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5 Secrets You Didn't Know About Mortgages

December 28th, 2015 9:10 AM by Jackie A. Graves, President

The big “secret” about mortgages, from the lender’s point of view, is that it's all about competition and risk. Competition limits what a bank can charge because borrowers will look for the best deal. But competition is tempered by risk. People with good credit scores – evidence that they habitually pay their bills on time – are better risks than people who don’t, no matter the reasons, so they usually get better rates. (For more, see Your Credit Score And Your Mortgage Payment: It Matters.) Whatever your situation, here are some things you may not know – but need to – when getting a mortgage. Be sure to keep them in mind.

1. You can save big money with a shorter term loan.

The most common mortgages have fixed rates and a 15- or 30-year term. The rates (NY-NJ-CT) for 15 years in late May 2015 were in the neighborhood of 3.38% for 15 years and 4.00% for 30 years, a difference of 63 basis points (0.63%). Any online mortgage calculator will do the math and show you that at those rates, a $200,000 mortgage for 30 years will cost you about $955 per month in principal and interest. The interest payment over the 30 years will add up to about $144,000. The 15-year note will cost $1,418 per month but the accumulative interest will be only about $53,000, a savings of $89,000. That will make a dent in your tuition bills down the road! If your cash flow can stand the higher monthly payment, a 15-year mortgage is a good deal. (See also: Benefits Of Paying Off Your Mortgage and Comparison Of A 30-Year Vs. A 15-Year Mortgage.)

2. You can save if you pay on a bi-weekly schedule.

Some banks allow or even encourage bi-weekly payments as an alternative to monthly payments, essentially having you pay half of the monthly amount 26 times per year or the equivalent of one extra full month per year. In the 30-year example above, the loan term is shortened to 49 months and the savings are about $22,000.

3. You can lower your initial costs with an ARM.

Adjustable rate mortgages (ARMs) usually start out with lower interest rates that are fixed for five or seven years and then reset at 2.5 to 3 percentage points above the LIBOR (London Interbank Offered Rate), currently about 0.75%. They are described as “5/1” or “7/1,” meaning that they are fixed for 5 or 7 years and then reset annually in relation to LIBOR. The risk with ARMs is that interest rates including LIBOR will go up sharply by the time the loan is to be reset.

ARM terms include caps on the interest adjustment, typically expressed as “Caps:5/2/5,” meaning that the maximum amount the interest rate can be increased after the first time period is 5 percentage points, after the second period, 2 points, and after the third period, another 5 points, for a total of 12 points above the initial rate of perhaps 3.25%. You will shop for the lowest caps you can find. Of course, the lender will be constrained by conditions at the time, but if we enter another period of extreme interest rates, as were experienced in the late 1970s, an ARM could get quite costly.

At any point you have the choice of sitting tight or refinancing with a fixed rate mortgage or another ARM, depending on conditions at that time. ARM loans are more risky than fixed rate loans, but they can be cheaper, too. Make sure your mortgage can be paid off early without penalty. (For more, see Fixed Or Variable-Rate Mortgage.)

4. Points may work in your favor.

One point is by custom 1% of the mortgage amount. On our $200,000 loan example above, one point would be $2,000. It is essentially prepaid interest due at the time of closing, and if you can afford the cash up front, it will earn you a lower interest rate. Whether paying points makes sense depends on how long you plan to own your house, and once again, there are online calculators that will help you figure out where the break-even point is between paying points up front and lower overall costs.

The longer you own your house, the better the payoff from paying points up front. Some lenders prefer or require you to pay points, others don’t care. Once again, the better your credit score, the more flexibility you will have, since the lender may require points in order to limit its risk.

5. Sometimes it’s good to have a middleman.

Mortgage brokers are financial services firms that will help you find a mortgage. They usually have good relationships with several lenders in a geographic area, and know from day to day what the rates are for each of the many types of loans that are available. They also know what each lender’s rules are for prospective borrowers. There are always nuances, even in a heavily regulated industry.

A mortgage broker will help you understand the requirements and also help you fill out the forms, assemble the necessary paperwork and submit it to one or more lenders. Their profit comes from the difference between the rate they can get because the bank has less work to do to get you as a mortgage customer, and what you could get by doing all the legwork yourself, or it comes from origination fees and other charges to you.

Conditions vary, of course, but using a mortgage broker should be a low- or no-cost option for you, and the rate you get through a broker will be as good as or very near the best rate you could get yourself. Caveat emptor, however. Be sure to ask those questions about costs and fees when you are interviewing brokers. (For further reading, see Advantages And Disadvantages Of Using A Mortgage Broker.)

The Bottom Line

Buying a house and taking out a mortgage are the biggest financial transactions most of us will ever undertake, but there has rarely in history been a better time to do so – from an interest rate perspective, at least, and that is where most of the cost of ownership is. The process can be daunting, but if you do your homework and don’t buy more house than you need just because interest rates are low, you can prosper.

By David F. Smith – To view the original article click here

Posted by Jackie A. Graves, President on December 28th, 2015 9:10 AM


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