If you are thinking about buying a house, you’ll undoubtedly need a mortgage. Mortgages can be complicated and have a language of their own. There are some important facts you need to know about mortgages that could save you money and keep you from getting in financial trouble. Here are eight of them.
Choosing an ARM could make good sense
An ARM or Adjustable Rate Mortgage is different from a conventional mortgage because its interest rate will move up and down each month as market interests change. These mortgages generally have a fixed rate that can range from a month to 10 years during which time the interest rate doesn’t change. Then there’s a longer period during which it can change at predetermined intervals. The standard for ARMs has become a 5/1. This loan has an initial fixed interest rate period of five years with the rate then adjusting annually after this. This is usually called a hybrid mortgage. Other popular hybrids are 3/1, 7/1 and 10/1.
If you believe you’ll be in the house for seven years or fewer an ARM could make good sense, as its lower interest rate would translate into a lower monthly payment. But if you were to choose a 5/1 where the interest rate would reset after five years, there starts to be a change in the math. This is because your interest rate typically would go up two points every year after that.
If you’re applying for a conventional loan be prepared to pay for PMI
The three most popular types of mortgages are VA, FHA and conventional mortgages. Both VA and FHA mortgages are backed by the federal government. This reduces the risk to the lender. Unfortunately, conventional mortgages are not federally backed and, therefore, represent more of a risk to the lender. In this case, the lender will likely require you to buy PMI or private mortgage insurance. This protects lenders against a loss if you were to default on the loans. If your loan has a loan-to-value (LTV) percentage in excess of 80%, most lenders will require you to buy private mortgage insurance. The good news for you as a borrower is that this would allow you to make a down payment of 3% to 19.99% in comparison with the 20% you would be required to put down without PMI. You would pay on your PMI every month until you have enough equity in your home that the lender would no longer consider you to be a high risk.
It costs no more to use a mortgage broker
A mortgage broker is different from a mortgage banker. When you use a mortgage broker it serves as an intermediary between you and the lender. It will gather all the paperwork from you and then pass it along to the mortgage lender for underwriting and approval. The funds for the mortgage are lent in the name of the mortgage lender and not the mortgage broker. However, a mortgage broker will collect an origination fee or a yield spread premium from the lender as compensation for its services In other words, using a mortgage broker is really no more expensive than using a mortgage lender. Which you choose will be mostly a matter of your personal preferences. Some people are just more comfortable going through a broker instead of having to deal directly with the bank or lender. Plus, brokers can sometimes smooth out the transaction and make things simpler and easier for the borrower.
An FHA loan almost always has a lower interest rate
FHA or Federal Housing Administration loans generally have lower interest rates than conventional loans because the federal government backs them. This reduces the risk to the lender. One of these loans can be a good choice for a first-time buyer that doesn’t have much money to put down, as the down payment can be as low as 3.5%. This means you could buy a $200,000 house for just $7000 down. However, the downside of FHA loans is that you would be required to buy two forms of private mortgage insurance. The first is an upfront mortgage premium that would be 1.75% or $3500. However, this can be added to the loan so you would not be required to pay it out of pocket. But there is also an annual mortgage premium. In this case with a down payment of less than 5% you would pay 1.35% of the total loan balance. This works out to be $214 per month on a $200,000 mortgage. If you continue paying on that mortgage for five years you’ll have paid $15,708 just in mortgage insurance and over the life of the mortgage you would pay an incredible $49,479.
There are times when you might want to pay points up front
If you don’t know what a point is, it’s a fee equal to 1% of the amount of your loan. As an example of this a 30-year mortgage $150,000 might have a 7% interest rate but also a charge of one point or $1500. Lenders can charge one, two or more points. These are called origination points. The lender charges them to cover the cost of making the loan. In comparison a discount point is prepaid interest on your loan. If you want to lower the interest rate on your loan you should pay more points. You can generally pay from one to three or four points. This will depend on how much you want to lower your interest rate.
The decision of whether or not you should pay points and how man will depend on a number of different factors including how much money you have to put down at closing and how long you intend to stay in your house. If you intend to be there for a while, paying points is prepaid interest will reduce your interest rate which could be an advantage. However, if your goal is to get the lowest possible closing costs that you should choose the zero-point option on your loan program.
The good news of discount points is that they are tax deductible.
You can refinance that mortgage as often as you like
Despite what a mortgage banker or broker might tell you, it’s possible to refinance a mortgage whenever the mood strikes you. Of course, there are always transactional costs involved with refinancing a mortgage so its best to refinance only when this would reduce your interest rate to the point where you could recoup the costs while you are still in your home.
You could buy a house as soon as three years after bankruptcy
There is a common myth that if you file for bankruptcy you can’t buy another house for anywhere from 7 to 10 years. The truth is that if you’re a veteran you might be able to qualify for a VA loan in as soon as two years. If you’re not a veteran you might qualify for an FHA-insured loan after just three years or even fewer if you can prove extenuating circumstances such as a medical emergency. However, both Fannie Mae and Freddie Mac generally will not insure loans to people until after seven years if they had lost their homes to foreclosure.
It might take more than 10 years before you’re really paying down the principle on a conventional mortgage.
If you had a conventional mortgage and 3.5%, the first $.35 of every dollar of your mortgage payment goes towards reducing the balance of your mortgage and the amount slowly goes up from there. It’s not until you’ve made 123 payments that half of your payment goes towards paying off your principal. And of course the higher interest rate, the longer it will be before your paying off half of your principal.
There are mistakes that can be made in choosing a mortgage and it’s important not to make them as this will probably be your biggest expenditure ever. Here’s a short video about these mistakes and how to avoid making them.