The margin is the markup that
lenders charge on the money they are lending. It is
usually somewhere around 2.50%. The margin does not
change during the life of the loan. If your lender
offers you various margins, you should consider the
lower margin since it will have an impact on how much
your rate will increase during the loan term. It is
the index plus the margin that gives you the fully
indexed rate. This is the rate that your loan should
actually be at according to current market conditions.
If you have a low start rate, you can be sure it will
adjust to the maximum amount it is allowed to at every
adjustment period until it reaches the fully indexed
rate. Remember though, that the fully indexed rate
will change because the index changes, even though
the margin does not.
It is important to find out how
often the particular ARM loan you are looking at will
adjust. Adjustments are usually every 6 or 12 months.
If your loan adjusts monthly this should alert you
that this loan might have negative amortization. Negative
Amortization loans will be discussed later in this
The lender must inform you before
your interest rate is about to adjust. There are usually
limits built into the loan as to how much the rate
can increase at any one time. These limits are known
as periodic rate caps. When shopping for an ARM loan
always find out how often the loan will adjust, and
what the interest rate caps are.
There are two types of rate caps.
There is the periodic adjustment cap and the lifetime
cap. The periodic adjustable rate cap limits the maximum
rate change, up or down, allowed for each adjustment.
If your ARM adjusts every 6 months, the periodic cap
is usually 1% (one percentage point above your current
rate). If your ARM adjusts every 12 months the periodic
cap is usually 2%.
You should never take an ARM without
a lifetime cap. This cap limits the maximum amount
the interest rate can adjust over the life of the
loan. ARM loans usually have a lifetime cap of 5 to
6 % above the start rate of the loan. When deciding
on an ARM loan always figure your payment at the maximum
rate. This way you will know in advance the very worst-case
interest rate for your loan.
Some loans have caps for the amount
of your monthly payment. At first this may appear
to be beneficial because even though your interest
rate might be at the fully indexed level, your payment
will only adjust a certain percentage each year. This
is a negative amortized loan. With this type of loan
you may get a low starting interest rate for the first
3 months and then the loan will go to the fully indexed
rate. Even though the rate has adjusted to the fully
indexed rate, your monthly payment will increase only
once per year. When it does increase, it can only
increase by a certain percentage from what it was.
This is the payment cap.
When you have a loan where the
payment does not adjust to meet the interest rate
being charged on the loan, you are not paying
off all of the interest each month. What then occurs
is the unpaid interest is added on to the balance
of your loan. You are not fully paying off your mortgage
over the 30 year period as you would in a fully amortized
loan over 30 years.
This type of loan does have some
benefits. It is usually easier to qualify for and
can help out buyers who are having problems qualifying
at the standard 30 year fixed rate. It also usually
offers the borrower an option on how they wish to
pay the loan off each month. They can pay the fully
amortized payment, and not allow the loan to go into
negative amortization. They can pay the full interest
only payment, which does not pay the mortgage down
but also does not add to the mortgage balance. They
can pay the fully amortized payment for a 15-year
loan and pay the balance in full in 15 years. They
can also pay the smallest payment allowed which is
at the payment cap and allows the loan balance to
increase. If your negative amortization loan has this
feature, you can usually choose each month which payment
option you want to take. This can often make this
type of loan very flexible. It is important to remember
though, that if you are the type of borrower who will
more then likely always pay the minimum due each month,
this type of loan is probably not for you.
Before you make your final decision
on an ARM loan you should ask yourself the following
1. Have you budgeted for higher
mortgage payments? Can you afford to pay the increases
in your mortgage and still be able to accomplish
your other financial goals?
2. Will you have at least 6
months worth of living expenses left over in an
accessible account after close of escrow? This will
help to cover rising mortgage payments.
3. Do you know that you can
pay the highest payment your ARM loan may reach?
This is the payment if the interest rate on the
loan were to reach the maximum rate possible. Your
lender should be able to tell you this payment.
4. If you are borrowing the
maximum amount allowable for the sales price of
the house, do you have a stable job and steady income?
Do you expect the size of your family to change
in the near future? It is important to budget for
any possible life changes.
5. Will an increasing mortgage
payment create undo stress in your life? If you
are the type of individual that does not easily
handle changes such as this, an adjustable mortgage
may not be a good choice for you.
An adjustable rate mortgage could
very well save you money over a fixed rate mortgage
over the life of your loan. Consider if you are financially
and emotionally secure enough to handle the maximum
possible payments over the life of the loan.
Also consider the length of time
you expect to be living in the home. If you donít
plan on staying there for a long period of time, (usually
more than 5 years) an ARM loan might be a good idea.
For the first 2 Ė3 years of an ARM loan you can usually
save money over the prevailing 30 year fixed rate.
If you expect to hold on to your
home for a longer period of time, a fixed rate loan
can be the best way to go.
