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September 5, 2018
Unbiased Financial Information Provided by Financial Finesse
Buying a home is the largest purchase most of us ever make, and unless you've been lucky enough to inherit a fortune or win the lottery, you'll have to go into debt for it. Since you'll be making loan payments for a very long time, it pays to learn enough about mortgages to be able to pick one you can live with.
What Is a Mortgage Payment Made Of?
In most cases, your monthly mortgage payment will consist of at least a portion of the loan principal plus interest. In the beginning of the loan term, most of the payment will be interest, but that will change slowly with each passing year. On the bright side, the high interest payments will reduce your income taxes -- one of the great benefits of homeownership.
If you put less than 20 percent down, you'll be required to make payments that include principal, interest, taxes and homeowners insurance (PITI). If you put more than 20 percent down, you may be given the option to pay the property taxes and homeowner's insurance on your own.
If your mortgage is not a government-insured loan (most aren't) and you make a down payment of less than 20 percent, you may be required to pay for private mortgage insurance (PMI) each month to protect the lender in case you default on the loan. Plan on an annual PMI cost of about a half to one percent of the loan amount, which sounds small but could be significant if you've got a big mortgage. In the example below, Jill, who put only five percent down, has to pay $440 more per month than Jack, who put 20 percent down and isn't required to have PMI.
|Down payment||$60,000 (20%)||$15,000 (5%)|
|Loan PMI||Not required||$185|
|Total monthly payment||$1,363||$1,803|
|* 30 year, 5.5% loan|
You may be able to cancel PMI when your equity in the home reaches 20 percent.
Know Mortgage Types to Identify Your Best Options
Most mortgages fall within a few key categories.
Fixed vs. Adjustable Rate: With a fixed rate mortgage, you have the peace of mind of always knowing your monthly payment will stay the same. Rising interest rates won't affect your payment, nor will falling rates, which means you'd have to refinance the loan to benefit from them. Fixed rate mortgages tend to have a higher initial rate, making them a little harder to qualify for.
The interest rate on an adjustable rate mortgage (ARM) goes up or down in tandem with a particular financial indicator at specified times during the mortgage term. ARMs typically start out with a lower interest rate and monthly payment than fixed-rate loans, not to mention the opportunity to benefit from falling interest rates without having to refinance. The flip side, of course, is that higher interest rates mean higher payments. In the worst-case scenario, rising rates could even make your new home unaffordable.
Conforming vs. Jumbo: Every year the Federal Housing Finance Agency (FHFA) sets a conforming loan limit which is the maximum size of a loan that Fannie Mae and Freddie Mac can purchase. In 2017, the conforming loan limit is $424,100 for most areas in the U.S., but the FHFA has specified higher limits in certain cities and counties (see Loan Limits by Area).
A jumbo loan is any loan over the conforming loan limit. Since jumbo loans are not available for purchase by Fannie Mae or Freddie Mac, borrowers will generally pay more for jumbo loans, typically in the form of a higher interest rate.
15-Years vs. 30-Years: The usual terms for home loans are 15 and 30 years. Generally speaking, the shorter the term, the less you pay in interest over the life of the loan. Of course, once you pay off your loan, you also lose your tax deduction. Since payments on a 15-year loan are higher than those on a 30-year loan, shorter-term loans can be harder to qualify for. Some financial advisors recommend taking the longer loan term even if you qualify for the shorter one. That way you're not locked into making higher payments every month, but you have the freedom to pay more if you want to.
Take a look at the difference in monthly payments between a 15-year mortgage and a 30-year mortgage for the same amount and at the same interest rate. The shorter loan could really stretch your budget.
Special Loan Programs: Depending on your circumstances, you might be able to buy a home through one of the special lending programs available. For example, low and middle-income homebuyers, or borrowers who serve the public (such as police officers and teachers), may qualify for special loans through community programs or the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development (HUD) . Homebuyers who've served in the military can apply for a loan through the Veterans Administration (VA). In general, the special programs help buyers by requiring a lower (or no) down payment and/or charging lower interest rates.
Some lenders offer "no-doc" (no documentation, such as pay stubs, tax returns, etc. is necessary) loans to borrowers who are self-employed or have a limited or problematic credit history, putting people who might not otherwise be able to get a mortgage into a home of their own.
What's the Point of Points?
Your lender may give you the option of paying "points" when you take out their loan (each point is equal to one percent of the total loan amount) in exchange for a lower interest rate. Each point you pay may lower your interest rate by an eighth or a quarter of a percent. Although a "zero-point" loan might seem like an attractive option -- after all, it means you're paying less money up front -- it can actually cost you thousands of dollars more over the years because of the higher interest rate you'll pay. Statistics show that most people own their homes for at least eight years, and even a quarter percent break on the interest rate can really add up. Before you sign on the dotted line for a loan, ask yourself how long you plan on owning the home. If you're in it for the long haul, paying points may be the better option.
The reason there are so many loan choices out there is because there's a market for each type. If you still have questions, you can always speak with a qualified mortgage broker or real estate agent. With so many options, you're sure to find a mortgage that opens the door for you.