it's a grown-up thing to do 21
Buying because you're afraid that escalating prices will lock you out 21
Misunderstanding what you can afford 22
Chapter 2 Getting Your Financial House in Order 23
Surveying Your Spending 24
Gathering the data 24
Analyzing your spending numbers 27
Reckoning Your Savings Requirements 29
Setting some goals 29
Retirement savings accounts and a dilemma 30
Other reasons to save 32
Protecting Yourself, Your Dependents, and Your Assets 33
Insuring yourself 35
Insuring your assets 37
Invest in Yourself 37
Chapter 3 What Can You Afford to Buy? 39
Lenders Can't Tell You What You Can Afford 40
The Cost of Buying and Owning a Home 41
Mortgage payments 41
Property taxes 49
Insurance 50
Maintenance and other costs 52
The tax benefits of homeownership 53
Closing Costs 56
Accumulating the Down Payment 58
The 20 percent solution 59
Ways to buy with less money down 60
Where to invest the down payment 62
Chapter 4 Why Home Prices Rise and Fall 69
What Drives Real Estate Markets and Prices? 70
Jobs, glorious jobs 70
Available housing 71
Inventory of homes for sale and actual sales 73
The rental market 73
How to Get a Good Buy in Any Market 77
Seek hidden opportunities to add value 79
Buy when others are scared to buy 79
Find a motivated seller 80
Buy during slow periods 80
Become a great negotiator 81
Buy in a good neighborhood 81
Part II Financing 101 83
Chapter 5 Understanding and Improving Your Credit Score 85
The Record You Can't Ignore: Your Credit Report 86
What your credit history comprises 86
What goes into your credit report 86
Why you should check your credit report 87
The Most Popular Kid on the Block: FICO Scores 88
How scores work - the short version 88
How a FICO score assesses your credit history - the long version 89
What FICO scores ignore 96
Why your score is what it is 97
Getting Hold of Your Report and Score 97
Chapter 6 Selecting a Mortgage 99
Fixed or Adjustable? That Is the Interest(ing) Question 100
Distinguishing fixed from adjustables 100
Looking at hybrid loans 101
Starting out risky: Interest-only mortgages 101
Making the fixed/adjustable decision 102
Deciding on your loan's life: 15 years or 30? 108
Finding a Fixed-Rate Mortgage 110
The all-important interest rate 110
The finer points of points 110
Other lender fees 112
Arriving at the Absolute Best Adjustable 113
Where an ARM's interest rate comes from 114
How often does the interest rate adjust? 116
Limits on interest-rate adjustments 116
Locating the Best, Lowest-Cost Lenders 117
Shopping on your own 118
Working with a mortgage broker 120
Chapter 7 Mortgage Quandaries, Conundrums, and Paperwork 125
Conquering Common Mortgage Problems 125
Insufficient income 126
Debt and credit problems 126
Lack of down payment 128
Dealing with Appraisal Problems 129
You've overpaid 129
The appraiser doesn't know your area 130
The appraiser/lender is sandbagging you 130
Those Darn Mortgage Forms 131
The laundry list of required documents 131
Permissions to inspect your finances 133
The Uniform Residential Loan Application 137
Other typical documents 147
Part III Property, Players, and Prices 151
Chapter 8 Where and What to Buy 153
Location, Location, Value 155
Characteristics of good neighborhoods 155
Selecting your best neighborhood 157
Fundamental Principles for Selecting Your Home 158
The principle of progression: Why to buy one of the cheaper homes on the block 158
The principle of regression: Why not to buy the most expensive house on the block 160
The principle of conformity: Why unusual is usually costly 161
Defining Home Sweet Home 162
Detached residences 163
Attached residences 168
Finding a Great Deal 178
Finding a fixer-upper 178
Taking over a foreclosure 181
Pooling Your Resources: Ad Hoc Partnerships 184
Types of residential partnerships 184
Structuring a successful partnership 185
Chapter 9 Assembling an All-Star Real Estate Team 187
The Team Concept 188
Lining up the players 188
Avoiding gratuitous advice 190
Reeling in a Real Estate Agent 191
Types of agent relationships 191
How agents get paid 194
Characteristics of good agents 196
Selecting your agent 198
Getting the most from your agent 205
Bagging a Broker 206
Landing a Lender 207
Procuring Property Inspectors 209
Electing an Escrow Officer 209
Finding (Or Forgoing) Financial and Tax Advisors 210
Looking for Lawyers 213
