Buying a house is a daunting prospect. There are so many different things that the potential buyer needs to consider. Location, size of the home, financing, home inspections, and more are all a part of the intricate dance that leads to the selection and purchase of a home. In addition, the buyer has to follow the housing and financing trends to ensure they are getting the best deal. While it is necessary to have trusted bankers, mortgage lenders, and real estate agents to assist in the search, the buyer must also educate themselves.
Researching information and making sense of it is best done with the help of experts. Ask lots of questions. While researching the information keep on ongoing list of the questions that come to mind. Keep a notebook that organizes all of the research. Following a few key steps can assist the consumer to gather pertinent information in a useful order.
Know What You Can Afford
An uneducated consumer can quickly be lead astray. Many consumers think that if the bank approves the loan then they must be able to afford it. Prior to beginning any property search the buyer must understand his or her financial situation. Do not depend on anyone else, to set your purchase price range. Do a search for information regarding average percentage rates, mortgage terms, and house pricing for the area. Decide on a maximum amount that can comfortably be paid every month. Once this range has been solidified reduce, it the number by twenty five percent. Now the consumer has a figure that is probably the most realistic.
Understand What Types of Loans Are Available
Once the price range is established it is time to contact a lender. Prequalification is an essential step. While it does not guarantee the consumer a mortgage, it does let a seller know that the potential buyer is serious. It sends the message that the buyer has done his or her homework, and the lender has judged they are probably capable of getting the appropriate loan. A bid from a consumer who is not prequalified sends the message that the buyer may not yet be committed to making a purchase.
Mortgages Rates
Mortgage rates change due to a myriad of factors. The Federal Reserve sets the rate at which banks loan each other money. The bank passes this cost of their interest onto the consumer. This federal rate is even more of a factor in adjustable-rate mortgages than fixed rates. If the bank has to pay a higher interest rate on their loan, they are going to charge the consumer higher interest rates too.
The current housing market will also influence the rates. If there is a lot of inventory on the market, and companies are not writing loans, the rate will decrease to help bring in new loans. If there is little inventory, and lots of applicants, the rates will go up. Higher rates help to weed out weak applicants, leaving only those with a strong financial position to compete for the loan. The stronger the consumers financial situation, the less risk the company faces when making the loan.
The worse a person’s credit rating is the higher the interest rate on their mortgage. The lenders increase the rate due to the higher risk of the applicant defaulting on the mortgage. The higher a credit rating lets the lender know that the applicant pays their bills reliably. Since the company can depend on the money being repaid, they will lend at a lower interest rate. Banks balance the number of high risk and low risk loans they make. This maximizes their profits and minimizes their risks.
The purchase price is also a factor. The more equity the applicant has in the property, the lower the interest rate. A person can build equity by putting larger amounts of money down, or purchasing below appraised market value. Most lenders want a buyer to have at least twenty percent equity in order to consider giving them the lowest interest rates. Lenders will occasionally offer lower down payment options. This allows consumers who may not otherwise qualify to get a mortgage.
Mortgage Terms
The terms are the interest rate, the cost of closing the loan, and incidentals such as application charges. Most mortgage companies are upfront and clear with their charges. Do not be hesitant to questions the company as to anything that is in the mortgage that is not clear. A consumer should expect mortgage brokers to charge a reasonable fee for their services. In addition, if dealing directly with the lender or bank, expect things such as application fees, title search fees, and such. These are sometimes referred to as hidden costs. They are not hidden, but the consumer is responsible for reading the contract and understanding all that it contains.
Common Mortgages
The 30 Year Mortgage
Most people think of the traditional thirty year, fixed rate mortgage when considering purchasing a home. The buyer puts at least five percent down, pays the closing cost, and then takes thirty years to pay for the home. The advantages of this set up, it offers the buyers a low monthly payment. For young home buyers, who expect to live in the home at least fifteen years, this can be a tempting offer. They can get a larger home at a lower price. However, as with everything there are drawbacks. The buyer pays significantly more money in interest charges than with the shorter-term mortgages. Equity is extremely slow to build, the first ten years the buyer is paying mostly interest. So overall, cost of the mortgage is much higher when compared to one with a shorter term.
The 15 Year Mortgage
A fifteen year fixed rate mortgage is another common practice. Reducing the term to fifteen years makes for a higher payment. The trade-off is a lower interest rate; less interest paid, and quicker pay-off time frame. In addition, the buyer builds up equity in the home much quicker. This is a great option for middle aged buyers who wish to pay off the home before retirement. It is also a convenient way for young couples to build a lot of equity in their home, in a short span of time. A $200,000 dollar home, financed in a fifteen year fixed rate mortgage at 5%, can save thirty thousand dollars in interest over a thirty year mortgage. That is a significant amount of money. But, it only works with the buyer can afford the higher payments.
The 5 Year Mortgage
Five-year mortgages are becoming a popular option for buyers of all ages. The five-year mortgage provides for a fixed interest rate. There is also the option of qualifying to pay an even lower interest rate during the first five years of the loan. On the fifth year, a balloon payment comes due. This payment is the remainder of the loan. The rate of the five-year ARM is set by the index market. There are several different index markets a lender may use. Rates tend to be unusually low because it gives the lender a quick return with sufficient profit to make the offer worthwhile. The consumer benefits from the tens of thousands of dollars they save over the cost of a traditional thirty year mortgage. The drawbacks include the tremendous balloon payment due in the fifth year, the exposure to varying payments due to changing interest rate, and the difficulty qualifying for this five-year rate. Five-year mortgages are targeted more toward the commercial market, than they are to the residential market. These loans can be adapted to the residential consumer. They are perfect for allowing the buyer to take advantage of low monthly payments and greater buying power.
Types of 5 Year Mortgages
5 year mortgages come in various configurations. Avoid any loan that leads to negative amortization. This occurs when the owner ends up owing more than the home is worth. It happens when the loan structure is such that the consumer pays no principle in the first several years of the loan. The I/O or interest only loan can occasionally present this situation. At the end of the five-years, the buyer has paid little to no principle on the home. If home costs have not risen, or the market has excess inventory, the house value could have declined. This causes the house’s assessed value to be less than the amount of money the owner owes on it.
Hybrid
The Hybrid 5 year mortgage is defined as when the first five-year the interest remains unchanged. However, after that period the interest will adjust according to the terms of the loan and the prevailing interest rates at the time. Since the buyer does pay on the principle, they achieve positive amortization. Interest is rates are a little higher due to the increased risk for the lender. The disadvantage is the large increase in the amount of the monthly payment when the loan adjusts.
Payment Option ARM
The payment-option ARM is another option in the five-year loan category. This loan allows the consumer to choose between three payment options each month. The flexibility is attractive to buyers. Buyers whose income is fluid can take advantage of these options. The owner can choose a traditional combination payment that includes interest and principal, a payment that is interest only, or a minimum payment. This loan also has an elevated potential for negative amortization.
Things to Consider With a 5 Year Mortgage
The terms of the loan are the most valuable thing to understand. The consumer unquestionably must be clear on the maximum amount the monthly payment can fluctuate, and what causes this rate to increase or decrease. Balloon payments are always associated with a five-year mortgage. It must be clear the month and year this payment will come due, and how much that payment will be. The annual interest rate is probably the third thing to bring into the equation. The amount that rate can change is as powerful as the initial rate.
The ability to take advantage of a five-year mortgage is not possible for many consumers. However, those that can tolerate the terms will save tens of thousands of dollars in financing charges. The thirty year mortgage offers greater payment stability, no balloon payments, and budget accommodation.