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Robert J. BrussOn my scale of one to 10, this outstanding home-mortgage book rates an off-the-chart 12.
With mortgage stories dominating the front-page news, people?whether they?re buying a new house or refinancing?increasingly have questions about the complicated issues at stake. Arranged in an easily accessible question-and-answer format, Mortgages 101 provides readers with essential lending formulas, as well as important information on lending requirements and application procedures. The book shows readers how to save money by:
? understanding key terms like ARMs and hybrids?and reading what?s in the fine print ...
With mortgage stories dominating the front-page news, people—whether they’re buying a new house or refinancing—increasingly have questions about the complicated issues at stake. Arranged in an easily accessible question-and-answer format, Mortgages 101 provides readers with essential lending formulas, as well as important information on lending requirements and application procedures. The book shows readers how to save money by:
• understanding key terms like ARMs and hybrids—and reading what’s in the fine print • improving their credit scores to increase their borrowing power • using technology to get the lowest interest rates • maximizing their return on investment, and cutting the cost of mortgage insurance
This revised edition includes up-to-date material on new loan and government programs, as well as changes to the law regarding tax deductions, down payment assistance, reverse mortgages, bankruptcy, negative amortization and more—in short, all the answers readers need, in one must-have reference.
Robert Bruss, nationally syndicated columnist: "On my scale of one to 10, this outstanding home-mortgage book rates an off-the-chart 12."
Introduction to Mortgages
There's a lot more to buying a home than just picking one out and moving in. If you don't have a wad of cash stuffed in your sofa cushions, chances are you'll need a mortgage. Mortgage lending has been around for a long, long time, and some things haven't changed while other parts of the mortgage process are brand new. Knowing what you're getting into can help you to make the right decisions.
1.1 What's the difference between buying and renting?
One way you own the roof over your head, and the other way, you don't. If you've always rented or otherwise never owned a home, one of the things you'll discover is that when things go wrong with your house there's no landlord to yell at. There's no superintendent to come fix your leaky faucet. If your hot water heater is busted, you're the one who has to make the trip to your appliance store to shell out another thousand bucks or so just so you can take a hot shower in the morning.
When you rent, you can pretty much walk away as long as your lease agreement has been fulfilled. Want a change of scenery? Pack up and move across town. Want a swimming pool and fitness center without the hassles of owning either? Rent. Want new carpet or drapes every year? Rent. Want your utility bills paid? Rent. Free cable? Ditto. You get the point. Renting has its perks. Much less responsibility and no hassles of ownership.
1.2 How do I know if it's better to buy a home or continue renting?
Perhaps one of the easiest ways to determine if it's better to buy or rent is to sit down and calculate the financial advantages of owning versus renting. This is commonly done online with a "rent versus buy" calculator found on the Web.
Tell Me More
These calculators compare your current or probable rent situation with a projected home ownership number. They're easy to find. I ran a Google search for the term "mortgage and calculator" and retrieved 6,100,000 websites that had those two terms.
But the kicker is that these calculators rarely will they tell you, "No, it's not a good idea to buy." That's because of the tax benefits of home ownership. The interest and property taxes associated with a mortgage are generally tax deductible. You can deduct them from your gross income when you file your taxes. With rent, you can't.
Yeah, I know. When you're a renter you don't pay property taxes or mortgage payments. Instead you give money to someone else for the privilege of living there. But you can't write off your rent. It's just that. Rent.
When might a "rent versus buy" calculator suggest it's better to rent? When you intend to own your next home for only a year or so. Buying a home incurs other expenses, such as money for the down payment, property taxes, and hazard insurance (which is much higher than a renter's policy). Many apartment complexes pay your electric bills along with water and other utilities. When you own, you pay all these expenses. Owing a home with all its tax benefits doesn't outweigh the acquisition costs to buy the home if you're only going to own it for a short period. Short term, rent. Longer term, buy. Are your rent payments the same or less than what a mortgage payment would be? Depending upon where you live, they may be the same. Especially if interest rates are relatively low.
Let's say you're renting a nice 3,000-square-foot, three-bedroom home close to schools in a friendly neighborhood. You might be paying $1,800 each month in rent. A similar three-bedroom home might cost $150,000. If you put 5 percent down to buy the home, your monthly house payment, including taxes and insurance, would be close to $1,200 using a 30-year fixed rate at 7.00 percent.
If rent payments in the area you want to buy are near what a mortgage payment would be, it makes sense to buy. If you can save $600 per month and you also get to write off the mortgage interest and property taxes, then it's truly a no-brainer.
Another reason buying is generally better than renting is simply a matter of appreciation and equity. When you rent and property values increase, your landlord will probably raise your rent again. And, of course, each time you make a rent payment you're not increasing your equity in anything; you're just helping your landlord increase his stake in your house or apartment. I'll give you an example.