Selecting your lawyer 213
Getting the most out of a lawyer 215
Chapter 10 What's It Worth? 217
The Three Elusive Components of Worth 218
Value is a moving target 218
Cost is yesterday 220
Price is what it's worth today 221
Fair Market Value 221
When fair market value isn't fair - need-based pricing 222
Median home prices versus fair market value 223
Determining Fair Market Value: Comparable Market Analysis 224
The basics of a helpful CMA 224
The flaws of CMAs 228
Getting a Second Opinion: Appraisals versus CMAs 230
Why Buyers and Sellers Often Start Far Apart 231
Inept agents 232
Unrealistic sellers 234
Chapter 11 Tapping the Internet's Best Resources 235
Finding Useful Information 235
Bypass traditional search engines 236
Get your feet wet at Realtor.com 236
Read quality real estate news 237
Discover more at these sites 237
Doing Some Preliminary Shopping 238
Surveying homes for sale 238
Sifting school information 239
Perusing "best places" to live 240
Familiarizing yourself with financing options 241
The Drawbacks of Searching for Houses in Cyberspace 242
Conflicts of interest 242
Bankruptcies 243
Misleading home-valuation tools 243
Untrustworthy mortgage calculators 244
Slow surfing 244
Part IV Making the Deal 245
Chapter 12 Negotiating Your Best Deal 247
Understanding and Coping with Your Emotions 248
Examining the violent forces at work 248
Controlling yourself 249
The Art of Negotiating 251
Being realistic 251
Examining your negotiating style 253
Negotiating with finesse 255
The Negotiating Process 256
Making an offer to purchase 256
Leaving an escape hatch: Contingencies 258
Getting a counter offer 259
The Finer Points of Negotiating 262
Negotiating when the playing field isn't level 262
Spotting fake sellers 264
Lowballing 267
Negotiating credits in escrow 269
Chapter 13 Inspecting and Protecting Your Home 273
Conducting Thorough Inspections 273
All properties should be inspected 274
The two types of defects: patent and latent 275
Patent-defect red flags 276
Types of property inspections 277
Inspecting inspectors 278
Insuring Your Home 284
Homeowners insurance 284
Title insurance 288
Chapter 14 It Ain't Over Till the Weight-Challenged Escrow Officer Sings 293
An Escrow Is a Good Thing 293
Know thy escrow officer 294
Cover all the bases 295
'Tis the season: December escrows 297
Follow through 299
How You Take Title Is Vital 300
Joint tenancy 300
Community property 301
Tenants-in-common or partnerships 301
Getting help drafting an agreement 301
Getting Possessive 302
Moving day 302
Final verification of condition 304
Coping with Buyer's Remorse 304
Part V The Part of Tens 307
Chapter 15 Ten Financial "To Do's" After You Buy 309
Stay on Top of Your Spending and Saving 310
Consider Electronic Mortgage Payments 310
Rebuild Your Emergency Reserve 311
Ignore Solicitations for Mortgage Insurance 311
Ignore Solicitations for Faster Payoff 312
Consider Protesting Your Tax Assessment 312
Refinance If Interest Rates Fall 313
Keep Receipts for All Improvements 314
Ignore Solicitations to Homestead 315
Take Time to Smell the Roses 315
Chapter 16 Ten Things to Know When Investing in Real Estate 317
Real Estate Is a Solid Long-Term Investment 317
Real Estate Investing Isn't for Everyone 318
REITs Are Good If You Loathe Being a Landlord 318
Don't Invest in Limited Partnerships 319
Avoid Timeshare Condos and Vacation Homes 319
Residential Properties Are Your Best Investment Option 320
Consider Fixer-Upper Income Property 321
Consider Converting Small Apartment Buildings to Condos 321
Considr the Property's Cash Flow 322
Your Rental Losses Are Limited for Tax Purposes 322
Chapter 17 Ten Things to Consider When Selling Your House 323
Why Are You Selling? 323
Can You Afford to Buy the Next Home? 324
What's It Worth? 324
Have You Done Your Homework to Find a Good Real Estate Agent? 326
Do You Have the Skills to Sell the House Yourself? 326
Have You Properly Prepared the House for Sale? 327
Do You Understand the House's Hot Buttons? 327
What Are the Financial Ramifications of Selling? 328
Do You Know the Rules for Capital-Gains Taxes on the Sale of a House? 328
Part VI Appendixes 329
Appendix A Sample Real Estate Purchase Contract 331
Appendix B Example of a Good Inspection Report 341
Appendix C Glossary 359
Index 375
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First Chapter

