Investing Programs Available to Borrowers
A key step in the home buying process is choosing the right type of loan for your needs. There are many types of loans, each having advantages and disadvantages; the right choice depends on your plans for the home. This article will provide you with a basic understanding of your options.
Talking with a lender early in the process puts you ahead of the game. They can explain what interest rate and payment to expect with each type of loan. They'll also let you know how much you can be approved for based on your financial position. There is often a difference between what the bank will lend you and what you think you can afford; sometimes they'll approve you for more and other times less. Knowing both the lender's limit, as well as your own, is important.
First, review the major kinds of mortgages you may encounter. The following list explains the most common. Be sure to ask questions; a good lender will work with you to understand your needs and counsel you until you come to a decision on what will work best for your situation.
Fixed-Rate Mortgage (FRM)
This is the standard mortgage model. It is the oldest and most easily understood type of mortgage. The interest rate and payments remain fixed over the life of the loan. This product is still attractive when the interest rates are low and the borrowers plan to live in their home for long periods of time.
Adjustable-Rate Mortgage (ARM)
With this mortgage, the interest rate periodically rises and falls based on other market indexes. You therefore assume the risk of rising rates but you also stand to benefit when rates fall. This product is often attractive to borrowers who won't be in the home for a long period.
When you get an ARM, two main factors determine the rate you pay: the index and the margin. The index is a rate set by market forces and published by a neutral third party. The margin is an agreed-upon number of percentage points that is added to the index to determine your rate. There are many indexes and each has its own characteristics for fluctuation. Examples of the indexes used for this purpose would be LIBOR, COFI, MTA or CMT.
An essential question to ask about an ARM is whether there are limits on how much the rate can be raised, both at each review and over the whole term of the loan. Without limits, known as "caps," you'll have no way to predict how much your rate (and thus your monthly payments) might change.
Under this arrangement, the buyer starts out with an ARM, but has the option of converting to an FRM at specified points during the loan term. You may want to ask the lender these questions: When can you convert? How often can you consider the option? Are there any up-front fees involved? Will you have to pay more for an ARM with the conversion feature than for an ARM without it? Are there additional fees due if and when you decide to convert? Find out the lender's conversion rate.
Graduated Payment Mortgage (GPM)
A GPM mortgage begins with small payments and gradually raises them (usually over a five to ten year period). The payments then remain fixed for the remainder of the loan. This situation can be ideal for a borrower expecting a steady salary increase over the early years of the loan.
Growing-Equity Mortgage (GEM)
This option is designed for borrowers who want to pay off their mortgage more quickly than normal but don't want the fixed payment of a shorter loan. In this program, the interest rate remains fixed, but the amount of the monthly payment increases according to a prearranged schedule. The extra money is applied to the principal and the balance is paid down more rapidly.
Federal Housing and Veterans Administration Loans (FHA/VA)
The Federal Housing Administration (FHA) and the Veterans Administration (VA) offer a wide range of mortgage choices. These include fixed and adjustable rate mortgages. An attractive aspect of these loans is that they feature low or no down payment terms and are often assumable by future purchasers. VA loans are restricted to individuals qualified by military service or other entitlements, but FHA-insured loans are open to all qualified home purchasers. Note that there are limits to handle moderate-priced homes anywhere in the country. Talk to your lender about FHA/VA possibilities.
Reverse Annuity Mortgage (RAM)
The Reverse Annuity Mortgage (RAM) is a fairly new product. For older Americans, especially retirees living on fixed incomes, the equity in their paid-for or almost-paid-for home represents a large but liquid asset. The RAM is designed to help supplement those homeowners' income.
The lender who will issue a RAM appraises the property and makes the loan based on a percentage of its current value. The homeowner retains ownership, and the property secures the loan. The lender then pays an annuity to the borrower, usually on a monthly basis, up to an amount equal to the equity they have in the home.
The advantage of such a loan is that of receiving a monthly tax-free income. Under one plan, this income is available for life or until the house is sold when the homeowner moves. The schedule of payments depends on the value of the home and the ages of the owners. There are risks involved, however. If the homeowner wants to move and buy a new house, there may not be enough equity in the home to permit such a plan. Or the lender may consider only the current market value of the home rather than any future appreciation when deciding on the monthly payments.
As you can see, there are many options available to you as a borrower. This is a great deal of information to understand and digest but talking with your real estate agent or lender can help answer any questions. We suggest taking the time to learn more about the programs that might be right for you!
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*Please bear in mind that the information supplied in our articles is not engaged in rendering legal, financial, or any other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
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