Your rent is currently $1,000 per month, and you're thinking about buying a $150,000 home. If you put 20 percent down and borrow $120,000 at 7.00 percent on a 30-year fixed rate, your principal and interest payment are about $800 a month. Let's also assume that property values are increasing in your area by about 5 percent per year. What's the situation after two years?
If you rented, you paid someone else $24,000. But if you owned and itemized your federal income taxes, you likely deducted over $16,600 in mortgage interest on your income taxes. You also paid your loan down by over $2,500 while at the same time increasing your equity position in the house by nearly $18,000.
Now you see why those calculators always tell you to buy a home.
Through all of these calculations, remember the real reason for buying: You buy a home because you want to. Because you like the place. It's your home. A home is one of the largest single financial commitments someone can make. And while I agree with that statement, let's not go overboard here. Buy a house because you want to, not because some calculator told you so.
1.3 How should I search for a house?
That's easy. Start doing some research on your own on the Internet, even before contacting a real estate agent. If the Internet was invented for any particular industry it has to have been for real estate. Before the World Wide Web was born, one could typically locate houses only in the newspaper on the weekend. If you saw a house that you liked, you'd contact the agent selling the home. Then came the endless cycle of driving around in a real estate agent's car looking at houses until--finally, finally--you found a home you wanted to buy.
Tell Me More
The Internet has helped agents become more productive by letting consumers do a little shopping first before they get serious enough to use an agent. An agent who advertises a house is called the "listing" agent, because he puts the house for sale on the multiple listing service, or MLS.
The agent will show you the home and ask if you are using another agent. If you aren't, the agent will ask if you would like to see other homes for sale. You of course say "yes," and the agent then becomes a "buyers" agent as well, helping you find a home to buy and not just listing a house for sale. You give your agent your requirements for your dream home, such as four bedrooms on a cul-de-sac with a swimming pool. Your agent would then scour the MLS to search for such homes. After the search, you'd both get in the agent's car and go see the homes.
But viewing homes on the Web gives both you and your agent a head start. You only look at homes you're interested in, and the agent's not dragging you all over town to look at homes you'd never buy. Your agent spends more time selling or listing homes and less time driving all over the place.
You can start with www.realtor.com. At this official site of the National Association of REALTORS, you can search for homes anywhere in the country or across town using home listings from your local newspaper to your local or even national real estate brokerage. It's really cool. You simply log onto the site, choose where you want to live, and select your preferences, like four bedrooms in this zip code in this price range with a pool or without, and so on. Next thing you know, there are your potential dream homes right on your computer screen. Some sites even have "virtual" tours showing different views of the house. This way you can see what homes are selling for and what's generally available.
Section I Mortgage Fundamentals 1
Chapter 1 Introduction to Mortgages 0
1.1 What's the difference between buying and renting? 0
1.2 How do I know if it's better to buy a home or continue renting? 00
1.3 How should I search for a house? 00
1.4 When is a good time to buy a home? 00
1.5 What's the difference between being prequalified and preapproved? 00
1.6 What is the preapproval process? 00
1.7 What are loan conditions? 00
1.8 What are Automated Underwriting Systems? 00
1.9 Who uses Automated Underwriting Systems? 00
1.10 If an Automated Underwriting System approves me, does that mean I get the loan? 00
1.11 What are the benefits of getting preapproved? 00
1.12 What are all these terms? 00
1.13 Who are the key people in a typical loan approval process? 00
1.14 What is the 1003? 00
1.15 What are the ten sections of the 1003? 00
1.16 What happens if the information you put on your application is wrong? 00
1.17 What happens after I fill out the 1003? 00
1.18 Are online applications the same as the five-page 1003? 00
1.19 Is an online application safe? Can someone steal my identity? 00
1.20 What happens after I make an offer for a house? 00
Chapter 2 How to Know How Much Home to Buy 000
2.1 How do I know how much I can borrow? 000
2.2 What are debt ratios? 000
2.3 How do I calculate my debt ratios? 000
2.4 How much do debt ratios affect how much I can borrow? 000
2.5 How can lenders approve people with high debt ratios? 000
2.6 Why do lenders use monthly tax and insurance payments in debt ratios? 000
