June 27, 2018
"Would you like the 5/1 ARM, the 15-year fixed, or the jumbo 30-year fixed?" asked our mortgage broker. We looked at each other with horror. Jumbo? That sounds so...huge. We couldn't possibly need a jumbo, could we?
If you're buying your first home, you'll quickly be introduced to a whole world of mortgage lingo. Some basic mortgage education might put you in a better position before you shop around for a loan. Not only will you look smarter, you'll actually be better prepared to make wise choices regarding the huge debt you're about to take on.
Terms of the Trade
- A fixed rate loan carries an interest rate that remains unchanged for the life of the mortgage, requiring the same payment (principal plus interest) every month.
- An adjustable rate loan carries an interest rate tied to an index or benchmark that fluctuates over time, changing your monthly payment. Rates are typically adjusted every year.
- A balloon payment is required on some loans, which means that after making the same principal and interest payment each month for a period of time (usually five or seven years), you will be required to pay the balance of the loan in a lump sum. (This may be a good option if you're planning to sell the home before the balloon payment comes due.)
- The length of time it will take for you to pay off the loan (plus interest) by making minimum monthly payments is called the term.
- The most popular mortgage may be the "30-year fixed." While most consumers still opt for the 30-year term with the fixed interest rate, the 15-year term has become an increasingly popular option in recent years.
- A standard adjustable rate mortgage (ARM) has a fixed-rate period, usually from one to ten years, after which the rate becomes adjustable on an annual basis. If, for example, the rate is fixed for five years and then is adjusted annually after that, it is called a 5/1 ARM.
- Whether you choose a fixed-rate loan or an ARM, the interest rate you're charged will depend in part upon the size of the loan. If you need to borrow more than what the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) have set as an upper limit - $424,100 for most areas in the U.S., but higher in certain cities and counties (see Fannie Mae loan limits) - then you will have to take out what is called a jumbo, or non-conforming, loan. What does this mean to you? Jumbo loans charge slightly higher rates than conforming loans. Generally speaking, you'll pay between a quarter and a half percent more in interest for the life of the loan. If you need to borrow half a million dollars, there's not much you can do about paying that premium. But if you need, say, $430,000, you'd probably be better off coming up with the extra $5,900 on your own and getting a lower rate on a conforming loan.
- Other types of loans include those guaranteed by the U.S. government. These are Federal Housing Administration (FHA) and Veterans Administration (VA)loans, which require little or no down payment and charge lower interest rates than you would find on a commercial loan. They sound great, don't they? One downside of these loans is cost. Once you qualify for the loan (you must meet certain income, job and credit requirements) you will find there are two kinds of mortgage insurance premiums that can increase your monthly payment throughout the loan. But this may be a good tradeoff for a much lower down payment.
The best way to get the right type of loan at the best terms is to educate yourself as much as possible. Once you know the basics, you can shop around on your own or work with a good mortgage broker who can do the legwork for you.
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