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There are many different types of home purchase loans. Some basic knowledge is a definate plus to
help ensure you are getting the right type of loan for your situation.
In a fixed rate loan the interest rate remains the same throughout the loan term. This offers
predictability as the monthly payments never change.
In an adjustable rate mortgage (ARM) the interest rate is tied to some index (for example the Cost
of Funds index - COFI) and will change up and down during the life of the loan. The monthly payments follow
suit. Usually there are caps on how much the payments can change in a given period of time. When a cap
prevents the monthly payments from increasing as much as the index then the loan amount increases to
account for the shortfall. This is called negative amortization. The advantage of an ARM is that the
interest rate is lower than a fixed rate loan in the beginning. This allows a homebuyer to get a bigger loan or
to have lower monthly payments. The trade offs are that the payments will eventually become higher and
the possibility of negative amortization.
Combinations of fixed and adjustable rate loans are possible. For example a 5/1 loan where the rate is fixed
for the first five years and adjustable thereafter on an annual basis.
VA loans are available to people that have served in the military. 100% financing is possible.
Loan assistance programs are available to help low and moderate income
buyers purchase a home. Rehab loans can sometimes be obtained with favorable terms for homes in
targeted areas.
A lender may charge you points if his yield from the loan is insufficient from the interest alone. A point
is one percent of the loan amount. Points go by various names such as discount fee or origination
fee and are charged up front. Points may be deductable, check with your financial advisor.
The value of a house, above and beyond the amount owed on the loan is called the equity.
For example a house is worth $200,000 and the loan balance is $150,000 so the homeowner has
$50,000 equity.
The amount of the loan expressed as a percentage of the value of the house is called the Loan to Value
ratio or simply LTV.
Lenders prefer to make loans of no more than 80% LTV. That way if the borrower goes into default
(misses payments) and the house has to be foreclosed (taken back by the lender and sold to pay
off the loan) there is sufficient equity to cover the cost of foreclosure.
A lender may be willing to lend more than 80% of the purchase price but will require the borrower to
purchase Mortgage Insurance (MI) to cover that portion of the loan which exceeds the 80% LTV.
The cost of the mortgage insurance may be added to the monthly payments. The insurance may be obtained
privately (PMI) or may be provided in the form of a guarantee from the Department of Housing and Urban
Development (HUD). This would be an FHA (Federal Housing Administration) loan. An FHA loan may be
for up to 97% of the purchase price.
It may be possible to take out a second loan to cover some or all of the remaining 20% of the purchase
price. The second will have a higher interest rate than the first to compensate the lender for the added
risk because there is less or no equity available to cover the costs if foreclosure becomes necessary.
Mortgage insurance is not required but the cost saving is offset by the higher interest rate.
The first and second loans may be packaged together. For example the 80/20 loan allows 100% of the
purchase price to be financed.
FHA Section 203(k) loans are available for single family residences in need of repair and rehabilitation.
In this program the loan amount is based upon an appraisal of the future value of the property after the
rehab has been completed. Work does not have to start until after close of escrow it is even possible to,
include up to six months of mortgage payments in the loan. There is a new Streamlined 203(k) program
which makes up to $35,000 available for a smaller scale of repairs.
The APR (Annual Percentage Rate) is a number that the Federal Truth in Lending law requires lenders
to disclose when they advertise financing details. The purpose is to provide a standardized figure of merit
encompassing the interest rate and various fees that lenders charge so that the consumer can compare
offerings from different companies.
A rate lock is where the lender commits, for a certain period of time, to a particular interest rate and
number of points. This allows a homebuyer to proceed with their purchase with the assurance that their monthly
payments will not be higher than expected due to an increase in interest rates. Make sure you get it in writing
and read it carefully to verify that both the interest rate and the points are locked and for how long.
Some loans include a prepayment penalty provision. If the loan is paid off within a certain time
(perhaps two years) then a substantial penalty must be paid to the lender. This is definately something
to try and avoid even if you intend to keep the loan longer than the penalty period because circumstances
change and you may later regret it. Accepting a prepayment penalty may facilitate a lower interest rate so
you should weigh the pros and cons carefully. Be sure to check if a loan includes a prepayment penalty provision.
Your loan may include an acceleration clause. This means that if there is any change of ownership
(for example by selling the house) then the balance of the loan becomes immediately due and payable.
Some loans are assumable. This means the buyer may take over the monthly payments from the seller.
This is less common now than in the past, usually only applies to ARMs.
It is even possible to get a no qualifying loan. With a large downpayment there is very little risk to the lender
and normal qualifying requirements may be suspended.
Lenders commonly sell their loans to quasi governmental agencies Fannie Mae and Freddie Mac.
This is called the secondary market, its purpose is to return money to lenders so that they can continue
to make loans. For a loan to be sold on the secondary market it must conform to certain requirements. Such loans
are called conventional or conforming loans. When a loan exceeds the dollar limit set by Fannie
Mae and Freddie Mac it is called a Jumbo loan.
If your loan is sold in the secondary market your lender may or may not continue to service the loan
(collect the payments). The terms of the loan cannot change but you may be notified of a new address to
send your payments to.
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