Chapter 5
Selecting a Mortgage

In This Chapter

  • The difference between fixed-rate and adjustable-rate mortgages
  • Hybrid loans, balloon loans, and negative amortization (Oh, my!)
  • Choosing the loan that's perfect for you
  • A look at points, caps, and other mortgage mumbo-jumbo
  • Finding a lender (or finding someone to find a lender for you)

"A bank is a place that will lend you money if you can prove that you don't need it." -Bob Hope

If you were Oprah Winfrey or Bill Gates, you could skip Chapters 5 and 6, which explain everything that you need to know about mortgages. If you have enough money to pay cash for your home, you can happily thumb your nose at bankers and other mortgage lenders. If you can afford to pay cash for your home, who needs them?!

As for the rest us, we need to take out a mortgage to buy a home for the simple reason that doing so is the only way we can afford a home that meets our needs. This chapter helps all non-wealthy folk to comprehend mortgages and then choose one. (If you are wealthy and have a great deal of money to put into a property, this part of the book can also help you to decide how much of your loot to put into your home purchase.)

Start with the basics. What is a mortgage? A mortgage is nothing more than a loan that you obtain to close the gap between the cash you have for a down payment and the purchase price of the home that you're buying. Homes in your area may cost $70,000, $170,000, or $370,000. No matter -- most people don't have that kind of spare cash in their piggy banks.

Mortgages typically require monthly payments to repay your debt. The mortgage payments are comprised of interest, which is what the lender charges for use of the money you borrowed, and principal, which is repayment of the original amount borrowed.

Learning how to select a mortgage to meet your needs ensures that you'll be a happy homeowner for years to come. You also need to understand how to get a good deal when shopping around for a mortgage because your mortgage is typically the biggest monthly expense of homeownership (and perhaps of your entire household budget). Paying more for interest on your mortgage than you pay for your humble abode itself is not unusual.

Suppose that you borrow $144,000 (and contribute $36,000 from your savings as the down payment) for the purchase of your $180,000 dream palace. If you borrow that $144,000 with a 30-year, fixed-rate mortgage at 7 percent, you end up paying a whopping $200,892 in interest charges alone over the life of your loan. That $200,892 is not only a great deal of interest -- it's also more than the purchase price of the home or the loan amount you originally borrowed!

So that you don't spend any more than you need to on your mortgage, and so that you get the mortgage that best meets your needs, the time has come to get on with the task of understanding the mortgage options out there.

Fixed or Adjustable? That Is the Interest(ing) Question

You may remember the skit from Saturday Night Live where Dan Aykroyd and John Belushi worked in a restaurant that served only cheeseburgers, chips, and Pepsi. Customers who tried to order a hamburger, fries, and Coke were out of luck. No hamburgers, just cheeseburgers; no fries, just chips; and no Coke, just Pepsi. At that restaurant, your choices were already made. If only you were so lucky with mortgages.

Like some other financial and investment products, tons of different mortgage options are available for your choosing. The variations can be significant or trivial, expensive or less-costly.

You will note throughout this chapter that two fundamentally different types of mortgages exist. Mortgages differ in terms of how their interest rate is determined. The two types of mortgages are fixed-rate mortgages and adjustable-rate mortgages.

Distinguishing fixed from adjustable mortgages

Before adjustable-rate mortgages came into being, only fixed-rate mortgages existed. Usually issued for 15- or 30-year periods, fixed-rate mortgages (as the name suggests) have interest rates that are fixed (unchanging) during the entire life of the loan.

With a fixed-rate mortgage, the interest rate stays the same and your monthly mortgage payment amount does not change. No surprises, no uncertainty, and no anxiety for you over interest-rate changes and changes in your monthly payment. Your mortgage interest rate and monthly payment remain locked for the life of the loan. If you like the predictability of your favorite television show airing at the same time daily, you'll probably like fixed-rate mortgages.

On the other hand, adjustable-rate mortgages (ARMs for short) have an interest rate that varies (or adjusts). The interest rate on an ARM typically adjusts every six to twelve months, but it may change as frequently as every month.

As we discuss later in this chapter, the interest rate on an ARM is primarily determined by what's happening overall to interest rates. If interest rates are generally on the rise, odds are that your ARM will experience increasing rates, thus increasing the size of your mortgage payment. Conversely, when interest rates fall, ARM interest rates and payments generally fall.

If you like change -- you enjoy trying different foods and getting up at a different time each day -- you may think that adjustable-rate mortgages sound good. Change is what makes life interesting, you say. Please read on, because, even if you believe that variety is the spice of life, you may not like the financial variety and spice of adjustables!

Looking at hybrid loans

If only the world were so simple that only pure fixed-rate and pure adjustable-rate loans were available. But one of the rewards of living in a capitalistic society is that you often have no shortage of choices. Enter hybrid loans (or what lenders sometimes call intermediate ARMs). Such loans start out like a fixed-rate loan -- the initial rate may be fixed for 3, 5, 7, or even 10 years -- and then the loan converts into an ARM, usually adjusting every 6 to 12 months thereafter.

In case you care (and you may not), loans called 7/23s (which are fixed for the first seven years and then have a one-time adjustment and remain at a fixed rate for the remaining length of the loan term) are also available. We discuss the pros and cons of these loans in the next section.

Making the fixed-rate/adjustable-rate decision

So how do you choose whether to take a fixed-rate or an adjustable-rate loan? Is it as simple as a personality test?

As with many things in life that give you choices, tradeoffs and pro and cons apply to each option. In this section, we talk you through the pros-and-cons of your mortgage options; but as we do, please keep one very important fact in mind: In the final analysis, which mortgage is best for you very much hinges upon your personal and financial situation. You are the one who is best- positioned to make the call as to whether a fixed or an adjustable loan better matches your situation and desires.