2.7 Why is escrow a requirement for loans with less than 20 percent down? 000
2.8 If I have a choice, are escrows right for me? 000
Chapter 3 Getting Your Finances Together 000
3.1 What will the lender look for when looking at my assets? 000
3.2 How do I document my assets? 000
3.3 How do I document my income? 000
3.4 If I just got my first job, how can I provide a W-2 from last year? 000
3.5 What do you mean by "how you're paid"? 000
3.6 Why do lenders ask for the most recent 30-day paycheck stubs? 000
3.7 If I get paid in cash, how do I document that? 000
3.8 How do I calculate hourly wages? 000
3.9 How do I calculate overtime? 000
3.10 How are bonuses used to figure my income? 000
3.11 How do I figure my income if it is based solely on commissions? 000
3.12 How do I calculate my pay if I have both a salary and a bonus or a commission? 000
3.13 If I can deduct a lot of expenses from my income taxes, does that help gross monthly income? 000
3.14 How do I show expenses on my loan application? 000
3.15 How do I calculate my dividends and interest income? 000
3.16 How do I calculate my income if I own my own business? 000
Chapter 4 Down Payments and How They Impact Your Mortgage 000
4.1 What exactly is a down payment? 000
4.2 What are the risk elements? 000
4.3 How do I know how much to improve another risk element? 000
4.4 What kinds of accounts can I use to fund the down payment? 000
4.5 Can I borrow against my retirement account? 000
4.6 Can my family help me out with a down payment? 000
4.7 What do I do if I don't have a down payment saved? 000
4.8 What is a "seller assisted" DPAP? 000
4.9 How do I know if I qualify for a down payment assistance program? 000
4.10 Is there an ideal amount I should put down on a home? 000
4.11 How much is a mortgage insurance policy? 000
4.12 Can I deduct mortgage insurance from my income taxes? 000
4.13 Can I "borrow" my mortgage insurance? 000
4.14 Will PMI come off of my mortgage automatically? 000
4.15 What about "zero money down" loans? 000
4.16 What is the My Community Mortgage? 000
4.17 How do I buy a house if I need to sell my house for my down payment? 000
4.18 Will I have to qualify with two mortgages? 000
Chapter 5 Getting Your Credit Together 000
5.1 What exactly is credit? 000
5.2 How were credit bureaus established? 000
5.3 What's in my credit report? 000
5.4 What's not in my credit report? 000
5.5 What's the difference between a Chapter 7 and a Chapter 13? 000
5.6 Do lenders view a Chapter 7 or a Chapter 13 more favorably when reviewing a mortgage application? 000
5.7 What's the difference between "good" and "bad" credit? 000
5.8 How do I establish good credit? 000
5.9 I've got great credit. How do I keep it that way? 000
5.10 I cosigned on my brother's car, but he's making the payments. Will this affect my credit? 000
5.11 What should I do first to improve my credit? 000
5.12 What happens if you find a mistake on your report? 000
5.13 Can't I write a letter explaining my side of the story to the credit bureaus? 000
5.14 Can my lender help fix mistakes in my credit history? 000
5.15 What do I need in order to prove something is a mistake on my credit report? 000
5.16 What about mortgage companies that advertise "bad credit, no credit okay"? 000
5.17 What about a cosigner? 000
5.18 Can a seller ask for a copy of my credit report? 000
5.19 What is alternate credit? 000
5.20 I have bad credit and was contacted by a credit counseling company that wants to help reestablish my credit. Can they do that? 000
5.21 Can I erase my old credit report completely and start all over again? 000
5.22 I have great credit, but my spouse has terrible credit. What do I do? 000
5.23 My "ex" has screwed up my credit. What do I do? 000
5.24 How will lenders view our credit report if we're not married? 000
5.25 How long do I have to wait in order to get approved for a mortgage if I declared bankruptcy in the past? 000
5.26 I filed a Chapter 13 bankruptcy and I'm still making the payments. Can I get a mortgage now? 000
Chapter 6 Credit Scores: What They Are, How They Work, and How to Improve Them 000
6.1 What are credit scores? 000
6.2 What makes up a score? 000
6.3 What things in my payment history affect my credit score? 000
6.4 What about my amounts owed? What is most important? 000
6.5 How do I find out what my score is? 000
6.6 How do I get a credit score? 000
6.7 What is the minimum credit score I need to qualify for a mortgage loan? 000
6.8 What if my lender told me I couldn't qualify because my credit score was too low? 000
6.9 How do I know how much to charge and how much to pay off? 000
6.10 What else affects my credit score? 000
6.11 How can I increase my available credit without opening up new accounts? 000
6.12 I've applied at more than one mortgage company. Will all those credit inquiries hurt my score? 000
6.13 How do I fix scores that are artificially low due to mistakes? 000
6.14 If there are several mistakes on my report, do I get them all corrected? How do I know which ones to correct? 000
6.15 I'm a single parent and a minority. Does this status help or hurt my credit score? 000
