What You Need to Know Before Choosing a Home Mortgage
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A home mortgage is an agreement between a borrower and a lender that the borrower will pay back the mortgage loan with a pre-determined amount of interest. Until the loan is completely paid off, the mortgage lender owns the home and allows the borrower to occupy it. After the mortgage is paid, the borrower owns the home outright.
There are several types of mortgages from which to choose:
• fixed mortgages
• adjustable rate mortgages (ARMs)
• balloon mortgages
• interest-only mortgages
• government-sponsored mortgages
How do these mortgage types differ?
Fixed-rate mortgages lock in the current mortgage interest rate for the duration of the loan. Often 10-year and 15-year rates are lower than 30-year rates.
ARMs have low introductory rates. After the introductory period, the interest rate adjusts to reflect current rates. ARMs vary in the number of years that lapse before the interest rate adjusts. Sometimes the rate is fixed for three years; sometimes it is fixed for five or even 10 years. Some ARMs adjust yearly after the introductory period, and some adjust every five years. For example, a 5/1 ARM will remain at the low, fixed rate for five years. After five years, the rate adjusts annually.
Balloon and interest-only mortgages have low introductory payments followed by a large payment after a set number of years. If buyers do not plan for this eventuality, their final payment could be very difficult or even impossible to make.
Government-sponsored mortgages, such as FHA and VA mortgages, usually have reasonable interest rates and low down-payment options.
What is a pre-approved mortgage?
A pre-approval shows sellers that you have met with a loan officer who has reviewed some basic financial information and tentatively qualified you to borrow a set amount of money. The pre-approval process is preliminary and not subject to the scrutiny of actually qualifying for a mortgage. However, a pre-approved mortgage is important in the bargaining process once you have found your dream home.
How do mortgage interest rates affect me?
The mortgage interest rate is the most important component of the loan since even one percentage point can mean hundreds of dollars more or less each month and thousands of dollars over the life of the loan. Mortgage interest rates are based on several factors, including the economy, the borrower’s credit score, the borrower’s assets, the Federal Reserve rate, and the secondary mortgage market.
What are discount points?
Borrowers purchase discount points to lower the interest rate. One point usually equals about one percent of the loan’s amount. In exchange for this purchase, the interest rate lowers about .25 percent.
For example, on a 100,000 mortgage, two points would cost about $2,000. If the original interest rate was five percent, the new rate would be about 4.5 percent. Therefore, purchasing the points for $2,000 saves the buyer about $10,000 over the life of the loan.
Purchasing points makes financial sense for borrowers who expect to stay in the home for a long time. However, if borrowers can reasonably expect to move within a few years, then paying points makes less sense.
What is a lien?
A lien is any unpaid fee, such as a second mortgage, insurance, taxes, and the like. Sellers must remove any liens before the mortgage company will close on the property. However, sometimes homes in foreclosure have unpaid liens. In these cases, borrowers must sometimes pay the fees before purchasing the home.
How does the secondary mortgage market affect me?
Since mortgages are commodities with associated risks and rewards, lenders often sell them to other lenders. This selling and reselling does not affect the loan agreement in any way. The only difference is that the mortgage is held by a new lender. The borrower is still obligated to pay the mortgage.
Understanding your mortgage before you close is extremely important since a home mortgage is probably the largest debt you will incur throughout your lifetime. Therefore, learning about your mortgage will help you plan and budget for a full and happy life in your new home.