Mortgage Information >
Borrowing to Buy
Most folks don’t have enough cash on hand to purchase property outright. Most existing loans on the property to be purchased are not assumable by the Buyer, and most Sellers are not willing to carry back any portion of the purchase price for future repayment. Therefore, most Buyers must borrow a substantial portion of the purchase price, with the financing instrument usually a Mortgage or Deed of Trust, instruments which pledge the property as security for the loan.
Mortgage plans can be divided into Conventional and non-conventional loans.
- Conventional Loans are those that are not backed by an agency of the federal government and can be either insured or uninsured. In an uninsured conventional loan, the borrower’s equity provides sufficient security for the lender to make the loan. In most cases the loan does not exceed a 75-80% LTV (Loan To Value) ratio and the 20-25% equity is enough to protect the lender from a possible borrower default. An insured conventional loan typically is one in which the borrower has a down payment of only 5-10% and thus is borrowing 90-95% of the property value. PMI (Private Mortgage Insurance) becomes a necessary protection to the lender and is paid for by the borrower.
- Non-conventional Loans are usually FHA or VA mortgage loans, those in which the federal government participates either by insuring the loan to protect the Lender (FHA-insured) or by guaranteeing that the loan will be repaid (VA-guaranteed)
The various mortgage programs may be classified as fixed rate loans, adjustable rate loans and combinations thereof.
Fixed rate mortgage (FRM) loans feature an interest rate and mortgage monthly payments remaining fixed for the period of the loan. Fixed-rate mortgages are available for 30 years, 20 years, 15 years and 10 years. Early in the amortization period, a larger percentage of the monthly payment is used for paying the interest. As the loan becomes paid down, more of the monthly payment is applied to principal.
Most mortgage terms feature 30 and 15 years amortizations. With the traditional 30-year fixed rate mortgage your monthly payments are lower than they would be on a shorter term loan. But if you can afford higher monthly payments a 15-year fixed-rate mortgage allows you to repay your loan twice as faster and save more than half the total interest costs of a 30-year loan. Besides, the shorter the term of a loan, the lower the interest rate you could get.
A variable or adjustable loan is a loan whose interest rate, and accordingly monthly payments, fluctuates over the period of the loan. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. The index for your particular loan is established at the time of application.
Well-known indices include:
- 1. Treasury Security Indexes
- 2. Treasury Bills
- 3. London Inter-Bank Offering Rates (LIBOR)
- 4. Certificate of Deposit Indexes
- 5. 11th District Cost of Funds Index (COFI)
- 6. Prime Rate
ARMs are available with 30-year terms and some with 15-year terms. Adjustable rate mortgages generally have a lower initial interest rate than fixed rate loans making them quite enticing. However, consider the recent dramatic changes in home values before making your decision.
If you plan to stay in your house less than five to seven years, it would be reasonable to consider an Adjustable Rate Mortgage. ARM’s traditionally offer lower interest rates during the early years of the loan than fixed-rate loans. However don’t accept the ARM unless you can afford the maximum possible monthly payment.
Generally, you can start to consider 15 or 30 year fixed rate mortgages if you plan to stay in your home for more than seven years.
The preceding information is intended as an overview only. More in-depth information is available from Lenders and Mortgage Brokers.