6.16 How do lenders choose which credit scores to use? 000
6.17 I have great credit scores, but my spouse has low credit scores. What happens? 000
Section II The Right Mortgage 000
Chapter 7 Finding Your Home Loan 000
7.1 What kinds of loans are there? 000
7.2 When would I want a fixed rate? 000
7.3 When would I want an adjustable rate? 000
7.4 How do adjustable rate mortgages work? 000
7.5 Are ARMs only helpful in the very near term? 000
7.6 What exactly is a hybrid loan? 000
7.7 What's a balloon mortgage? 000
7.8 What is a buydown? 000
7.9 Apart from choosing fixed or adjustable rates, what types of loan programs should I consider? 000
7.10 How are limits on conventional loans set? 000
7.11 Who or what are Fannie and Freddie? 000
7.12 What are special commitments? 000
7.13 What exactly is a jumbo mortgage? 000
7.14 Can I prepay my mortgage or pay it off early? 000
7.15 What are prepayment penalties? 000
7.16 Why do lenders have prepayment penalties on some of their loans? 000
7.17 What are VA loans? How do you get them? 000
7.18 Who's eligible for a VA loan? 000
7.19 What is a VA "entitlement"? 000
7.20 How often can I use my VA eligibility? 000
7.21 What is a VA streamline refinance? 000
7.22 Do states have VA loan programs, too? 000
7.23 What about FHA loans? 000
7.24 Who sets FHA loan limits and how much are they? 000
7.25 Is FHA only for first-time home buyers? 000
7.26 When do I choose an FHA loan instead of any other? 000
7.27 Can I use a coborrower to help me qualify for an FHA loans? 000
7.28 Does FHA help me save money on closing costs? 000
7.29 What about first-time home buyer loans? 000
7.30 What does "portfolio lending" mean? 000
7.31 What's the difference between second homes and rental property? 000
7.32 How does the lender know that a property is a second home and not a rental unit? 000
7.33 Can I use rental income to qualify for a mortgage? 000
7.34 Are loan limits for rental properties the same as for primary residences? 000
7.35 What is an interest-only loan? 000
7.36 What is a negative amortization loan? 000
7.37 What is a payment option ARM? 000
7.38 What about seller financing? 000
7.39 How can I rent-to-own or use a lease-purchase to buy a house? 000
7.40 What's a wraparound mortgage? 000
7.41 What is a biweekly loan program? 000
7.42 What is alternative or "Alt" lending? 000
Chapter 8 Loans for Good to Great Credit 000
8.1 What should I look for in a mortgage loan? 000
8.2 So everyone should first try for a conventional loan? 000
8.3 What if my loan isn't a Fannie loan? What if it's a jumbo or a portfolio? 000
8.4 Then how do I manage to find the loan that's right for me? 000
8.5 Should I always try to put as much down as I can? 000
8.6 Do I have a choice in my loan term? 000
8.7 Why are payments higher on a 15-year loan even though the rate is lower? 000
8.8 Won't my loan officer help me find the right mortgage? 000
8.9 What if I can't provide parts of the documentation for the loan? 000
8.10 Why wouldn't I just apply for a "NINA with no job" and forget about all the other hassles of pay stubs and W-2s? 000
8.11 Why would I ever want to apply for any of those loans? 000
8.12 Does the type of property affect the kind of loan I can have? 000
8.13 What types of property can I expect problems with? 000
Chapter 9 Loans for People with Impaired or Damaged Credit 000
9.1 My credit's not so good. Where do I get a mortgage for my situation? 000
9.2 Do I have to put more down with a subprime loan? 000
9.3 What's the matter with subprime loans? 000
9.4 What kind of interest rates can I expect from a subprime loan? 000
9.5 What about prepayment penalties on subprime loans? 000
9.6 How can a hybrid adjust after two years? 000
9.7 Aren't subprime loans more expensive? 000
9.8 Should I just wait until my credit gets better and apply later? 000
9.9 What if the rates are higher when I go to refinance a subprime loan? 000
9.10 What is a predatory loan? 000
9.11 Don't some lenders make a loan hoping they can foreclose on it? 000
9.12 What's the difference between subprime and predatory? 000
9.13 Are subprime loans harder to qualify for now because of past problems in the industry? 000
Chapter 10 Refinancing and Home Equity Loans 000
10.1 Why would I want to refinance my mortgage? 000
10.2 Should I wait until the interest rate is 2 percent lower than my current one to refinance? 000
10.3 What is my rescission period? 000
10.4 How long should I wait to recover closing costs? 000
10.5 Do I have to close my loan within thirty days, or can I wait to see if rates drop further? 000
10.6 Why are there fees on a refinance? 000
10.7 Should I pay points for a refinance? 000
10.8 What about reducing my interest rate and also reducing my loan term? 000
10.9 Why not just pay extra each month instead of refinancing? 000
10.10 What's a cash-out mortgage? 000
10.11 How do I get money out of my property without refinancing? 000
10.12 How do I refinance if I have both a first and a second mortgage? 000
10.13 Which is better, a cash-out refinance or a HELOC? 000
10.14 Why is my loan payoff higher than my principal balance? 000
