Housing Services Resources

If you expect to live in your home for many years, the interest rate of your loan may be your primary consideration. You may want a fixed-rate mortgage that will ensure that your interest rate will remain the same for as long as you have your loan.

If you decide that you like the stable, predictable payments of a fixed-rate loan, then you must choose form variety of repayment terms – 15, 20, and 30 years are the most common. Here are some points to compare about various fixed-rate loans:

• A 30-year fixed-rate mortgage is the easiest fixed-rate loan to qualify for. Its longer term gives you the best chance to keep monthly mortgage payments low and use the extra cash for other purposes.
  
  
• A 20-year fixed-rate mortgage amortizes principal and interest over a 20-year period, 10 years sooner than the traditional 30-year mortgage. If offers you the opportunity to own your home debt-free much more quickly. Yet, the monthly payment is only somewhat higher than the 30-year mortgage loan.
  
  
• A 15-year fixed-rate mortgage offers a lower interest rate than a 30-year or 20-year mortgage and will save you a significant amount of interest over the life of the loan. You will build up equity in your home quickly, which can allow you to move to a more expensive home sooner. If you’re nearing retirement, this shorter-term mortgage allows you to own your home sooner. The benefits of a 15-year mortgage come with a price – your monthly mortgage payment will be considerably higher than for the 30-year mortgage.

If you’re confident that your income will increase steadily over the years, or if you plan to move in a few years and aren’t concerned with potential rate increases, then you may want to consider an ARM. ARMs feature an interest rate that moves up and down as market conditions change. Although an ARM usually offers a lower initial interest rate, your mortgage payments change periodically (usually once or twice a year). Interest rate changes typically are subject to two caps, one for each adjustment period and one for the life of your loan. For example, a typical ARM that adjusts annually may have a per adjustment cap of 2 percent and a lifetime cap of 6 percent.

Because ARMs offer lower initial interest rates, initial monthly payments will be lower, so you may be able to qualify for a larger mortgage amount. However, you will likely be required to come up with more than a 5 percent down payment (usually at least 10 percent). Of course, if interest rates go down, your payment will decrease as well. Some ARMs offer you the chance to convert to a fixed-rate loan (for a fee) within a certain period of time. The interest changes on an adjustable-rate mortgage are always tied to a financial index. A financial index is a readily publishable rate—for example, the financial index for many credit cards is the prime rate.

The three most popular types of ARMs are:

• Treasury-indexed ARMs, indexed to six-month, one-year, or three-year Treasury bills or securities. Depending on which of these three indexes you choose, your interest rate will adjust once every six months, once each year, or once every three years.
• CD-indexed ARMs, which adjust to a Certificate of Deposit (CD) index. Rate adjustments typically occur every six months, with a per adjustment cap of 1 percent and a lifetime cap of 6 percent.
• Cost of Funds-indexed ARMs, indexed to the actual costs a particular group of lending institutions pays to borrow money. Lenders using this index can adjust mortgage rates monthly, every six months or annually. The most popular index of this type is the Cost of Funds Index for the 11th Federal Home Loan Bank District of San Francisco.

When comparing ARMs that have different indexes, you should look at how the index has performed recently. Some indexes are widely published in newspapers, making them easy to track. Mortgage lenders are required to provide you with information on how to track the index and to provide a 15-year history of the index they use. Remember, though, that past performance cannot predict future performance of the index or the direction your interest rate may go.

Other types of ARMs

ARMs with an initial fixed period: you may wish to look into a special type of adjustable-rate mortgage that doesn’t adjust your interest rate until several years after you take out the loan. These loans offer you several years of fixed payments before there is an interest rate change. You can get a three-, five-, seven-, or ten-year fixed period ARM. This means your interest rate would be the same for the first three, five, seven, or ten years and then, at the end of your chosen fixed-rate period, your interest rate would adjust every year. This type of adjustable-rate mortgage protects you against rapid interest rate increases in the early years of your loan.

ARMs that adjust only once: you can also choose an ARM that adjusts just one time. The first adjustment would happen at five or at seven years. After that initial adjustment, the mortgage maintains a fixed rate for the remaining 23 or 25 years of a 30-year mortgage term. This type of ARM, sometimes called a “two-step,” provides the benefit of initial low rates with the stability of longer term financing.

Balloon loans offer lower interest rates for shorter termfinancing, usually five, seven, or ten years. At the end of thisterm, they require financing or paying off the outstandingbalance with a lump-sum payment. Balloon mortgages may besuitable if you plan to sell or refinance your home within a fewyears and want a fixed, low monthly payment. The advantagethey offer is an interest rate that is lower than fully amortizingfixed-rate mortgages. For example, your initial interest rate maybe 6.5 percent and you would pay the rate for the first five,seven, or ten years (depending on the term of your balloon loan).Then, your entire outstanding loan balance would be due to thelender or you might have to pay a fee to refinance your loan atthe prevailing interest rate. However, ask about all the conditionsfor a refinance option at the end of the balloon term. Withsome balloon mortgages, the lender doesn’t guarantee to extendthe loan past the balloon date. If you don’t feel you will be able tomeet all the refinance conditions or think the balloon term may beup before you are ready to move, this type of loan may not beappropriate for you.

