Buying a Home, Know Your Mortgages

Buying a home, here are some mortgages the average home buyer should be aware of and avoid.

*Multiple Choice Mortgage- the pay-option adjustable rate mortgage (ARM)
This mortgage offers a low initial interest rate with the choice of four monthly payment options. Borrowers can make a payment on the interest and the principal on a fully amortized loan, or make a payment that doesn't cover all of the interest due on the mortgage. Many average home buyers are attracted to these mortgages because of the lower payment option, but could soon find they owe more than they originally borrowed. This mortgage should be avoided because the home buyer could end up owing more than they borrowed.

*Cash-Out Financing- 103's, 107's and 125's
With this mortgage homeowners take a mortgage for more money than their home is worth. There is also an option of borrowing an extra 3%, 7% or 25% of the properties value which could be used for closing costs, renovations or to payoff credit card debt. The home must appreciate enough to cover the amount of the loan, if not the homeowner will have to come up with extra cash to pay off the mortgage. The interest rate on this mortgage is generally 50% more than normal. This mortgage should be avoided because a home must appreciate in order to build equity.

*Adjustable-Rate Mortgages- 1yr and 3yr fixed rate ARM'S
The borrower locks into a lower than average interest rate for the first 1-3 years. This mortgage readjusts every year in tandem with short-term interest rates which are highly volatile. Since 2004 the 1yr ARM has increased two percentage points from 4% to 6%. The home buyer would be better off to lock into an interest rate on a 30yr fixed-rate mortgage so they won't have to worry about fluctuations in the short term interest rates. This mortgage should be avoided since the monthly payments are variable in just 1 to 3 years.

*Interest Only Payments- 3yr, 5yr, 7yr and 10yr interest only option on an ARM, aka interest only mortgages.
Borrowers only pay the interest on the loan for the first 3, 5, 7 or 10yrs of the loan with no money being applied to the principal. When the interest only period expires, the monthly payments balloon to cover the remaining interest and all of the principal payments on the mortgage. The borrower could then be forced into spending more money to refinance or end up having to sell their house. This mortgage should be avoided because monthly payments could quickly balloon.

*Fixed Rate Loans- 40yr and 50yr fixed-rate mortgages.
This mortgage amortizes over 40 or 50 years. This mortgage entices borrowers because the monthly payment is lowered, which is true. However, the savings are not that significant. An individual with a $300,000 mortgage would reduce the monthly payment approximately $80 with a 40yr mortgage vs a 30yr one. The borrower will end up paying more interest on the loan, the interest rate is generally 1/4 % more than a 30yr mortgage. This mortgage should be avoided because it builds equity slowly.

Questions or comments: write or email eugene.dougherty@realliving.com