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Get an overview of types of loans and terms and tips on how
to afford a mortgage and down payment.
What's Below:
- What are the best sources of home
loans or mortgages?
- What are options for buyers who can't
afford a 20% down payment?
- What is private mortgage insurance?
- Can I tap into my IRA or 401(k) plan
for down payment money?
- What kinds of government loans are
available to homebuyers?
- What's the difference between a fixed
and adjustable rate mortgage?
- Which is better -- a fixed or adjustable
rate mortgage?
- How do I find the least costly mortgage?
Mortgage Question
#1: What are the best sources of home loans or mortgages?
Many entities, including banks, credit unions, savings and
loans, insurance companies and mortgage bankers make home
loans. Lenders and terms change frequently as new companies
appear, old ones merge and market conditions fluctuate. To
get the best deal, it's a good idea to compare loans and fees
with at least a half a dozen lenders. Because many types of
home loans are standardized to comply with rules established
by the Federal National Mortgage Association (Fannie Mae)
and other quasi-governmental corporations that purchase loans
from lenders, comparison shopping is not difficult. Be sure
to ask for the same size, type, and length of mortgage --
such as a 30-year fixed term mortgage for $300,000 -- so you're
comparing apples to apples.
Fortunately, mortgage rates and fees are usually published
in the real estate sections of metropolitan newspapers, and
are increasingly available on online mortgage websites. You
can also work with a loan broker, who is someone who specializes
in matching house buyers and appropriate mortgage lenders,
normally collecting a fee from the lender.
Be sure to check out government-subsidized mortgages, which
have no down payment and low down payment plans. Also, ask
banks and other private lenders about any "first-time
buyer" programs that offer low down payment plans and
flexible qualifying guidelines to low- and moderate-income
buyers with good credit.
Finally, don't forget private sources of mortgage money --
parents, other relatives, friends or even the seller of the
house you want to buy. Borrowing money privately is usually
the most cost-efficient mortgage of all.
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Mortgage Question #2: What
are options for buyers who can't afford a 20% down payment?
Assuming you can afford (and qualify for) high monthly mortgage
payments and have an excellent credit history, you should
be able to find a low (10% to15%) down payment loan. However,
you may have to pay a higher interest rate and loan fees (points)
than someone making a larger down payment.
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Mortgage Question #3: What is private
mortgage insurance?
Private mortgage insurance (PMI) policies are designed to
reimburse a mortgage lender up to a certain amount if you
default on your loan and the foreclosure sale is less than
the amount you owe the lender -- that is, the amount of your
mortgage loan plus the costs of the foreclosure sale. Most
lenders require PMI on loans where the borrower makes a down
payment of less than 20%. Premiums are usually paid monthly
and typically cost less than one-half of one percent of the
mortgage loan. With the exception of some government and older
loans, you can drop PMI once your equity in the house reaches
22% and you've made timely mortgage payments. Ask your lender
for details on the cost of PMI and requirements for canceling
it.
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Mortgage Question #4: Can I
tap into my IRA or 401(k) plan for down payment money?
Under the 1997 Taxpayer Relief Act, first-time homebuyers
can withdraw up to $10,000 penalty free from an individual
retirement account (IRA) for a down payment to purchase a
principal residence (though you might have to pay income tax
on the amount withdrawn.) This $10,000 is a lifetime limit
-- and the money must be used within 120 days of the date
you receive it. The law defines a first-time homeowner as
someone who hasn't owned a house for the past two years. If
a couple is buying a home, both must be first-time homeowners.
Ask your tax accountant for more information, or check IRS
rules at www.irs.gov.
Another source of down payment money is a loan against your
401(k) plan. Ask your employer or plan administrator if your
plan allows loans. If it does, the maximum loan amount under
the law is the one-half of your vested balance in the plan
or $50,000, whichever is less. (If, however, you have less
than $20,000 in your plan, your limit is the amount of your
vested balance, but no more than $10,000.) Other conditions,
including the maximum term, the minimum loan amount, the interest
rate and applicable loan fees, are set by your employer. Any
loan must be repaid in a "reasonable amount of time,"
although the Tax Code doesn't define what is reasonable. Be
sure to find out what happens if you leave your job before
fully repaying a loan from your 401(k) plan. If a loan becomes
due immediately on your departure, income tax penalties may
apply to the outstanding balance -- but you can usually avoid
this hassle by repaying the loan before you leave the job.
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Mortgage Question #5: What
kinds of government loans are available to homebuyers?
Several federal, state and local government financing programs
are available to homebuyers. The two main federal programs
are:
- VA Loans.
U.S. Department of Veterans Affairs (VA) loans are available
to men and women who are now in the military and to veterans
with other than dishonorable discharges who meet specific
eligibility rules, most of which relate to length of service.
The VA doesn't make mortgage loans but guarantees part of
the house loan you get from a bank, savings and loan or
other private lender. If you default, the VA pays the lender
the amount guaranteed and you in turn will owe the VA. This
guarantee makes it easier for veterans to get favorable
loan terms with a low down payment. For more information,
check the VA's Website at www.va.gov or contact a regional
VA office for advice.
- FHA Loans.