Special loan programs often exist to help first-time buyers. With some of these programs, you may be able to accept a gift from a relative or to borrow a portion of the money you will need for the down payment and closing costs from a local nonprofit organization or government agency. With others, you may be able to get a grant or other funds that you will not have to repay and can use to cover some of these costs. If you don’t qualify for a mortgage based on some of the traditional underwriting factors described earlier, you may want to find lenders who offer special mortgage loans like these. These loans allow you to use a greater percentage of your income toward monthly housing expenses and will not require you to have two months of cash in reserve at closing. If you don’t have a traditional credit history, you can show you have a good credit history using your rent and utility receipts.

You may want to consider the mortgage plans offered by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the Rural Housing Service (RHS). Properties purchased under these programs must meet certain minimum standards and possible loan limits. FHA-insured loans offer very low down payments (3 to 5 percent). VA-guaranteed mortgages with no down payment are available to qualified veterans. You must get a certificate of eligibility from the Department of Veterans Affairs for a VA loan. The guaranteed rural housing program offered by the RHS is for people who meet certain income requirements and wish to buy a home in a rural area. This government-guaranteed loan requires no down payment. You may shop for a mortgage loan at mortgage companies, savings and loan associations, commercial banks, and credit unions.

• Shop around for the best loan for your situation. Ask in places where you feel comfortable, such as a bank, credit union, or a local nonprofit housing or consumer credit-counseling agency. To confirm current interest rates, look in the business or real estate section of your local newspaper. Call more than one bank, savings and loan, or mortgage company.
  
  
• Borrow only the amount you need and can afford to repay. You may be encouraged to borrow more than you need. So before deciding on a loan, be clear about how you will use the money and how you plan to pay it back. If you are already in debt and having problems making your payments, you probably shouldn’t borrow more money. Instead, try to negotiate a payment plan with your current lenders.
  
  
• Understand exactly how much the entire loan will cost. Review the complete payment schedule. Be sure to find out how much you will have paid in total when the final payment is made. Above all, beware of loans with one large “balloon” payment at the end. If you have difficulty making the final payment when it is due, you may have to refinance the loan to make the balloon payment. If your original loan does not guarantee a new loan with reasonable rates, the refinanced loan can cost you even more money because of additional points and fees.
  
  
• Make sure that the loan fees are reasonable. In most cases, loan fees should not exceed 5 percent of the loan amount unless you are paying more for a lower interest rate. However, there are some situations that may cause the loan fees to be higher. If you’re not sure, ask a trusted advisor such as a nonprofit housing counselor.
  
  
• Read every word in a loan document, and check everything for accuracy. Don’t accept loan terms just because the lender says they are “standard.” Make sure you understand the reason for—and effect of—every loan term before you sign.
  
  
• Do not be pressured into signing for a loan you can’t afford. But if you do get pressured into signing for a loan you can’t afford, act fast. You have a legal right to cancel, or “rescind,” a loan contract when your home is used as security for a home-equity loan. But you must generally cancel the loan in writing within three business days of signing the loan documents.

• Watch out for loan offers from someone who calls you on the telephone or comes to your door without an invitation. Throw away mail from companies offering to arrange a loan for you. Advertisements promising easy money should be viewed with caution. Remember, if an offer sounds too good to be true, it probably is.
  
  
• Be wary of high-pressure sales pitches, such as claims that an offer is good only for a limited time. If the offer is good—and legitimate—today, it should still be good tomorrow. Take time to check it out.
  
  
• If you’re thinking about consolidating your debts into a home-equity loan, talk to a local nonprofit housing or consumer credit-counseling agency first. These agencies have your best interest in mind. They may be able to help you work out credit arrangements to avoid debt consolidation altogether. If debt consolidation is the most appropriate choice, they can help you select the best available options. Without their assistance, you may choose a bad loan and end up losing your home.
  
  
• Avoid loans that include extras you don’t need. Loans should not include unnecessary costs like prepaid single-premium credit life insurance. Predatory lenders may require that you purchase a credit life insurance policy as a condition of getting a loan. This is not necessary. These extras will be added to the total cost of your loan and make your payments higher.
  
  
• Never sign an agreement that you don’t completely understand. And don’t take a lender’s word that an agreement is “standard.” If the agreement seems unreasonable, or uses terms that are unfamiliar to you, ask for a complete copy of the loan agreement. Get a second opinion from someone you trust before you sign the loan agreement. Bring it to your advisor or local nonprofit housing or consumer-credit counselor to review it.
  
  
• Fill in all blank spaces. If an answer is not required, write “N/A” (Not applicable) in the blank. Do not sign a document until you have completed every space. Someone could fill in the blank later and make you responsible for something without your knowledge or agreement.