Interest-only mortgages

(This was Written By Dian Hymer)

Many home buyers are turning to mortgages with interest-only payment schedules so they can afford to buy a more expensive home. These mortgages have lower monthly payments, which makes qualifying easier. But the lower payments don’t last forever, and interest-only loans aren’t for everyone.

Mortgages with an interest-only payment feature come in many varieties. Basically, they work like this. The borrower pays interest-only payments for the first five, 10 or 15 years. The monthly payments are lower than they would be with a fully amortized loan during this initial period. However, at the end of the interest-only payment period, the borrower still owes the entire amount borrowed.

With a fully amortized loan, part of each monthly payment pays back a portion of the principal (the amount borrowed). A fully amortized payment schedule pays back the loan in full during the term of the loan, which is usually 30 years. At the end of 30 years, you owe nothing.

Interest-only is a bit of a misnomer. You ultimately have to repay the amount you borrow, so you won’t make interest-only payments indefinitely. After the initial interest-only period, the principal is amortized over the remaining loan term. With a 30-year mortgage that has a 5-year interest-only payment plan, the principal will be amortized over the remaining 25 years of the loan. A shorter amortization period requires the borrower to make a higher monthly payment in order to repay the loan more quickly. This means an increase in the monthly payment starting with year six of the loan.

For example, if you were to borrow $250,000 at 6 percent, using a 30-year fixed-rate mortgage, your monthly payment would be $1,499. On the other hand, if you borrowed $250,000 at 6 percent, using a 30-year mortgage with a 5-year interest-only payment plan, your monthly payment initially would be $1,250. This saves you $249 per month or $2,987 a year. However, when you reach year six, your monthly payments will jump to $1,611, or $361 more per month. Hopefully, your income will have jumped accordingly to support the higher payments.

Mortgages with interest-only payment options may save you money in the short-run, but they actually cost more over the 30-year term of the loan. However, most borrowers repay their mortgages well before the end of the full 30-year loan term.

A mortgage with an interest-only payment schedule makes sense for some borrowers and is potentially risky for others. Borrowers who are counting on home-price appreciation to build equity could find themselves in a financial bind if home prices should drop and, for whatever reason, they’re forced to sell.

Not all interest-only mortgages have a fixed interest rate. Some have one rate for the initial interest-only period and a higher rate—with a much larger monthly payment—for the remainder of the loan term. Others resemble adjustable-rate mortgages (ARMs). A popular variety has a fixed rate with interest-only payments for the first five years. Then it converts to a 1-year ARM. You could face serious payment shock if interest rates rose significantly during the first five years.

Borrowers with sporadic incomes can benefit from interest-only mortgages. This is particularly the case if the mortgage is one that permits the borrower to pay more than interest-only. In this case, the borrower can pay interest-only during lean times and use bonuses or income spurts to pay down the principal.
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Mortgage Information: The Right Loan for You

(This was Written By Dian Hymer)

Today's low interest rates make 30-year fixed-rate mortgages pretty attractive. But, is a 30-year fixed-rate mortgage the best way to go? What about an ARM (adjustable rate mortgage); a 5-year fixed; a 5/2/5 or even a 15-year fixed? With so many mortgage products to choose from, how do you decide which is best for you?

Assuming you have no problems qualifying for a loan, the decision will depend on your personal goals as well as your tolerance for risk. An ARM is riskier than a fixed-rate loan because the interest rate and monthly payment might go up over time. Borrowers who have a low tolerance for risk, or who are on a fixed-income, often prefer a fixed-rate mortgage with an interest rate and monthly payment that won't change.

The length of time you plan to stay in your home should weigh heavily in your decision. If you're sure that you won't be moving for seven to 10 years, a 30-year fixed-rate loan might best suit your needs. These mortgages are currently available in the 5 percent range.

But borrowers who are sure they'll be moving within the next five years will save money with a 5-year fixed-mortgage product. These are currently available in the 4 percent range. For the first five years, the interest rate is fixed. Then the mortgage converts to an ARM.

The specifics will vary from one 5-year fixed product to another. A common variety is called a 5/2/5 mortgage. The interest rate is fixed for the first five years. After that, the rate adjusts. The rate can only move up 2 percent in any one year. And over the life of the loan, the interest rate cannot rise more than 5 percent from where you started.