The Federal Housing Administration (FHA), an agency of the
Department of Housing and Urban Development (HUD), insures
loans made to all U.S. citizens and permanent residents
who meet financial qualification rules. Under its most popular
program, if the buyer defaults and the lender forecloses,
the FHA pays 100% of the amount insured. This loan insurance
lets qualified people buy affordable houses. The major attraction
of an FHA-insured loan is that it requires a low down payment,
usually about 3% to 5%. For more information on FHA loan
programs, contact a regional office of HUD or check the
FHA website at www.hud.gov.
For information on other government loans, contact your state
and local housing offices. They often have programs available
for first-time homebuyers who are purchasing modestly-priced
properties. Start by looking at your state's home page. You'll
probably find the listing for your state's housing office.
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Mortgage Question #6: What's
the difference between a fixed and adjustable rate mortgage?
With a fixed rate mortgage, the interest rate and the amount
you pay each month remain the same over the entire mortgage
term, traditionally 15 or 30 years. A number of variations
are available, including five- and seven-year fixed rate loans
with balloon payments at the end.
With an adjustable rate mortgage (ARM), the interest rate
fluctuates according to the interest rates in the economy.
Initial interest rates of ARMs are typically offered at a
discounted ("teaser") interest rate that is lower
than the rate for fixed rate mortgages. Over time, when initial
discounts are filtered out, ARM rates will fluctuate as general
interest rates go up and down. Different ARMs are tied to
different financial indexes, some of which fluctuate up or
down more quickly than others. To avoid constant and drastic
changes, ARMs typically regulate (cap) how much and how often
the interest rate and/or payments can change in a year and
over the life of the loan. A number of variations are available
for adjustable rate mortgages, including hybrids that change
from a fixed to an adjustable rate after a period of years.
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Mortgage Question #7: Which
is better -- a fixed or adjustable rate mortgage?
It depends. Because interest rates and mortgage options
change often, your choice of a fixed or adjustable rate mortgage
should depend on:
- the interest rates and mortgage options available when
you're buying a house
- your view of the future (generally, high inflation will
mean ARM rates will go up and lower inflation means that
they will fall), and
- how willing you are to take a risk.
When mortgage rates are low, a fixed rate mortgage is the
best bet for most buyers. Over the next five, ten or thirty
years, interest rates are more apt to go up than further down.
Even if rates could go a little lower in the short run, an
ARM's teaser rate will adjust up soon and you won't gain much
if you plan to stay in the house more than a few years (the
broker can tell you your break-even point). In the long run,
ARMs are likely to go up, meaning most buyers will be best
off to lock in a favorable fixed rate now and not take the
risk of much higher rates later.
Keep in mind that lenders not only lend money to purchase
homes; they also lend money to refinance homes. For example,
if you take out a fixed rate loan now, and several years from
now interest rates have dropped, refinancing will probably
be an option.
There are several downsides to refinancing. Unless you can
negotiate a low-cost refi, you may have to pay the same fees
and points as for an original mortgage. This means you may
reduce your monthly payment right away but not actually begin
to save money on the refi for several years. (Again, your
broker can tell you when you will break even.) So, if you
think you will be moving again soon, it may not make sense
to refinance.
Second, on a refinanced mortgage your debt position under
your state's law can get worse. In California, for instance,
when a homebuyer defaults (stops paying the mortgage) on a
purchase mortgage, the lender can foreclose on the house but
take nothing else from the homebuyer, while on a refinanced
mortgage it can go after the homebuyer's cash and other assets,
after the house, to satisfy the debt.
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Mortgage Question #8: How do
I find the least costly mortgage?
You can save real money if you carefully shop for a mortgage.
Everything else being equal, even a one-quarter percentage
point difference in interest rates can mean savings of thousands
of dollars over the life of a mortgage.
In addition to comparing interest rates, there are a variety
of fees -- and fee amounts -- associated with getting a mortgage,
including loan application fees, credit check fees, private
mortgage insurance (if you're making a low down payment) and
points. Since points comprise the largest part of lender fees,
it's important to understand how they work: One point is 1%
of the loan principal. Thus, your fee for borrowing $250,000
at two points is $5,000. There is normally a direct relationship
between the number of points lenders charge and the interest
rates they quote for the same type of mortgage, such as a
fixed rate. The more points you pay, the lower your rate of
interest, and vice versa.
Before comparing points to interest, factor in how long you
plan to own your house. The longer you live in your house
(or pay on the mortgage), the better off you'll be, paying
more points up front in return for a lower interest rate.
On the other hand, if you think you'll sell or refinance your
house within two or three years, we strongly recommend that
you obtain a loan with as few points as possible.
A good loan officer or loan broker can walk you through all
options and trade-offs such as higher fees or points for a
lower interest rate.
Many online services provide mortgage rate information, though
they tend to assume you want a "standard" loan and
omit information on other available loans. Nevertheless, they
offer a great way to start your research and get a sense of
market rates, points and terms, as well as useful advice on
choosing a mortgage. And even if you are considering a loan
you found via more traditional approaches, you can check the
Internet to see if you have been offered the best terms.
Real Estate Lawyers.com provides a nationwide listing
of real estate lawyers, mortgage brokers and real estate agents
to represent you in your real estate transaction needs. Simply
type in your zip code to find the right real estate professional
near you.
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