Balloon loans

One type of mortgage, known as a balloon loan, appears at first blush to be somewhat like a hybrid loan. The interest rate is fixed, for example, to five, seven, or ten years. However, and this is a big however, at the end of this time period, the entire loan balance becomes due. In other words, you must pay off the entire loan.

Borrowers are attracted to balloon loans for the same reason that they are attracted to hybrid or ARM loans -- because balloon loans start at a lower interest rate than do fixed-rate mortgages. Buyers are sometimes seduced into such loans during high-interest-rate periods or when they can't qualify for or afford the payments of a traditional mortgage.

We don't like balloon loans because they can blow up in your face. You may become trapped without a mortgage if you are unable to refinance (obtain a new mortgage to replace the old loan) when the balloon comes due. You may have problems refinancing if, for example, you lose your job, your income drops, the value of your property declines and the appraisal comes in too low to qualify you for a new loan, or interest rates increase and you can't qualify for a new loan at those higher rates.

In the real estate trade, balloon loans are also called bullet loans. Why? If the loan comes due during a period of high mortgage rates, industry people say that it's like getting a bullet in the heart.

Remember that refinancing a mortgage is never a sure thing. Taking a balloon loan may be a financially hazardous short-term solution to your long-term financing needs.

The one circumstance under which we say that it's okay to consider a balloon loan is if you absolutely must have a particular property and the balloon loan is your one and only mortgage option. If that's the case, you should also be as certain as you can be that you'll be able to refinance when the balloon comes due. If you have family members that could step in to help with the refinancing, either by cosigning or by loaning you the money themselves, that's a big back-up plus. Oh, and if you must take out a balloon loan, get as long a term as possible, ideally for no less than seven years (and preferably for ten years).

Fixed-rate mortgages

It stands to reason that, because the interest rate does not vary with a fixed-rate mortgage, the advantage of a fixed-rate mortgage is that you always know what your monthly payment is going to be. Thus, budgeting and planning the rest of your personal finances is easier.

That's the good news. The bad news is that you will pay a premium, in the form of a higher interest rate, to get a lender to commit to lending you money over many years at a fixed rate. The longer the mortgage lender agrees to accept a fixed interest rate, the more risk that lender is taking. A lender who agrees to loan you money, for example, over 30 years at 8 percent will be hurtin' if interest rates skyrocket (as they did in the early 1980s) to the 15+ percent level. (With the rise of interest rates and inflation at that time, mortgage lenders were paying depositors interest rates that were almost double the levels of the interest that they were charging for mortgages that had commenced a decade before. Not a very profitable way to run a bank!)

In addition to paying a premium interest rate when you take the loan out, another potential drawback to fixed-rate loans is that, if interest rates fall significantly after you have your mortgage, you face the risk of being stranded with your costly mortgage. That could happen if (due to a deterioration in your financial situation or a decline in the value of your property) you don't qualify to refinance (get a new loan to replace the old). Even if you do qualify to refinance, doing so takes time and usually costs money for a new appraisal, loan fees, and title insurance.

Here are a couple of other possible minor drawbacks to be aware of with some fixed-rate mortgages:

  • If you sell your house before paying off your fixed-rate mortgage, your buyers probably won't be able to assume that mortgage.
  • Fixed-rate mortgages sometimes have prepayment penalties (explained in the nearby sidebar). The ability to pass your loan on to the next buyer (in real estate talk, the next buyer assumes your loan) can be useful if you're forced to sell during a rare period of ultra-high interest rates, such as occurred in the early 1980s. Selling during such a time could reduce the pool of potential buyers for your home if, in order to avoid a prepayment penalty, you don't allow an otherwise-qualified buyer who is having trouble obtaining an affordable loan to assume your mortgage.

Adjustable-rate mortgages

Fixed-rate mortgages aren't your only option. Mortgage lenders were intelligent enough to realize that they couldn't foresee interest rates, and thus were born adjustable-rate mortgages (adjustables for short).

Although some adjustables are more volatile than others, all are similar in that they fluctuate (or float) with the market level of interest rates. If the interest rate fluctuates, then so does your monthly payment. And therein lies the risk: Because a mortgage payment is likely to be a big monthly expense for you, an adjustable-rate mortgage that is adjusting upwards may wreak havoc with your budget.

Given all the trials, tribulations, and challenges of life as we know it, you may rightfully ask, "Why would anyone choose to accept an adjustable-rate mortgage?" Well, people who are stretching themselves -- such as some first-time buyers or those trading up to a more expensive home -- may financially force themselves into accepting adjustable-rate mortgages. Because an ARM starts out at a lower interest rate, such a mortgage enables you to qualify to borrow more. As we discuss in Chapter 2, just because you can qualify to borrow more doesn't mean that you can afford to borrow that much, given your other financial goals and needs.

