Credit history, how long you plan to stay in your home, and payment schedules determine the mortgage that is right for you.
A mortgage is a loan that is secured on the property you buy with an agreed repayment schedule ranging from 15 to 30 years. With this arrangement, the lender essentially owns the property, so if you don’t pay the mortgage, the lender gets it. You can obtain a mortgage through a commercial bank, a mortgage company, or a credit union.
Mortgage Providers Commercial banks are investor-owned institutions that provide a number of lending services, while mortgage companies exist solely to negotiate mortgage loans. Since this is all they do, mortgage companies sometimes offer more competitive rates. Credit unions are member-based, non-profit institutions that serve a specific group of people, such as teachers or firefighters. If you want to get a mortgage from a credit union, you’ll need to be a member first.
Mortgage Holders Even though you’ll negotiate your mortgage with one of these organizations, your mortgage will likely be sold on the secondary mortgage market within a short period of time. Don’t be fazed by this. It doesn’t mean the terms will change, but you may have to change your payment date, payment arrangements, or even rules regarding grace periods and penalties. The two largest investors in the secondary mortgage market are Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation). Other buyers in the secondary market include pension funds and insurance companies. Mortgage Types All mortgages combine a portion of the amount you borrowed, known as the principal, and a chunk of interest, or the cost of borrowing the money. Some mortgages also include payments for real estate taxes and insurance. To calculate the total monthly cost of a mortgage, all of these components–known collectively as PITI (principal, interest, taxes, and insurance)–must be added together.
Fixed-rate and adjustable-rate mortgages are the most common mortgage arrangements available. A fixed-rate mortgage means that the interest rate will stay the same throughout the life of the loan. The loan is divided into equal payments, so that the first mortgage payment is the same as the last one, 15 or 30 years later. The first payments will have a high interest portion, while later payments will be mostly principal. This type of loan is ideal for those with fixed incomes or the need for a reliable figure for monthly expenditures. Fixed-rate mortgages typically carry a higher interest rate than adjustable-rate mortgages because they are guaranteed to remain stable over the life of the loan.
An adjustable-rate mortgage (ARM)–also known as a variable-rate mortgage–offers an interest rate that fluctuates in response to the prime rate, which is the lending rate set by the Federal Reserve Bank. For an initial period, between one and 10 years, the interest rate is fixed but then adjusts annually depending on the actual prime rate. Since loan repayments are initially lower than fixed-rate payments, this type of loan is ideal for people who expect their income potential to increase over time, such as students or young homebuyers embarking on new careers. Once the fixed-rate period has ended, rates on these mortgages can rise sharply, so it may be wise to consider refinancing the loan at that time.
Balloon Mortgage Strategy
Brent and Diane have relocated to a new town while Brent completes a four-year residency at the local hospital. Their finances are still moderate but they want to buy a house while Brent is completing his training. The balloon mortgage is a good option for them because the lower fixed interest rate means they can get more property for their money, while feeling secure that they can afford the payments. When they researched home buying in the area they discovered there is a healthy housing market because of the regular flow of new medical personnel into the community. They are confident that they will be able to sell the property when Brent’s residency is over, making the balloon mortgage option a good one for them.
Rebuilding Credit with a Two-Step Mortgage
Steve and Julie are recovering from a difficult 18 months after the company they worked for closed down and left them without jobs. During that time they got behind on car and credit card payments, which lowered their credit rating score considerably. They are now both working again and want to buy a house, but they need to re-establish a good credit history. They can do this with the lower initial payments of a two-step mortgage. Since they are both at the start of their careers, they also like the security of knowing that their rate will only be adjusted once.
Mortgage Payment Options It is important to look at how the loan will be repaid and select a payment plan that works for your financial situation. A two-step mortgage combines fixed and adjustable mortgage elements. It begins like an ARM, with the interest rate fixed at a lower level for an initial period. After that period the rate is adjusted once–not annually–and remains at the adjusted level for the remainder of the loan period. This kind of loan can help borrowers with damaged credit to establish a good payment track record.
A variation on the fixed-rate mortgage is the biweekly mortgage, in which borrowers make mortgage payments every two weeks instead of once a month. The result is that borrowers make the equivalent of 13 mortgage payments a year instead of 12. It’s a good strategy because by repaying principal early you can reduce the mortgage period by more than 25 percent. That means a total payoff in 23 years instead of 30 for a standard 30-year mortgage. This option is especially convenient for borrowers who are paid biweekly. The drawback is the lack of flexibility should you experience an unexpected financial change. Regardless of the plan, it is always helpful to make an additional payment each year. This reduces the principal left on the loan and brings you to complete ownership faster.
A balloon mortgage is another type of fixed-rate mortgage. The interest rate on a balloon mortgage is fixed for three to ten years at a rate lower than regular fixed rates. When that time is up the loan has to be repaid in full. This may be a good option if you plan to be in a home for only a short period of time. If not, borrowers will need to figure in the additional cost of refinancing the property when the mortgage comes due.