Shopping for Mortgage - Part II
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This is the continuation of previous article on shopping for mortgage.
Most lenders are reputable and honest. Still, before you go with any, it’s a good idea to make sure the firm is on the up-and-up. Beware lenders or mortgage brokers who ask you to pay stiff fees up front. Call your state banking department as well as the local Better Business Bureau to find out if any of the lender’s customers have filed complaints. When an honest lender goes out of business, it will hand off its mortgages to another firm. However, if you are dealing with fraudulent lender, your chances of getting money back depend on what’s left when the scamsters are caught.
The type of mortgage you should choose generally depends on how long you plan to remain in the home and how you feel about your payment changing from month to month. There are two basic varieties: (1) fixed-rate loans, which have interest rates that do not change over the life of the loan and generally run for 15 to 30 years; and (2) variable- or adjustable-rate mortgages (ARMs), whose rates can rise or fall along with other interest rates. Most ARMs have 15-year or 30-year terms. An ARM’s rate generally cannot rise by more than two percentage points a year or six points over the life of the loan, however. A 15-year mortgage has two attractions: your interest rate on a 15-year mortgage will probably be about a quarter of a percentage point lower than that of a comparable 30-year loan; and your total interest payments will be cut in half. The drawback is that 15-year loans have higher monthly payments. At recent rates, you would face a $1,010 monthly nut on the average $100,000 15-year mortgage, compared with $823 on a 30-year fixed-rate loan –a 23% difference. All in all, if you can afford a 15-year mortgage, go for it.
Adjustable-rate loans typically have initial interest rates that are about two percentage points lower than fixed loans plus lower initial monthly payments. At recent rates, for example, the initial monthly payment on a $100,000 ARM was about 20% lower than the payments on comparable 30-year fixed-rate mortgages, or $659 versus $823. Payments on adjustable-rate mortgages can increase substantially, though, if interest rates rise. Typically, you lock in the initial interest rate on an ARM for six months or a year. Then every year or so the lender will raise or lower the rate in tandem with an index, such as the one-year Treasury bill rate.
The first-year ARM rate is set at a discount from the index, so even if interest rates remain flat, a borrower’s ARM would go up in a year. That’s right: after the first year of your ARM, your interest rate and monthly payments will rise even if other interest rates haven’t increased.
You may have to sign up for an ARM if your income is too low to qualify for a fixed rate. (As a rule, you can qualify for a mortgage on a home that costs up to about 2 ½ times your gross income. Also, your monthly debt payments cannot exceed 36% of your gross monthly income). If you do not expect to own the house for more than five years, an ARM can be especially appealing, since there is little risk that your rate will rise substantially over that short time. Before you commit to any adjustable mortgage, sees whether you can live with it under the worst-case scenario. With a 6% ARM that maxes out each year –jumping to 8% in year two, 10% is year three, and 12% in year four –you still end up with a four-year average rate of 9%, which would beat a 30-year fixed-rate average of 9.2%.
A few other mortgage variations are worth considering. If you think mortgage rates might be heading down in a few years, check out a convertible loan, which starts out as an ARM but gives you the option of switching to a fixed rate between the second and fifth years of the loan. The interest rate is initially about one percentage point higher than that of a comparable ARM, though still lower than what you would pay for a fixed-rate mortgage. At conversion, you will owe a fee of about $250. Another type of convertible loan that makes sense is the fixed-to-adjustable variety. The initial rate is fixed for the first few years, then the rate adjusts annually.
If you plan to be in your house for five to seven years or so, a two-step or balloon-reset mortgage might be the call. The monthly payments stay at the same level for the first five or seven years, then are reset for the duration of the loan. Typically, the new rate is the yield of the 10-year U.S. Treasury constant maturity plus 2.5 percentage points. The rate on a balloon-reset mortgage is often one-half to three-quarters of a percentage point less than that of a 30-year fixed. For example, if a 30-year fixed rate is 8.61%, a balloon reset might charge 8.07%.
If you would rather lock in a discounted interest rate for a longer period than two-step loans offer, check out a comparatively new loan called 10/1 adjustable-rate mortgage. A 10/1 ARM can be a smart choice if you plan to move within 10 years. It locks in a rate for 10 years, but generally at a lower rate than the traditional fixed-rate loan. After 10 years, the rate adjusts annually as if it were a one-year ARM.
A biweekly loan is another way to slash your interest costs. It requires that you make half your monthly payment every two weeks. Because most months are longer than four full weeks, or 28 days, you’ll end up making two extra half payments a year. These extra payments will shave up to 12 years off the life of a 30-year loan. Problem is, most banks don’t offer biweekly mortgages as such. Those that do may charge a higher interest rate that could offset your savings, making it essential to compare your lender’s rate to biweekly loans and standard loans. Avoid third-party firms that will convert your standard mortgage to a biweekly for a fee of a few hundred bucks.
If you want to pay less in interest and unload your mortgage ahead of time, you can shorten the life of your loan on your own simply by tacking on more to your monthly payments. For example, if you added $25 to your regular monthly payments of $805 on a $100,000 30-year 9% fixed rate loan, you could save $29,440 in total interest and shorten your loan by almost four years. Most lenders will let you make these extra payments, although some will impose a prepayment penalty if you do so during the first few years of your mortgage. That’s why you’ll need to check with your lender before making extra payments. If there is a penalty, ask to have it waived. Then explain how much more you’d like to pay and how often, finding out the way the lender will want you to submit your extra payments.
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