Avoid loans with prepayment penalties

Some mortgages come with a provision that penalizes you for paying off the loan balance faster. Such penalties can amount to as much as several percentage points of the amount of the mortgage balance that is paid off early.

Some lenders won't enforce their loan's prepayment penalties when you pay off a mortgage early because you sold the property or because you want to refinance the loan to take advantage of lower interest rates as long as they get to make the new mortgage. Even so, your hands are tied financially unless you go through the same lender.

Many states place limits on the duration and amount of prepayment penalty lenders may charge for mortgages made on owner-occupied residential property. The only way to know whether a loan has a prepayment penalty is to ask and to carefully review the federal truth-in-lending disclosure and the promissory note the mortgage lender provides you with. We think that you should avoid such loans. (Many so-called no points loans have prepayment penalties.)

Other homebuyers who can qualify for both an adjustable-rate and fixed-rate mortgage of the same size have a choice, and some choose the fluctuating adjustable. Why? Because they may very well save themselves money, in the form of smaller total interest charges, with an adjustable-rate loan instead of a fixed-rate loan.

Because you accept the risk of a possible increase in interest rates, mortgage lenders cut you a little slack. The initial interest rate (also sometimes referred to as the teaser rate) on an adjustable should be less than the initial interest rate on a comparable fixed-rate loan. In fact, an ARM's interest rate for the first year or two of the loan is generally lower than a fixed-rate mortgage.

Another advantage of an ARM is that, if you purchase your home during a time of high interest rates, you can start paying your mortgage with the artificially depressed initial interest rate. If interest rates then decline, you can capture the benefits of lower rates without refinancing.

Another situation when adjustable-rate loans have an advantage over their fixed-rate brethren is when interest rates decline and you don't qualify to refinance your mortgage to reap the advantage of lower rates. The good news for homeowners who are unable to refinance and who have an ARM is that they probably already capture many of the benefits of the lower rates. With a fixed-rate loan, you must refinance in order to realize the benefits of a decline in interest rates.

When to consider hybrid loans

If you want more stability in your monthly payments than comes with a regular adjustable, and you expect to keep your loan for no more than from five to ten years, a hybrid (or intermediate ARM) loan, which is explained earlier in this chapter, may be the best loan for you.

The longer the initial rate stays locked in, the higher it will be, but the initial rate of a hybrid ARM is almost always lower than the interest rate on a 30-year, fixed-rate mortgage. However, because the initial rate of hybrid loans is locked in for a longer period of time than the six-month or one-year term of regular ARMs, hybrid ARMs have higher initial interest rates than regular ARM loans.

During periods, such as in 1995 and 1996, when little difference existed between short-term and long-term interest rates, the interest-rate savings in the early years with a hybrid or regular adjustable (versus a fixed-rate loan) were minimal (less than 1 percent). In fact, during certain times, the initial interest rate on a seven- or ten-year hybrid was exactly the same as on a 30-year, fixed-rate loan. During such periods, fixed-rate loans offer the best overall value.

To evaluate hybrids, weigh the likelihood that you'll move before the initial loan interest rate expires. For example, with a seven-year hybrid, if you're saving, say, 0.5 percent per year versus the 30-year, fixed-rate mortgage, but you're quite sure that you will move within seven years, the hybrid will probably save you money. On the other hand, if you think that there's a reasonable chance that you'll stay put for more than seven years, and you don't want to face the risk of rising payments after seven years, you should opt for a 30-year, fixed-rate mortgage instead.

The downside to an adjustable-rate loan is that, if interest rates in general rise, your loan's interest and monthly payment will likely rise, too. During most time periods, if rates rise more than 1 or 2 percent and stay elevated, the adjustable-rate loan is likely to cost you more than a fixed-rate loan.

Before you make the final decision between a fixed-rate mortgage versus an adjustable-rate mortgage, read the following two sections.

What would rising interest rates do to your finances?

Far too many homebuyers, especially first-timers, take out an adjustable-rate mortgage because doing so allows them to stretch and borrow more and buy a more expensive home. Although some of this overborrowing is caused by the modern-day American spendthrift "I gotta have it today" attitude, overborrowing is also encouraged by some real estate and mortgage salespeople. After all, these salespeople's income, in the form of a commission, is a function of the cost of the home that you buy and the size of the mortgage that you take on.

Short-term versus long-term interest rates

When choosing between an adjustable-rate mortgage and a fixed-rate mortgage, many people don't realize that they are making a choice between a mortgage on which the interest rate is determined by either short-term or long-term interest rates.

"What's a short-term versus a long-term interest rate?" you say. Glad you asked. When a mortgage lender quotes an interest rate for a particular type of loan, he should specify (in terms of how many years until the loan is completely paid off) the length of the loan.

Most of the time, borrowers must pay a higher interest rate to borrow money for a longer period of time. Conversely, borrowers generally pay a lower rate of interest for shorter-term loans. So?

