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The 15 Year Fixed Rate loan is much like the 30 Year Fixed Rate loan but with two major differences. One, the 15 Year loan amortizes (reduces and pays off) in half the time of the 30 Year product. Second, the 15 Year loan will cost less than one-half the interest of the 30 Year mortgage. This is the result of what might be called “reverse compound interest” theory. Here is an example that explains this important feature:
Loan Amount: $200,000 Interest Rate: 6.0%
Total Interest on a 30 Year loan: $231,932
Total Interest on a 15 Year loan: $106,428
Savings with 15 Year loan: $125,503
In addition, your monthly payment will not be double the 30 Year payment. Using the example above, your monthly payment on a 15 Year Fixed Rate loan would be $1,702.38 while your payment for a 30 Year Fixed Rate product will be $1,199.81. This means your regular monthly payment only increases by 42% even if you had an identical interest rate. To further enhance the attraction of the 15 Year loan: You will probably pay an interest rate that is around one-quarter to one-half percent less than the 30 Year mortgage!
As you can see, there are some good reasons to consider a 15 Year Mortgage loan, but it's not for everyone. Your cash flow, future ownership and financial plans, and the potential savings you might enjoy with an Adjustable Rate Mortgage loan should all play a role in your analysis of the best mortgage loan for you.
The creation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the 1970's changed the home loan landscape with the introduction of the 30 Year Fixed Rate mortgage loan. Today, the 30 Year Fixed Rate loan is the “staple” of mortgage loans in the U.S.
Because of the stability of this loan, it is very popular among both borrowers and the secondary market. It is a “what you see is what you get” loan. The interest rate at the beginning of the loan is the same rate in the middle and at the end of the loan. For borrowers, it is simple to analyze which offers are best.
A comparison of the interest rate, points to be paid, and closing costs will normally present a clear picture of your best financing option. Because of the term of this loan, do not be surprised if your Truth-In-Lending (TIL) estimate shows that you will pay back double the amount you borrow over 30 years. While it is a bit scary to look at, borrow $200,000 and pay back over $400,000, the odds indicate you will not keep this loan to end of term. The average life of a mortgage loan in the U.S. is around 7½ to 10 years, so you probably won't pay all of the projected interest. If you either plan on keeping your property for the long term or are totally undecided whether this home will be a short or long term relationship, a 30 Year Fixed Rate loan is often the best choice.
Remember that “fabulous” young man or woman in high school that everyone wanted to date? You finally get your chance, and, unfortunately, you find they aren't nearly as fabulous as you thought. The 40 Year Fixed Rate mortgage can be somewhat like that. It may appear to be the answer to your prayers, and sometimes it is, and you rush into it. After a few years, however, you see that your principal has been reduced only very slightly and you now have buyer's remorse. Like the Interest Only mortgage loan, the 40 Year Fixed Rate product is neither good nor bad, but just a tool that, if used correctly, can be beneficial.
The interest rate is fixed for the entire term, although it will normally be somewhat higher than the 30 Year Fixed Rate loan. Why? The usual reason: Higher risk because of less principal reduction. That is also the reason that this loan isn't for everyone. It's interesting because many financial experts said the same thing about the 30 Year Fixed Rate loan. It was introduced when the 20 Year Fixed Rate product was the standard. Many disparaged the 30 Year loan for the same reasons. And now the 30 Year product is the standard.
When is the 40 Year Fixed Rate a good tool? When your gross monthly income and/or debt-to-income ratio make it difficult for you to qualify for the loan amount you want, the 40 Year mortgage might help you get approved. The lower monthly payment might be just enough to allow you to qualify for the mortgage amount you need. The added benefit of a fixed interest rate allows you to keep the loan as long as you want or need it without fear of rapidly escalating monthly payments. But – if you don't need this loan, stick with a 30 Year mortgage, either fixed or adjustable. You will be very happy you did when you refinance the loan or sell your home. Your equity will increase much more rapidly with the shorter term product.