So, if you started at 4 1/4 percent and interest rates rose to 12 percent, the most you'd ever pay would be 9 1/4 percent. However, on the first adjustment only, the rate can adjust up the full 5 percent allowed if the index the ARM is tied to has gone up 5 percent or more since you took out the loan.

Today, it's hard to imagine that interest rates will ever hit 9 percent again. But 20 years ago, we were sure we'd never see rates drop below 10 percent. Interest rates are expected to stay low for some time. However, financial markets can change quickly, and without warning.

For this reason, it's a good idea to consider the worst-case scenario before choosing a fixed-rate ARM. Suppose you don't move at the end of five years as you thought you would. Calculate how much the loan will cost you if interest rates were to skyrocket during the fixed-rate term of the loan and you ended up paying the maximum rate allowed for several years.

Fully adjustable-rate mortgages are available in the 3 percent range. Many of these loans adjust monthly. Although riskier, these loans are popular with borrowers who need financial relief. These loans are also the easiest to qualify for. Some ARM products even allow the borrower to make a reduced payment in lean financial times.

The 15-year fixed loans are popular with borrowers who think they want to own their homes free of any debt. These loans are harder to qualify for because of the higher monthly payment.

The Closing
A 30-year loan offers more flexibility than a 15-year because you're not locked into a higher monthly payment. But, you can always pay more on a 30-year loan if you want to pay it off faster. Just make sure the loan doesn't have a prepayment penalty.

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Mortgage Information: Applying for a Mortgage

(This was Written by Craig Romero, Mortgage Analyst)

When applying for a mortgage, it’s important you get answers to the following questions. Be sure and print these questions out and take them with you when meeting with a potential mortgage lender. By taking the time to learn the answers to these questions, you can reduce or eliminate the chances of being taken advantage of. Thus, saving you thousands of dollars.

1. Will There Be an Additional Charge to Lock-In an Interest Rate and Discount Points?Since rates fluctuate daily, Most lenders offer a lock-in policy that guarantees your quoted interest rate and points will not change for a specified number of days. Allowing you time to organize your documents and shop other loans before applying with this lender. By paying a one time lock-in fee you may be able to save you thousands if the interest rate rises during the time you are locked in.

2. How Many Points Will Be I Charged?The answer to this question will vary from lender to lender. A point is calculated as one percent of the loan amount. Points charged are additional to the interest rate that is charged on the loan. A lender often makes his fees by charging points or to negotiate a lower interest rate. Be careful with this because a loan with a low interest.

3. What Will Be The Interest Rate & Annual Percentage Rate for This Mortgage?The answer to this question will allow you to compare the loan costs of this particular mortgage with other loans you may compare against. Your loan APR is figured by combining the interest rate, points and other fees divided by the loan’s term to give an annualized rate. A low interest rate and high points could end up costing you thousands more than one with a higher interest rate but low points.

4. How Long Will it Take to Process My Mortgage?Processing is the time it takes from the day you submit your application to the time your loan is approved. The time it takes to process a loan will vary for different loan types and among lenders. Normally loans should be funded within 7 to 10 working days, unless there is a problem with your application.

5. Will I Be Charged For Private Mortgage Insurance (PMI)? And If So, Can I Finance the Upfront Premium into the Loan Amount?If you’re unable to put a 20% down payment on your new home, you will be charged PMI (an insurance premium to protect the lender in case you default on the loan). If you are charged this, find out if you can add these premiums into your financing.

6. What Are The Total Closing Costs?Be sure and get this in writing within 3 days of applying for the loan. If they can’t provide this within 3 days…the lender has broken the law. When a list of closing fees are provided, be sure you understand each fee. Sometimes lenders will tack on unnecessary fees to boost profit. Lenders charge fees for the services incurred to process and close your mortgage. Also, make sure the closing costs that were presented to you in the beginning match the closing costs presented at closing.

7. Is There a Pre-Payment Penalty?This is a penalty some lenders apply to your loan if you decide to pay off your loan early. Either by making bi-weekly payments or 1/12 extra payments (see table of contents). This is important, since you will want to pre-pay your loan in order to eliminate costly interest overpayments. Most lenders don’t charge a pre-payment penalty, so there is no need to go with a lender who charges this.

8. Rapid Loan ApprovalBe sure and ask your lender if they utilize Rapid Loan Approval Software. This computer software allows lenders to determine a borrowers credit risk instantly. Allowing for them to approve a loan within hours or even minutes. Look for a lender who utilizes this software. It will save you valuable time especially when shopping for the best interest rate.

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