Well, the interest rates that are used to determine most adjustable-rate mortgages are short-term interest rates; whereas fixed-rate mortgage interest rates are dictated by long-term interest rates. During most time periods, longer-term interest rates are higher than shorter-term rates because of the greater risk the lender accepts in committing to a longer-term rate.

It stands to reason, then, when little difference exists in the market level of short-term and long-term interest rates (such as occurred during 1995), that the rates of fixed-rate mortgages shouldn't be all that different from the rates of adjustable-rate mortgages. Thus, adjustables appear less attractive, and fixed-rate mortgages appear more alluring.

On the other hand, when short-term interest rates are significantly lower than long-term interest rates (such as during the early 1990s), adjustable-rate mortgages should be available at rates a good deal lower than the rates for fixed-rate loans. All things being equal, adjustables appear more attractive during such time periods and save you more money during the early years of your loan.

If you haven't already done so, let your fingers do the walking back to Chapters 2 and 3. Read and digest these chapters in order to understand how much you can really afford to spend on a home, given your other financial needs, commitments, and goals.

If you're at all considering an ARM, you absolutely, positively must understand what rising interest rates (and, therefore, a rising monthly mortgage payment) would do to your personal finances. Only consider taking an ARM if you can answer all of the following questions in the affirmative:

  • Is your monthly budget such that you can afford higher mortgage payments and still accomplish other financial goals that are important to you, such as saving for retirement?
  • Do you have an emergency reserve (equal to at least six-months' living expenses) that you can tap in order to make the potentially higher monthly mortgage payments?
  • Can you afford the highest payment allowed on the adjustable-rate mortgage?

    The mortgage lender can tell you the highest possible monthly payment, which is the payment that you would owe if the interest rate on your ARM went to the lifetime interest-rate cap allowed on the loan.

  • If you are stretching to borrow near the maximum the lender allows or an amount that will test the limits of your budget, are your job and income stable?

    If you expect to be having children in the future, consider now the fact that your household expenses will rise and your income may fall with the arrival of those little bundles of joy.

  • Can you handle the psychological stress of changing interest rates and mortgage payments?

If you are fiscally positioned to take on the financial risks inherent to an adjustable-rate mortgage, by all means consider taking one -- we're not trying to talk you into a fixed-rate loan. The odds are with you to save money, in the form of lower interest charges and payments, with an ARM. Your interest rate starts lower (and stays lower, if the overall level of interest rates doesn't change). Even if rates do go up, as they are sometimes prone to do, they will surely come back down. So, if you can stick with your ARM through times of high and low interest rates, you should still come out ahead.

Also recognize that, although ARMs do carry the risk of a fluctuating interest rate, almost all adjustable-rate loans limit, or cap, the rise in the interest rate allowed on your loan. We certainly wouldn't allow you take an ARM without caps. Typical caps are 2 percent per year and 6 percent over the life of the loan. (We cover ARM interest rate caps in detail later in this chapter.)

Consider an adjustable-rate mortgage only if you're financially and emotionally secure enough to handle the maximum possible payments over an extended period of time. ARMs work best for borrowers who take out smaller loans than they are qualified for or who are consistently saving more than 10 percent of their monthly income. If you do choose an ARM, make sure that you have a significant cash cushion that is accessible in the event that rates go up. Don't take an adjustable just because the initially lower interest rate allows you to afford a more expensive home. Better to buy a home that you can afford with a fixed-rate mortgage. (And don't forget hybrid loans if you want a loan with more payment stability but aren't willing to pay the premium of a long-term, fixed-rate loan.)

You can't (nor can the experts) predict where interest rates are headed

All the logicians out there are probably commenting that the choice between an adjustable-rate mortgage and a fixed-rate mortgage is simple. All you need to know in order to make a decision is the direction of interest rates. It's only logical. If interest rates look set to rise, a fixed-rate mortgage would be favorable. Lock in a low rate and smile smugly when interest rates skyrocket.

Conversely, if you thought that rates were going to stay the same or drop, you would want an ARM. Some real estate books that we've read even go so far as to say that your own personal interest-rate forecast should determine whether to take an ARM or fixed-rate mortgage! "Interest-rate forecasts should be the major factor in deciding whether or not to get an ARM," argues one such book.

Now we don't think that you're stupid, but you are not going to figure out which way rates are headed. The movement of interest rates is not logical, and you certainly can't predict it. If you could, you would make a fortune investing in bonds, interest-rate futures, and options.

Even the money-management pros who work with interest rates and bonds as a full-time job can't consistently predict interest rates. Witness the fact that bond-fund managers at mutual fund companies have a tough time beating the buy-and-hold bond-market indexes. If bond-fund managers could foresee where rates were headed, they could easily beat the averages by trading into and out of bonds when they foresaw interest-rate changes on the horizon.

How long do you expect to stay in the home/mortgage?