10.15 My credit has been damaged since I bought the house. Will that hurt me? 000
10.16 How do I get a note modification? 000
10.17 What is a "recast" of my mortgage? 000
10.18 I've heard of a modifiable mortgage. What's that? 000
10.19 What happens when my loan is sold? 000
10.20 What's a reverse mortgage? 000
10.21 Who qualifies for a reverse mortgage? 000
10.22 How much can I get with a reverse mortgage? 000
10.23 Why not do a cash-out refinance instead of a reverse mortgage? 000
10.24 Are the closing costs the same for a reverse mortgage as with a regular mortgage? 000
10.25 What are the rates for reverse mortgages? 000
10.26 I have a current mortgage on my house. Do I get to keep that? 000
10.27 How do I know if a reverse mortgage is right for me? 000
Chapter 11 Construction and Home Improvement Loans 000
11.1 Why would I want to build a home? Why can't I just go out and buy one? 000
11.2 How do construction loans work? 000
11.3 Do I buy a home from a developer, or is it better to start from scratch? 000
11.4 How do I get approved for a construction loan? 000
11.5 How much do I need for a construction loan? 000
11.6 Does the lender approve my builder? 000
11.7 How does the mortgage lender know what the house is worth before it's built? 000
11.8 What if I already own the land? Do I still include that amount in the construction loan? 000
11.9 But what if I don't want a permanent mortgage, but just a construction loan? 000
11.10 What choices do I have for construction loans? 000
11.11 Is a one-time close better than a two-time close? 000
11.12 What if rates drop during my one-time close loan? 000
11.13 What if my builder is financing the construction? 000
11.14 Do I have to use the builder's mortgage company? 000
11.15 What are my options if I just want to build onto my current house? 000
11.16 How can I borrow enough to make major improvements on my home? 000
11.17 What is an FHA 203(k) loan? 000
Section III The Right Lender and Rate 000
Chapter 12 Finding the Best Lender 000
12.1 I've decided on my loan. Now what? 000
12.2 How do I find the best lender? 000
12.3 But where do I get the names of all these lenders in the first place? 000
12.4 How do I know if I can trust these lenders? 000
12.5 Should I use my real estate agent's mortgage company? 000
12.6 I thought all money came from the bank. Doesn't it? 000
12.7 What is a mortgage broker? 000
12.8 Are mortgage brokers more expensive? 000
12.9 Why do mortgage companies use mortgage brokers? 000
12.10 How do mortgage brokers get paid? 000
12.11 How many lenders do mortgage brokers use? 000
12.12 Will the broker keep my lender a secret? 000
12.13 Is a mortgage broker my best choice? 000
12.14 Should I choose a broker or a banker? 000
12.15 What happens if I want to change lenders in the middle of my loan process? 000
Chapter 13 Finding the Best Loan Officer 000
13.1 How do I find the best loan officer? 000
13.2 How do I know if the loan officers my real estate agent suggests are any good? 000
13.3 What if my agent is not a heavy hitter? 000
13.4 Do the best loan officers work with the biggest lenders? 000
13.5 What questions should I ask a potential loan officer? 000
13.6 How do loan officers get trained? 000
13.7 What training or courses do loan officers take? 000
13.8 How do loan officers get paid? 000
13.9 What are market gains? 000
13.10 Are market gains legal? 000
13.11 Do all loan officers charge one percent on every loan? 000
13.12 My loan officer isn’t any good. Can I change loan officers? 000
13.13 Where do I complain about my loan officer? 000
Chapter 14 Finding the Best Interest Rate 000
14.1 Who sets mortgage rates? 000
14.2 How does my loan officer quote rates? 000
14.3 But doesn't the Fed set interest rates? 000
14.4 Are mortgage rates tied to the 30-year treasury and the 10-year treasury? 000
14.5 Who invests in bonds? 000
14.6 Where are rates headed? 000
14.7 What types of economic reports should I pay attention to? 000
14.8 Do I follow all of the economic reports? 000
14.9 When is the best time to get a rate quote? 000
14.10 Can I trust the interest rates in the newspaper? 000
14.11 Why are some lenders so much lower than everyone else? 000
14.12 How do I get a good rate quote from all my competing lenders? 000
14.13 What do I do with my two best quotes? 000
14.14 How do I lock in my mortgage rate? 000
14.15 Does my lock mean I'm approved? 000
14.16 What happens if my rate lock expires and I still haven't closed my loan? 000
14.17 What happens if I lock and rates go down? 000
14.18 Will lenders drag their feet to make a lock expire? 000
Chapter 15 Closing Costs and How to Save on Them 000
15.1 What types of closing costs can I expect? 000
15.2 Why are there so many charges? 000
15.3 Why do lenders charge fees? 000
15.4 On which closing costs can I save and which ones can I forget about? 000
15.5 Are fees for purchases and refinances the same? 000
15.6 How can I save on my appraisal fees? 000
15.7 How can I save on my credit report? 000
15.8 How can I save on title insurance? 000
