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While 30-year fixed
rate mortgages still make up the majority of mortgages
being used by home owners today, itīs possible for
home buyers to secure what amounts to being a custom
mortgage specifically designed to meet their unique
financing needs.
Still, even heavily customized mortgages are typically
some variation of one of just a few basic mortgage
types.
Fixed-Rate
This is typically the choice of home buyers who
want to know exactly what their payment will be
month after month for the life of the loan. Often,
the holders of these mortgages are committing to
the possibility of long-term residency. Principle
and interest payments remain exactly the same throughout
the life of the loan, which usually is 30 years,
but can be 10, 15, 20, or even 40 years.
Adjustable-Rate
This mortgage has steadily gained in popularity
in recent years. It enables a home buyer to secure
a loan at a lower interest rate compared to the
going fixed rate. The lower, adjustable rate is
typically locked in for the first year, or sometimes
just a few months, and then adjusts in subsequent
years in relation to some economic index - such
as the prime lending rate or interest on one-year
Treasury bills. The rate can go up only a certain
amount in any given year, usually 1-2 percent. There
is also a lifetime cap on the increase, usually
6 percent. So an adjustable rate mortgage that is
secured at 5 percent could climb to as high as 11
percent in three years during a period of rapid
inflation and rising interest rates. In recent years,
though, with negligible inflation and declining
or relatively stable interest rates, adjustable
rate mortgages have proven to be a wise buy, with
little fluctuation occurring. Still, the primary
customers for such mortgages are home buyers having
trouble qualifying for a house at a fixed rate because
of lack of income, lack of down payment, or too
high an existing debt-to-income ratio. With an adjustable-rate
mortgage, such buyers can qualify for a larger loan.
If theyīre anticipating an increase in income or
a lowering of debt that will keep pace with the
maximum increase in the rates, itīs a safe move.
Often these buyers end up refinancing at a fixed
rate once their income enables them to do so - especially
if rates are going up or the home owner thinks they
are about to go up. An adjustable rate mortgage
also is attractive to home buyers who know theyīll
be staying in a house for only a few years. Sometimes,
the total payments made during those few years can
end up being less than the total if a fixed rate
had been used - even if the adjustable rate moves
up its maximum amount during those two to three
years.
Two-step
These mortgages could be described as a hybrid of
the fixed rate and adjustable rate mortgages. Typically,
such loans provide a fixed rate for the first five
or seven years of a 30-year mortgage, then revert
to a fixed or adjustable rate (convertible or nonconvertible)
for the remaining 25 or 23 years. The adjustable
or fixed rate at the end of the five- or seven-year
periods is typically tied to some predetermined
index and will also include a margin for the lender.
So the home buyer is accepting the risk of facing
potentially higher rates after the first five or
seven years. But during the first five or seven
years, the interest rate is typically lower than
the current 30-year fixed rate and higher than adjustable
rates. So two-step mortgages enable home buyers
to secure a rate thatīs lower than the fixed rate,
but doesnīt have the risk of the potentially rapid
increase that comes with an adjustable rate. Like
adjustable rate mortgages, these mortgages are especially
attractive to home buyers who plan to move within
a short time frame - in this case, five to seven
years.
FHA
Not so much a mortgage type as it is a mortgage
program, Federal Housing Administration loans are
backed by the U.S. government. That means the lender
is reimbursed by the federal government if the borrower
defaults on the loan. The primary benefit of the
program is that it enables home buyers to purchase
a home with a minimal down payment. Typically, just
5 percent is needed, compared to the 20 percent
down payment thatīs usually needed to secure conventional
financing. Some FHA programs enable certain first-time
home buyers in particular income brackets to buy
a home with a down payment as small as 3 percent.
The size of an FHA loan is limited, based on the
average cost of housing within a particular geographic
area. So typically, a borrower using FHA financing
in a large metro area where housing prices are steep,
can borrow a much larger amount than the home buyer
shopping in a rural area with lower housing costs.
While the down payment qualifications are much easier
to meet with FHA financing, that doesnīt necessarily
translate to a better deal over the life of the
loan. Mortgage insurance premiums, required because
of the minimal down payment, will make monthly payments
higher than conventional loan payments at the same
interest rate.
VA
Another U.S. government loan program is the Veterans
Administration loan, which is primarily designed
to enable qualifying veterans of the U.S. military
to buy a home with no down payment and minimal closing
costs. Depending on your veteran status, there is
an origination fee that will add to the cost of
using this financing. A disabled veteran, for example,
may not need to pay any fee at all, while a reservist
who hasnīt seen active duty might pay the maximum
fee, which today can be as high as 3 percent. |
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