If you don't plan or expect to stay in your home for a long time, you should consider an ARM. Saving money on interest charges for most adjustables is usually guaranteed in the first two to three years, because an ARM starts at a lower interest rate than a fixed-rate loan does.

Should interest rates rise, however, you can end up paying more interest in subsequent years with the adjustable-rate loan. If you're reasonably certain that you'll hold onto your home for fewer than five years, you should come out ahead with an adjustable.

As we explain earlier in this chapter, a mortgage lender takes more risk when lending money at a fixed rate of interest for many (15 to 30) years. Lenders charge you a premium, in the form of a higher interest rate than what the ARM starts at, for the interest-rate risk that they assume with a fixed-rate loan.

If you expect to hold onto your home and mortgage for a long time -- more than five to seven years -- a fixed-rate loan may make more sense, especially if you're not in a position to withstand the fluctuating monthly payments that come with an ARM. If you don't plan on keeping your home and mortgage for more than five years, an ARM likely will save you money. However, you should also ask yourself why you're going to all the trouble and great expense of buying a home that you expect to sell so soon. If you're in the intermediate area (expecting to stay seven to ten years, for example), consider the hybrid loans we discuss earlier in this chapter.

If you're still stuck on the fence, go with the fixed-rate loan. A fixed-rate loan is financially safer and easier to shop for than an ARM.

Choosing between a 15-year and a 30-year mortgage

After you've decided which type of mortgage -- fixed or adjustable -- you want, you may think that your mortgage quandaries are behind you. Unfortunately, they're not. You also need to make another important choice -- typically between a 15-year and a 30-year mortgage. (Not all mortgages come in just 15- and 30-year varieties. You may run across some 20- and 40-year versions, but that won't change the issues we're about to tackle.)

If you're stretching to buy the home that you want, the choice of how long-term your mortgage will be may very well not be yours to make. You may be forced (we should say forcing yourself, because you choose what home to buy) to take the longer-term, 30-year mortgage. Doing so isn't necessarily bad and, in fact, has advantages.

The main advantage that a 30-year mortgage has over its 15-year peer is that it has lower monthly payments that free up more of your monthly income for other purposes, such as saving for other important financial goals (such as retirement). You may want to have more money so that you aren't a financial prisoner to your home and can just have a life! A 30-year mortgage has lower monthly payments because you have a longer time period to repay it (which translates into more payments). A fixed-rate 30-year mortgage with an interest rate of 7 percent, for example, has payments that are approximately 25 percent lower than those on a comparable 15-year mortgage.

What if you can afford the higher payments that a 15-year mortgage requires? Should you take it? Not necessarily. What if, instead of making large payments on the 15-year mortgage, you make smaller payments on a 30-year mortgage and put that extra money to productive use?

If you do, indeed, make productive use of that extra money, then the 30-year mortgage may be for you. A terrific potential use for that extra dough is to contribute it to a tax-deductible retirement account that you have access to. Contributions that you add to employer-based 401(k) and 403(b) plans (and self-employed SEP-IRAs or Keoghs) not only give you an immediate reduction in taxes but also enable your money to compound, tax-deferred, over the years ahead. Everyone with employment income may also contribute to an Individual Retirement Account (IRA). Your IRA contributions may not be immediately tax-deductible if your (or your spouse's) employer offers a retirement account or pension plan.

If you have exhausted your options for contributing to all the retirement accounts that you can, and if you find it challenging to save money anyway, the 15-year mortgage may offer you a good forced-savings program.

If you elect to take a 30-year mortgage, you retain the flexibility to pay it off faster if you so choose. (Just be sure to avoid those mortgages that have a prepayment penalty.) Constraining yourself with the 15-year mortgage's higher monthly payments does carry a risk. If you fall on tough financial times, you may not be able to meet the required mortgage payments.

Selecting a Fine Fixed-Rate Mortgage

If you decide, based upon our advice and selection criteria, to go with a fixed-rate loan, great! You shouldn't be disappointed. You'll have the peace of mind that comes with stable mortgage payments. And because fixed-rate loans have fewer options, they are a good deal easier to compare than adjustable-rate loans.

However, we don't want to give you the false impression that fixed-rate loans are as simple to shop for as carbonated beverages. Unfortunately, because of the hundreds of lenders in your local area who likely offer such loans and the seemingly never-ending, nit-picky, extra fees and expenses that lenders tack onto loans, you will need to put on your smart-consumer hat and sharpen your No. 2 pencil.

Be sure that you understand the following sections before you attempt to choose the best fixed-rate loan to meet your needs.

(this chapter has been abridged)

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See All Sort by: Showing 1 – 20 of 31 Customer Reviews
  • Anonymous

    Posted June 9, 2011

    Do not buy!!!

    Do not purhcase this Nookbook. I could not get past page 53. I called B&N Digital Support numerous times. After much troubleshooting, I finally said enough is enough and requested a refund. The pages I did get to ready I really enjoyed and thought had very useful information. May try the updated version next although waiting for other people to try it first.