15.9 What exactly is the good faith estimate? 000
15.10 How do I use a good faith estimate to compare lenders? 000
15.11 What is APR, and does it really work? 000
15.12 How can I get the seller to pay for my closing costs? 000
15.13 What's a "one-fee closing" cost? 000
15.14 Can a lender pay all my fees? 000
Chapter 16 The Internet and Mortgages 000
16.1 How has the Internet helped mortgage lending? 000
16.2 Should I apply for a mortgage online or meet with a loan officer? 000
16.3 How can I use the Internet to find the best mortgage rate? 000
16.4 What about online companies that advertise they will have lenders "bid" on my mortgage loan? 000
16.5 What happens if I choose an online lender but the closing papers are all wrong? 000
16.6 Should I avoid online lenders? 000
16.7 I keep getting e-mails from companies with some very competitive offers. Shouldn't I at least explore them? 000
16.8 Can I get my loan approval online? 000
16.9 Is there any way I can check on rates without contacting a lender? 000
16.10 Can I track my loan approval online? 000
16.11 What are some good Web sites consumers can use to help them? 000
Appendix: Monthly Payment Schedules 000
Finding a home loan, at first glance, is a simple process. A loan is nothing more than money you borrowed and promised to pay back, right? Right. But if a loan is a loan is a loan, then why are some lender's mortgage rate sheets sixteen pages long with over 100 loan programs? That's when it gets tricky, choosing the right loan for you.
7.1 What kinds of loans are there?
As many as you can imagine. Here's a brief list of the most common types of mortgage loans offered by every lender or mortgage broker:
30-year fixed 25-year fixed 20-year fixed 15-year fixed 10-year fixed 5-year balloon 7-year balloon 1-year ARM 3/1 ARM 5/1 ARM 7/1 ARM 10/1 ARM buydown 3/6 ARM 5/6 ARM 7/6 ARM 10/6 ARM VA fixed FHA fixed FHA ARM Conf. 97 Conf. 100 Conf. 103 Conf. 107 80/20 interest-only state bonds seconds HELOC const.-perm neg-am portfolio
These loans, and plenty more variations, are good for conforming loan amounts. Another set of loan programs is available for jumbo loans, and still another group is set aside for sub-prime loans. There are still probably more. But the good (or bad) thing about it is that most all of the loans are alike in some way. With a few exceptions, most lenders offer the same programs, with the only variable being the cost of the loan itself. If one lender introduces a new program and it's successful, you can bet the other lenders will soon follow with a replica product.
But that can lead to confusion on both the borrowers' and loan officers' parts. Some mortgage brokers advertise that they have access to forty or fifty mortgage lenders. Or more. Are lenders all that different? Do we really need that many loan programs? Of course not, but a loan falls into either one of two categories: a fixed loan, and a loan that can adjust over the life of the loan, called an adjustable rate mortgage. The only difference really is the rate and terms of the mortgage from one place to another.
7.2 When would I want a fixed rate?
1. When rates are at relative lows compared to the previous two or three years. Here a fixed rate is good, because it locks in that money for the remaining term. Over the past twenty-five years fixed rates have been as high as 18 or 19 percent and as low as 5 percent. If you're in a high interest rate cycle, it might not be the best time to get a fixed rate. If rates are relatively low, it might be a good time to lock in the low rates.
2. When you're holding onto the property for a long time, say more than five years. This could be the home you plan to retire in, or a home where you can say, "Enough! I'm tired of moving."
3. When you're not one of the gambling types. Fixed rates never change. Yeah, adjustable rates can start low but they can also go much higher. Some like to be able to plan in the long run what their house payment will be five, ten, or twenty years from now. Others can't sleep at night because they're wondering if their house payments will go up next year.
7.3 When would I want an adjustable rate?
1. When rates are at relative highs compared to the previous years. If rates are currently at a high cycle, chances are rates will go down in the near future. On the other hand, if rates are at historical lows you may want to avoid an adjustable rate mortgage.
2. When your job has you move a lot. Adjustable rate mortgages typically have lower starting rates than fixed ones, and if you transfer or move often you'll have retired your mortgage before an adjustable has time to move upwards.
3. When you have a gut feeling that rates will stay the same or move lower for the long term. If your rate is in the middle of the pack compared to historic rates, an adjustable rate gives you the benefit of a lower start rate with the possibility of moving into an even lower rate later on.
7.4 How do adjustable rate mortgages work?
There are four basics for adjustable rate mortgages (ARMs): the index, the margin, the adjustment period, and rate caps.