In addition to the four basic
components, an ARM usually contains certain consumer
safeguards such as interest rate caps, which limit
the amount that the interest rate applied to the payments
may move. This prevents the amount of interest the
consumer pays from rising higher than perhaps the
homeowner can afford. For instance, a typical ARM
would have a six percentage point cap over the life
of the loan. That means a loan with an initial interest
rate of 6.25 percent would be able to go no higher
than 12.25 percent over the life of the loan, and
it would be able to move no more than two percentage
points per year.
Another safeguard found on some
ARMs are monthly payment caps that limit the amount
homeowners need to increase their payments at adjustment
time. Monthly payment caps can, however, sometimes
prevent the monthly payments from increasing enough
to keep up with the rise in the interest rate, causing
negative amortization-resulting in higher or more
payments for the homeowner later on.
Other options you should ask about
when shopping for an ARM are:
- Assumability, or whether
you may transfer the mortgage to a new home buyer,
usually with the same terms if the new home buyer
qualifies for the loan. ARMs are almost always assumable.
- Convertibility allows
the borrower to change an ARM to a fixed-rate mortgage,
usually at the end of some predetermined period,
locking in a lower interest rate.
A relative newcomer in the mortgage
market is a Reverse Annuity Mortgage (RAM).
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 for
older Americans is that of receiving a monthly tax-free
income. Under one plan, this income is available for
life or until the house is sold or 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
The Federal Housing Administration
(FHA) and the Veterans Administration (VA) offer a
wide range of mortgage choices that may appeal to
you. These include 30 and 15 year fixed- rate mortgages,
as well as ARMs. Insured by these government agencies,
the loans 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.
This type of financing became
popular when interest rates went to very high levels
in the early 1980s. Seller-assisted creative financing
usually means the seller of the home helps with financing
by underwriting all or part of the loan.
The advantage of this type of
arrangement is the mortgage usually carries a lower
interest rate with lower monthly payments. The disadvantage
is the previous homeowner, not an institution, may
hold the deed of trust. If the loan terms call for
certain payment schedules, the buyer may have to seek
new financing. Many home buyers in recent years have
found "creative financing" deals to be fraught with
problems and useful only as short-term alternatives
to mortgages from traditional lenders.
One type of mortgage you are apt
to run into with seller financing is the balloon payment
mortgage. Balloons, as they are known, are
usually offered as short-term fixed-rate loans. The
balloon payment mortgage gets its name from the payment
schedule, which involves smaller payments for a certain
period of time and one large payment for the entire
amount of the outstanding principal. They have terms
of 3, 5, and sometimes 15 years, though payments are
usually calculated as though it were a 30 year loan.
Sometimes a balloon will be offered as a second mortgage
where you also assume the homeowner's first mortgage
. The major disadvantage with a balloon payment loan
is that it may be difficult to save the money to make
the final large payment (often the entire amount of
the principal) while paying interest on the loan.
Some lenders guarantee refinancing, though the interest
rate is usually adjusted when the principal comes
due. If you cannot refinance, you may have to sell
the property if you cannot meet the large payment.
Balloons are an advantage if you plan on living in
an appreciating house for a short period of time and
want to pay less while you live there.
There are several ways. First,
talk with your real estate agent or broker. Real estate
professionals are normally in the best position to
learn about financing opportunities in the marketplace.
Lenders regularly call agents to alert them to financing
packages. And, of course, agents are highly motivated
to obtain financing for their buyers. Without a suitable
loan, the sale can't proceed, and agents won't get
their sales commission on the house.
Second, look for rate surveys
in your local newspaper. Many now include brief tables
on interest rates and mortgage availability in their
real estate or business section. They can help guide
you to sources you have not thought about.
Third, look in the Yellow Pages
under "Mortgages," and shop for quotes by telephone.
Call five to 10 different lenders for rates and terms
on fixed and adjustable loans.
Finally, if your area is covered
by one of the many commercial computerized mortgage
shopping services, give it a try. You may find,
however, that the computer services have only a selection
of local lenders on their listings.
One important method is by bearing
in mind that mortgage packages consist of more than
interest rates. They consist of a quoted rate, plus
discount points (pre-paid interest assessed by the
lender at settlement, or the meeting when the property
legally changes hands) and other fees, plus a full
range of terms including adjustable versus fixed-rates,
low down payment versus high down payment, the presence
or absence of prepayment penalties, and many other
features noted earlier in this brochure.
When you call around to different
mortgage lenders, you might find one lender quoting
you an interest rate of 7% for a 30 year fixed rate,
while another lender quotes you a rate of 6.75%. If
you automatically jump at the lower rate of the two,
it could end up costing a lot more money.
Remember, an interest rate quote
always goes along with points to be paid on the loan.
A lender can quote you varying interest rates, and
almost always the lower rate has the higher points.
Points are charged by the lender
as a way to pay for the expense and work associated
with obtaining you a mortgage loan. When comparing
rates it is always important to also calculate the
One way to do this is to calculate
the difference between the payment for the 7% loan
and the 6.75% loan. Now you know how much you would
save each month if you took the lower interest rate.
Next, compare the points. A point
is 1% of the loan amount. So if your loan is $100,000
one point would be $1,000. Letís say the interest
rate of 7% is for a one point loan or $1,000. Maybe
the points for the 6.75% loan are 1.50% or $1500.