Interest Only mortgages have become popular because the fair market value (FMV) of residential property has increased so significantly. These loans, while potentially dangerous, give some borrowers needed advantages. The most important positive features of these loans:
So-called “Government Mortgages” have helped millions of people who might otherwise be shut out of the market buy homes for over 50 years. In fact, the U.S. Government does not really make any mortgage loans. They do, however, guarantee mortgage loans through the Federal Housing Administration (FHA) and the U.S. Department of Veterans' Affairs (VA). There is technically a third government program, the Rural Housing Service (RHS), administered by the U.S. Department of Agriculture which performs similar functions for rural home buyers, although this program does not have the impact of the prior two.
These mortgage loans are tailored to help prospective home buyers who have little cash for down payments and/or loan qualification issues purchase the homes they want. Those buyers who have little or no money to put down, less than perfect credit, or income issues may not qualify for conventional mortgage loans. The FHA and the VA, through relaxed down payment and credit requirements, may allow you to qualify for the mortgage loan you need to purchase the home you want. Most of the required documentation for conventional loans is also necessary for FHA and VA. There is also some additional information needed for these programs. VA loans require evidence, through a Certificate of Eligibility , that you are veteran of the U.S. military. FHA loans require a somewhat different, more extensive home appraisal than required for conforming loans.
Mortgage lenders must be approved by FHA and VA to make loans that they will guarantee. If you are considering one of these government loans, be sure ask any loan officers you speak with if they are approved to write government mortgage loans. You should also be aware that these loans have a couple of items that must be considered.
In return for their guarantees, both programs impose a fee not found with conforming programs. FHA charges an “insurance” fee (for the guarantee) of 0.50%, which becomes part of your regular monthly payment. VA charges a “funding” fee at the closing of your loan. This fee varies depending on whether you have used your Certificate of Eligibility before and the amount, if any, of your down payment. You can expect to pay around 2.0% of your loan amount for the VA guarantee. An additional quirk of the VA program which sometimes causes problems concerns closing costs.
Even with their quirks, government loans can help you purchase the home you want with little or no money down. You might even be able to include some costs to rehabilitate your new property in your mortgage loan. With the exception of the fees for guaranteeing your loan, your interest rate will be in the current market range. Government loans have served a valuable and effective purpose for years and continue to do so. If you are a military veteran or have lack of down payment issues, consider a government mortgage to achieve your goal of home ownership.
Balloons are fun, right? Balloon mortgage loans may or may not be quite as enjoyable. Depending on your circumstances, a balloon mortgage may be the answer to your prayers or your worst nightmare. Basically, a balloon mortgage will have a monthly payment based on a long term amortization (payoff) but for which the balance will be due in a much shorter period of time than that for which the payment is calculated. Here is a brief example of the good news/bad news potential of this type of loan.
You have the opportunity to buy a great property that is under priced but beyond your normal affordability because of your debt-to-income position. If you can find a way to buy it and keep it for a few years, you might be able to sell it for a great profit. You select a Balloon Mortgage loan because you can afford it for the short term. Why? It is written with a 40 year amortization (pay off schedule) but the balance is due in ten years. The 40 year pay back schedule results in a much lower than normal payment, which you can afford, and in a few years, you can sell the property for a good profit. In this example, a Balloon Mortgage loan may be perfect for you.
A second situation that may make a Balloon Mortgage loan a good choice is when you have the opportunity to purchase an owner-occupied home for a wonderful price but the cost of the property is still beyond an amount that your income supports. Using the monthly payment reductions of a Balloon Mortgage, you qualify to purchase the property. Your loan balance is due and payable in a shorter term than the amortization (pay back) period calculated but you believe you can re-structure your loan before the shortened due date.
The potential problems: You haven't refinanced or sold the collateral (the real estate) and your balloon date is coming due shortly. Mortgage interest rates have been – and continue – to increase and you still owe a large balance. Unless you win the lottery before the balance due date, you must refinance your loan at interest rates that you do not like. Or worse, you cannot afford to refinance because the resulting monthly payment at current interest rates is more than your income can support. You are facing potential financial disaster.
As you can see, Balloon Mortgages can be a very useful, helpful financing source or a possible recipe for financial Armageddon. Like many other financial products, Balloon Mortgage loans can be very positive tools or quite dangerous choices. As always, give all your choices serious consideration and analysis. This philosophy will give you the best chance to make the right financing decisions.