1. The Index. This is what your interest rate is tied to. Your index can actually be anything you agree upon, but most ARMs are indexed to a 1-year treasury, or something called a LIBOR. LIBOR stands for the London Inter-Bank Offered Rate and is quite similar to the federal funds rate found here in the United States. The LIBOR index is released each business day and is the index by which banks lend money to one another over the short term, for example overnight.
The 1-year treasury is a security or treasury bill issued by the Feds to, among other things, raise money. Other indexes that ARMs might be tied to are various LIBOR and treasury maturities, like 1-month or 6-month LIBOR ARMs, the prime rate, or even certificates of deposit (CDs). Your index could theoretically be anything you agree to. It could be the price of a gallon of ice cream if that's the deal you come up with.
2. The Margin. The margin is the difference between your mortgage rate and your index. The index is what your rate is based upon, and the lender adds a margin to it (think profit margin or cushion) to arrive at your note rate. This is also called your fully indexed rate, the number reached when you add your index and your margin. Common margins are anywhere from 2.00 percent to 2.75 percent, although some loans let you pay extra fees, such as 1/2 discount point, to get a lower margin.
3. The Adjustment Period. This is the period after which your rate can adjust. At the end of each adjustment period, your margin is added to the current index to get your new rate. Sometimes the rate won't change, but most often it will, as the index will have changed. Common adjustment periods are every six months or once per year (anniversary date). Using the ice cream example, let's say your new loan is an ARM with the cost of a gallon of ice cream as the index. You also agree that the lender will add 2.00 (the margin) to whatever that cost (index) will be. One year from now the cost of a gallon of ice cream is $5.00. Since your margin is 2.00, your new rate for the following year will be 5.00 + 2.00, or 7.00 percent. But what if there's a milk shortage and the cost of ice cream zooms to $50.00 a gallon? Will your rate then be 52 percent?
4. Rate Caps. This is how high your rate is permitted to change each adjustment period. Yeah, maybe the ice cream went from $5.00 a gallon to $50.00 a gallon, but don't sweat it. An adjustment cap protects consumers from wild swings in their loan index by limiting the increase from period to period. When the adjustment rate cap is set for 1 percent every six months, or 2 percent every twelve months, it means that at the end of each six-months adjustment period the rate is allowed to increase only another 1 percent over the previous rate. In the ice cream example, even though your fully indexed rate might be 52 percent, because of the rate cap the rate is only allowed to jump to 6.00 percent.
A second type of cap is called a lifetime cap, which means that, no matter what, the interest rate can never be higher than the cap. Some caps are at 5.00 percent above the starting rate, but most caps are at 6.00 percent above the starting rate. If your loan has a 5 percent lifetime cap and you started out at 5.00 percent, then, no matter what, your fully indexed rate will never be higher than 5 + 5, or 10.00 percent.
Other types of adjustables have an initial cap, meaning that at the very first, or initial, adjustment period the cap is 5.00 percent or 6.00 percent, or whatever the agreed-upon loan parameters actually are.
There are then three possible caps on an adjustable rate mortgage: the adjustment cap, the lifetime cap, and the initial cap. You might see some adjustable rate mortgage cap numbers reading 2/6 or 1/5. That means the adjustment cap is 2 percent or 1 percent and the lifetime cap of the loan is 6 percent or 5 percent. For loans with initial rate caps it might read 5/2/5, meaning a possible 5 percent cap at the very first adjustment, 2 percent annually or at each adjustment period, and 5 percent over the life of the loan.
7.5 Are ARMs only helpful in the very near term?
Probably. They may also help those who locked in at the right time to not only get a lower starting rate than competing fixed rate mortgages but to have their index actually drop over the next few years. For them it means simply watching their mortgage payment drop every six months or so, while people who chose a fixed rate mortgage have to refinance their loan to get a lower rate. There is actually a combination of a fixed mortgage and an adjustable rate mortgage. It's called a hybrid.
7.6 What exactly is a hybrid loan?
A hybrid is simply a combination of a fixed and an ARM where the rate is fixed for a predetermined number of years before turning into an ARM for the remaining life of the loan. Hybrids have a lower starting rate than a fixed rate mortgage but a slightly higher rate than an adjustable rate mortgage. The trade-off is the rate guarantee for the near term. Most hybrids are fixed initially for three or five years. Some hybrids have fixed terms that go as high as ten years, but if their rates are higher than comparable fixed rates, they may not make much sense. Hybrids, then, even though they're a "combination" of a fixed and an adjustable mortgage, are essentially ARMs that are fixed for the first few years.
A hybrid fixed for three years before turning into an annual adjustable rate mortgage is called a 3/1 loan. Similarly a 5/1 hybrid is fixed for five years before becoming an ARM, and so on. Over the past few years hybrids have b ecome more and more popular as consumers determined that they're not very likely to own a home for fifteen or twenty years but in practice only plan to live in the house for three, four, or five years. In these cases hybrids are hard to beat.
