Find the Right Mortgage

Oct. 26, 2009 at 1:30 PM
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Today's mortgage market is no longer as simple or as straightforward as it was twenty years ago. Now you have a much wider choice of mortgage types, each with their advantages and disadvantages. Some will fit your financial lifestyle, others won't. Finding the mortgage that is right for you is a very important decision. Many people got themselves into serious financial trouble and lost them homes to foreclosure when they took out mortgages without understanding all the implication and obligations involved.

To decide which mortgage is right for you, consider which circumstance each is designed for.

30-Year Fixed Rate This is the most comment type of mortgage. It calls for exactly the same payments over a thirty year period. With the passage of time, you will pay more and more on the principal and less interest, which will increase your equity , or ownership, of your home but reduce the amount you can deduct on your taxes under the mortgage interest deduction. The burden of this loan will ease in time as inflation--and your potential wage growth--makes the payments seem smaller. The only relative disadvantage is that the payments will be higher than those initial low teaser rates of an ARM, so you won't be able to afford as much of a house.

15-Year Fixed Rate If you can afford it, a 15-year mortgage offers quicker repayment and faster growth of your equity. You save a great deal in interest over the life of the loan, because the rate is usually lower than a 30-year loan.

5/1 Adjustable Rate Mortgage An adjustable rate mortgage allows you to start off with low payments and afford more house now. Two numbers identify these loans: the first is the number of years until the rate resets and the second is how often it will reset. A 5/1 ARM will reset after five years and never again. ARMs are for people who expect to move before the rate jumps or people who expect their income to rise significantly. Be careful. Thousands of people took out ARMs during the housing boom expecting to me able to sell or refinance at a profit. When prices fell, they found themselves "under water"─owing more on their home that it was worth. If you expect your income to rise or to pay off a big expense (such as school loans) they might be right for you, too.

The lender sets the interest rate by adding a margin to an index rate. Common indexes include:

Cost of Funds Index. The Eleventh District of the Federal Home Loan Bank Board, which covers California, Nevada and Arizona, publishes the Cost of Funds Index. For more information on the index, visit the Web site of the Federal Home Loan Bank of San Francisco.

Treasury bill yields. The yield on the 1-year T-bill, adjusted for a constant-maturity security, is widely used.

Most ARM loans have a periodic rate cap and lifetime cap to limit the amount the interest rate can increase each adjustment period and over the term of the loan, respectively. If you have a payment cap in your loan agreement, you may face negative amortization of your loan. This has the effect of increasing the amount you owe.

Convertible Mortgage Loans. These are ARM loans that allow you to convert to a fixed-rate loan at or before a specified time. The conversion privilege lets you start off with a low variable rate, then lock in when fixed rates drop low enough.

Balloon Mortgage Loans. These loans often have interest-only payments. In this case, you don't amortized any loan principal and the entire loan amount is due at the end of the loan term. A balloon mortgage allows you to minimize your monthly payments until you refinance the loan. Another advantage is that a larger share of your payment may be eligible for the mortgage interest tax deduction.

1/1 Interest Only Loans. An interest only mortgage allows buyers to pay just the interest on a mortgage initially. Then, payments rise. People who take out these loans are typically counting on their house value to rise, a strategy that got a lot of people in trouble.

Option Loans. You can decide each month whether you'll just pay the interest or work off some principal with an option loan. This mortgage is designed for those with an erratic income, say, someone who gets a big bonus. The minimum payments are so low that you may actually sink deeper into debt with each minimum payment.

40-Year or 50-Year Mortgages. You can get slightly lower monthly payments by stretching out the loan for a decade or two, but at a high cost. Someone with a 30-year $300,000 mortgage would pay $1,837 a month, for a total interest cost of $361,466. By stretching the loan out for 50 years, they would only save $213 a month and end up paying about $300,000 more in interest

From Real Estate Economy Watch

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