You will then be paying $500 more in points for the
lower rate. If the difference in payment is $33.23
per month, how long will it take to make up for paying
the extra $500? If you divide $500 (the difference
in the cost of the points) by $33.23 (the monthly
savings) you will get 15.05. It will take 15 months
to break even. After 15 months you will actually be
saving money. If you plan on keeping this house for
a long period of time and staying in this mortgage
you will be saving a lot of money over the life of
the loan. After the first 15 months you will save
$398.76 per year if you take the lower interest rate.
Also consider the tax benefits.
Points paid on the purchase of a home are tax deductible.
You can claim them as an itemized expense on schedule
A of IRS form 1040.
If you have the cash, and will
live in the home for a long period of time, you will
want the lowest interest rate you can get. Paying
the extra points required to get the lower interest
rate can be a good idea if you work out the cost and
the months of lower payments required to make this
If you are strapped for cash and
can come up with the down payment and minimal closing
costs there wonít be a lot of money to pay points.
If you plan on living in the home a short period of
time, paying less in closing costs and a little more
each month makes good sense.
If someone quotes you a no point
loan, donít automatically think you are getting a
deal. This is also true of a no point Ė no fee loan,
where you do not pay any fees at all for the loan.
Remember the rates/points tradeoff. You donít get
something for nothing. A no point loan may make sense
if you have very little funds available for closing
costs. You will also find that homeowners who refinance
over and over again like to have a no point loan.
This way they can refinance into another interest
rate whenever rates decline and not be concerned with
the added expense of paying points to do this. They
still will not be receiving the best rate available,
but it can still work to their advantage if they think
rates will be going even lower and will want to refinance
again, or will not be staying in this home that much
One way to evaluate rates, however,
is by examining the Annual Percentage Rate (APR).
The APR can help you compare different types of mortgages.
It indicates the "effective rate of interest" paid
per year. The figure includes discount points and
other charges and spreads them out over the life of
By law, the APR must always be
disclosed to you within three days after applying
for a loan. The APR is the effective interest rate
for loans that are repaid over their full term. The
APR calculation assumes you will be keeping your loan
for its full term. However, most people sell or refinance
their loan within 6 to 12 years. If a $100,000 loan
were repaid after 6 years rather then the usual 30,
the effective interest rate would be 8.66%; not the
8.32% APR you would be quoted. A fairly accurate way
to estimate the APR for comparison is:
Effective interest rate = quoted
rate + (number of points / 6) If you plan to stay
only 4 to 6 years, divide the points by 4. If you
plan to stay for 1 to 3 years, divide the points by
the number of years.
While the APR provides you with
a common point for comparison, look at the whole product
before deciding which mortgage to get. Pick the one
with the rate, payment schedule and other terms that
suit your situation best.
To compare costs when shopping
for loans ask lenders to quote a rate based on the
same points (a one-point loan is good for comparison).
That way you can generally see which lender has the
better rate. Donít forget to compare the APR also,
to ensure the lender with the better rate/point quote
isnít adding on additional fees. Always ask a lender
whose loan you are considering to provide you with
an estimated breakdown of closing costs. That way
you can compare more accurately.
- Acceleration Clause
If you miss a monthly
payment, an acceleration clause allows the lender
to speed up the rate at which your loan comes
due or even to demand immediate payment of the
entire outstanding balance of the loan.
Assuming a mortgage
is simply taking the loan over from the holder
(seller) and becoming liable for the repayment.
The Buydown mortgage
is one where the seller and/or the home builder
subsidizes the mortgage by lowering the interest
rate during the first few years of the loan. While
the lower initial payment and interest rate make
this kind of loan easier to qualify, the payments
may increase when the subsidy expires.
- Closing Costs/Settlement
Closing costs are the
costs associated with settlement, the meeting
where the buyer and seller (or their agents) sit
down to fill out the papers and make the exchanges
that allow the property to legally change hands.
Closing costs include appraisal fees, title search
and insurance, survey, tax adjustments, deed recording
fees, credit report and points, among others.
- Due-on Sale Clause
A clause or provision
in a mortgage or deed of trust that allows the
lender to demand immediate payment of the balance
of the mortgage at the time of sale.
This occurs when your
monthly payments are not large enough to pay all
the interest due on the loan. This unpaid interest
is added to unpaid balance of the loan. The danger
of negative amortization is that the home buyer
could end up owing more than the original amount
of the loan.
Private Mortgage Insurance
In the event that you
do not have a 20 percent down payment, lenders
will allow a smaller down payment-as low as 5
percent in some cases. With the smaller down payment
loans, however, borrowers are usually required
to carry private mortgage insurance.
- Private mortgage insurance
will require additional premium payment of 0.5 percent
to 1.0 percent of your mortgage amount plus an additional
monthly fee depending on your loan's structure.
On a $75,000 house with a 10 percent down payment,
this would mean an initial premium payment of $338
to $675 and an extra $15 to $20 a month.