Are hybrids the best choice? Not necessarily. Again, there is a risk that they indeed can change into a semi-unpredictable ARM later on. For instance, you figure that you'll be up for a big promotion in three years so you choose a 3/1 hybrid. But during those three years you don't get that promotion, and now you're stuck with a possible rate increase at the first adjustment period. Life's what happens when you're busy making plans, right? Plans can change but your note stays the same.
Some people are almost positive they'll be out of their mortgage in four years but don't choose a 5/1 ARM because they're just not comfortable with the possibility of higher payments down the road. Just understand that there is an alternative between an adjustable rate mortgage and a fixed one. But in the long run, there really are only two basic loans: fixed loans and adjustable loans.
7.7 What's a balloon mortgage?
A balloon mortgage is a loan whose entire note balance becomes due after a predetermined period. Balloon mortgages are recognized by their names, such as 5/25 or 7/23. In this example, the amortization period is 30 years-either 5 + 25 or 7 + 23-for the purpose of calculating monthly payments, but after five or seven years the remaining principal balance becomes due to the lender. The payment "balloons."
Balloon mortgages are similar to a hybrid in that their initial interest rate is fixed for either the 5-year or 7-year period, but instead of turning into an adjustable rate mortgage the entire note comes due. Balloon mortgages offer below market rates for the initial term. Most balloon mortgages have an internal "reset" feature that accommodates borrowers who don't want to pay the entire balance after 5 or 7 years. When the mortgage is reset, an index plus a margin will determine the fixed rate payment for the remaining 25 or 23 years. If a balloon is a Freddie Mac loan, the index will typically be a Freddie Mac index plus a margin of anywhere from 1/2 to 1 percent.
7.8 What is a buydown?
A buydown either temporarily or permanently reduces the note rate on a mortgage. A temporary buydown is sometimes called a "two-step" or a "2-1" buydown, where there is a lower start rate for year 1, with a higher rate for years 2 through 30. Buydowns can help borrowers who might have trouble qualifying at 8.00 percent but can qualify at the lower, buydown rate of 7.00 percent.
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Temporary buydowns are nothing more than prepaid interest to the lender expressed as a note rate. They can be applied to most any fixed rate mortgage in the market. Temporary buydowns can also be for three years, called a 3-2-1 buydown. A 3-2-1 could have a start rate of 6.00 percent for year 1, 7.00 percent for year 2, and 8.00 percent for years 3 to 30. Temporary buydowns can be a good choice if you expect to have increased income in the next year or two, as in the case of starting a new job or practice.
To calculate a temporary buydown, you take your principal balance and calculate a monthly payment using a current market rate with no points. If current rates were 7.00 percent and your loan amount is $300,000 then your monthly payment would be $1,995, using a 30-year fixed rate. For a 2-1 buydown, drop the rate from 7.00 percent to 6.00 percent, then again calculate the monthly payment, which would be $1,798; subtracting that from $1,995 gives you $196. If you multiply that $196 by the twelve months you'll have the 6.00 percent rate you get the amount you must pay the lender for the temporary buydown, or $2,356.
You now have a choice of paying that tax-deductible interest in the form of cash at closing or you can adjust your interest rate to accommodate the interest. By dividing the buydown interest of $2,356 by your loan amount of $300,000, you get about 80 basis points, or almost 7/8 of a discount point. If you increase your rate by about 1/4 percent your lender will accept the higher rate in lieu of a cash payment from you.
Temporary buydowns are effective if you're either having trouble qualifying at higher market rates or if you simply want lower rates to start out with.
The other type of buydown is a permanent buydown. A permanent buydown is nothing more than paying discount points to get a lower rate and can be applied to either a fixed rate or an adjustable one. There is a difference here. Temporary and permanent buydowns mean different things to lenders.
7.9 Apart from choosing fixed or adjustable rates, what types of loan programs should I consider?
Besides choosing a fixed rate versus an adjustable rate, you also need to examine the types of loans available to you. And again, most loans will fall into two types: conventional and government.
Excerpted from Mortgages 101 by David Reed Copyright © 2004 by David Reed. Excerpted by permission.
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Posted April 13, 2005
Posted January 27, 2005
I bought this book to see if the author really knows what he's talking about. Not only does he know what he's talking about, he taught me a few things as well. I'm a mortgage broker in Miami, and went online to buy 10 more Mortgages 101 books for our loan officers and real estate agents. Thorough, insightful and fun to read.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.
Posted August 30, 2004
This book takes all the terms I didn't understand and made me understand them. The author is actually fun to read, something different when it comes to something boring like mortgages. Some of it is easy, some of it takes you behind the scenes, especially when it comes to how loan officers get paid and how and when you can use their comissions to help pay for closing costs.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.
Posted April 8, 2010
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Posted November 24, 2010
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