    3 out of 3 people found this review helpful.

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  • Posted June 10, 2011

    Doesn't Work on Nook

    I am sure I would find this book to be very helpful if I could read it. Every time I try to open it and read it, it freezes my Nook. Sometimes I can get a few pages in, and sometimes it will not even open the book. All of my other eBooks read wonderfully on the Nook, so I feel confident that this is an isolated incident related to how this book if formatted for electronic reading. Buy the book in traditional print form and save yourself some trouble.

    2 out of 2 people found this review helpful.

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  • Anonymous

    Posted June 5, 2011

    Nookbook has error

    Wish I had read the previous review, just bought this today, cannot get past page 59. Have reached out to customer service... but do not download until they fix!!!

    2 out of 3 people found this review helpful.

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  • Anonymous

    Posted May 19, 2011

    Do NOT purchase!!

    This eBook had an error that did not allow me to get past something like page 63. Two months later, it still doesn't work.

    1 out of 1 people found this review helpful.

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  • Anonymous

    Posted April 22, 2013


    Like everyone else says, you can't get past 50 some odd pages. Looks like they don't care to actually fix the problem as it has been like this for years!!! Is this typical B&N??

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  • Anonymous

    Posted March 27, 2012

    NookBook Issues This Version

    Cannot read the Appendix documents - the writer warns you to get an Inspection and gives a Sample what to look for - but as of 3/26/2012 cannot enlarge enough to read them. My Nooks finger-zoom function works well but not on these documents.

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  • Posted October 13, 2011


    This book looks amazing. I made it to about 50 pages in before the nook book stopped working entirely, like many of the other reviewers here. For some reason they still keep selling it. I'm definitely going to buy the book (SOMEWHERE ELSE) in print form, because what little I read seems great. DO NOT BUY THE NOOK VERSION.

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  • Anonymous

    Posted October 9, 2007

    A reviewer

    I picked up a copy of this book this spring as my wife and I started house shopping. It covered just about everything but I would suggest the following book to help fill the gaps in this dummies book:

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  • Anonymous

    Posted November 5, 2006

    USEFUL - for the novice

    One main aspect of this book that is very important -- before buying a home, inspect it! And not by your own eyes, bring in a home inspector that offers a warranty. Doing both protects you and your family from potential issues (like mold). If you are buying 'cheap homes' for investment, this book can still help you, but there are other recommendations. See below.

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  • Anonymous

    Posted March 18, 2006

    Best book on the topic, period!

    I've read many real estate books. This is BY FAR the best. Comprehensive, objective and detailed. Filled with great war stories and do's and don'ts. And the authors are not cheerleaders for buying. They caution who shouldn't buy. You won't be disappointed... I've read their Real Estate Investing for Dummies which is also OUTSTANDING!

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  • Anonymous

    Posted June 25, 2004

    Great Read Especially for First-time

    I bought my first house following this book throughout the searching and buying process. It was so handy, I kept it with all my house paperwork! Years later, I sold the house using 'House Selling for Dummies'. Unfortunately, I should have refreshed my memory and read the book again before purchasing my second home. I made better decisions the first time around! Great reference book or for first-time buyers.

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  • Anonymous

    Posted July 22, 2002

    Very helpful!

    I reviewed many books before I decided to buy this one as I embarked on my homebuying journey. I chose this one because it had something the other books did not: financial values. I noticed that many other books were written by Real Estate Agents. That's not bad to learn the process, but there tended to be a theme in those books that encouraged people to buy, even if it financially hurt. And if you don't have enough money for a downpayment, they show you how you might be eligible for a loan anyway. While all that is accurate, the bigger financial picture may get overlooked and can lead to some unpleasant consequences (overextending yourself, fights with spouse, more debt, etc...). I really appreciated learning this process from people who undersood that there are other things I want to do with my money in addition to buying a home (saving for retirement, kids education, etc...).

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  • Anonymous

    Posted November 30, 2001

    Excellent for beginners at home-buying

    I enjoyed this book -- outlined the basics of what you need to know when you're planning to buy your 1st home...on the down side, it didn't cover some of the minutia about home buying I learned from friends, family and my broker. Nonetheless, it was a quick easy read that helped somebody completely ignorant to understand the real estate business.

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  • Anonymous

    Posted April 24, 2001

    Shallow Content

    This is a good book for someone confused on whether to buy or rent. This book is only intended for first time home buyers. It doesn't go in depth to letting you know what causes an ARM to fluctuate and maybe the Mortgages for Dummies is a better buy for a 2nd time home buyer. The book is very shallow but offers good advice. It describes what is involved in the buying process but says virtually nothing about how you will have to pay for the house.

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    Posted April 6, 2010

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    Posted January 2, 2011

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    Posted September 25, 2009

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    Posted April 14, 2011

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    Posted January 25, 2014

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    Posted June 7, 2009

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