These loans are structured so that the first two (2/28) or three (3/27) years are Fixed at the Start Rate. The remaining term (28-27 years) converts to a One Year Adjustable Rate Mortgage (1 Year ARM) or sometimes a 6 Month ARM after the fixed rate period is over. At least this loan is “fully amortizing” and normally written for 30 years, without any “balloon” provisions.
If you are planning to keep your new property or this loan for the short term, one of these loans might be an excellent choice. The start rate should be less than a comparable 30 Year Fixed Rate mortgage and will not adjust (increase) for the first two to three years. You must be careful, however, when you analyze your choices with this loan. First, examine how the loan changes after the fixed rate period. Does it become a one year adjustable rate mortgage (1 Year ARM) or a six month ARM? Regardless of the new terms, examine the Index, Margin, Adjustment and Lifetime Rate Caps for the loan being considered to decide if this loan is for you. Except in sub-prime borrowing situations, the start rate will be lower than the market rate for fixed rate loans.
This mortgage loan type can be a very useful tool but the terms after the fixed rate period should be analyzed properly. Examine the Index, Margin, Adjustment and Lifetime Rate Caps carefully so you don't get unpleasantly surprised at interest rate adjustment time. If the start rate is sufficiently below the current fixed rate and the ARM terms are reasonable, one of these mortgage loans could be a good choice for you.
With potential interest rate adjustments only every three years, after which the new rate is fixed for the next three years, this loan has worked for millions of people in the past. There are two primary reasons for this decline in its activity, however.
First, like the 5 Year ARM, fewer mortgage lenders are offering this loan as an option. Second, the interest rate differential between a 3 Year ARM and a 30 Year Fixed Rate loan has not been significant enough for many borrowers to choose the former. Years ago, the 3 Year ARM was a popular loan, particularly with the savings and loan industry. However, those mortgage lenders who still hold loans and don't sell all of their mortgages into the secondary market, might still offer terms that are attractive to you.
Much depends on your future plans for your home and this mortgage. If you plan to sell your home in three to five years, the interest rate differential might make financial sense. If, however, you plan to keep your property long term and the interest rate difference between a 3 Year ARM and a 30 Year Fixed Rate loan is less than one per cent or more, you might be better served with the fixed rate mortgage loan.
Historically the most popular of the non-fixed rate loans, the One Year Adjustable Rate Mortgage (1 Year ARM) has been the flagship of the ARM's for years. The 1 Year ARM has long been marketed as a cost effective alternative to fixed rate loans. The interest may adjust every 12 months depending on the newly calculated rate per the terms of your loan. Depending on the market, your rate could increase, decrease, or remain the same for the coming 12 months. You will not be “blind sided” with information about your new interest rate and monthly payment. The interest rate for the coming year must be calculated 60 days prior to the end of your rate year. Your mortgage lender must notify you at least 45 days before implementing the rate change, which gives you time to refinance your property should you not wish to continue with this mortgage.
The usual five components of an ARM apply and should be examined for any loan you are considering: Start Rate, Index, Margin, Adjustment Rate Cap, and Lifetime Rate Cap. All of these will influence your future interest rates. When you analyze various ARM products available to you, use worse case numbers to project the future of your interest rates. If market conditions dictate that you enjoy a best case result, you win. However, should the interest rate market turn against you, problems, including foreclosure, may result. You must minimize this potential issue and a good analysis of your ARM choices will help you greatly.
One of the least popular mortgage loans is the Six Month Adjustable Rate Mortgage (6 Month ARM). The reason for this skepticism is, of course, the short period between interest rate adjustments; only six months. Then why does this loan even exist?
First, from the mortgage lender's prospective, this product protects them against having a long term fixed rate loan in their portfolio that could cost them serious income if market interest rates turn sharply upward. From a borrower' prospective, the rate differential between a 6 Month ARM and Fixed Rates may be so significant, the borrower may opt to enjoy these savings in the short term and be prepared to refinance to a fixed rate if interest rates show a longer term upward trend.
One situation that might make this loan a good choice for you involves your projected time of ownership of the property. Should you consider purchasing a home for strictly short term purposes and have firm plans on selling it within a couple of years, you might explore the savings you might enjoy if you use this loan. Just be very careful with your analysis and use worst case numbers to compare this loan with others.
|Sheri Ann Richerson|