| FINANCING A HOME PURCHASE
Q. How do I finance the purchase of a home?
A. Few people have enough cash to buy a home outright--most need
to finance their purchase by borrowing money. Usually, this is done by
contracting with a financial institution such as a bank or savings and
loan. The buyer agrees to pay interest on the money borrowed and the lender
retains a lien (mortgage) on the property. In some cases, buyers are able
to obtain seller financing in which the buyer pays interest to the seller
and the seller retains a lien on the property. In other cases, a buyer
is able to assume the seller's mortgage. That is, the buyer pays the difference
between what is owed on the mortgage and the purchase price and takes
over the seller's payments on the mortgage. (Note that this can occur
only if provisions in the mortgage state specifically that it is assumable.
Most mortgages written today include a due-on-sale clause that prohibits
assumption of a mortgage.) In the event that a buyer can assume the seller's
mortgage, the seller should remember that he or she remains liable to
pay the mortgage unless the seller's lender specifically and in writing
releases the seller from this obligation.
Today, a wide variety of financing mechanisms exist to finance a purchase.
Some buyers
may qualify for federally insured loans that permit smaller-than-normal
down payments and lower interest rates than prevailing market rates.
Q. How do lenders determine the interest rate?
A. Interest rates for home loans are determined by the overall
market in interest rates. Short-term rates, such as those paid on a six-month
certificate of deposit, are usually the lowest. The highest rates are
usually paid on unsecured loans, such as credit-card debt.
Home loan rates are very interest-sensitive; that is, when rates are declining,
they are
usually the last to be lowered, but when rates are rising, they are among
the first to go up. This is because most home loans are made at a fixed
rate over a fairly long term fifteen to thirty years during which time
interest rates may increase substantially. Thus, lenders attempt to protect
themselves from making too many long-term loans at low rates by taking
a go-slow approach to reducing interest rates.
Interest rates for home loans fell dramatically from the highs of the
early 1980s through
most of the 90s. These lower rates have made home buying much more affordable.
These rates can and will rise very quickly, however, if the prevailing
trend changes and other interest rates begin to escalate. Present mortgage
rates are easy to find on the Internet.
Anyone interested in an adjustable-rate mortgage, in which the interest
rate changes during
the life of the mortgage, should be aware that rates could climb rapidly
and significantly increase
the amount of the mortgage payments.
Q. Does it pay to shop around for an interest rate?
A. Yes. Lenders are very competitive. Interest rates and fees
charged to originate a loan vary
among financial institutions. Typically, lenders charge the prospective
buyer a fee to obtain a loan- -this may be a flat fee or a percentage
of the loan (one point is 1 percent of the loan amount).
One lender might offer an 8 percent, thirty-year fixed-rate loan with
a flat fee of two
hundred dollars. A second lender might offer a 7 percent, thirty-year
fixed-rate loan with two
points. A third lender might offer the loan without points or other fees
but at a higher interest rate.
This could be advantageous for a buyer who wants to put as much as possible
into his or her down payment. Another buyer might prefer to pay higher
points in exchange for a lower interest rate because the IRS allows points
to be deducted against taxable income in the year the home is purchased.
Shopping for Interest Rates
You can and should shop for rates. As noted earlier, a 1- percent
change in the interest rate on a $100,000 thirty-year fixed-rate loan
could mean a seventy-five dollar difference in each monthly loan payment.
The market is competitive. Lending institutions often will offer lower-than-market
rates to attract borrowers.
There are several ways to shop for home loans. By far the easiest
way to do this today is via
the Internet, which is awash in interest rate information and mortgage
brokers that will compete with each other to get you the best deal.
Most websites related to mortgages also feature useful mortgage and
home finance calculators. Search for "mortgage" and the
name of the state where you are planning to buy for the first cut
of these websites.
In addition, many metropolitan newspapers carry a weekly listing or
sampling of rates
offered in their areas. Rates can change very rapidly, which might
mean that these listings may not be up to the minute. However, they
can give you a good general idea of the market. In addition, several
reporting services offer details on a variety of loan types and interest
rates available from area institutions. Prices of these services range
from ten to thirty dollars. Therefore, you may want to use a reporting
service only when you are ready to apply for a loan. You also can
call a real estate mortgage broker for information. |
Q. What is a land contract?
A. A land contract is a common form of seller financing. The
buyer pays the seller a down
payment and agrees to make payments of interest and principal on the outstanding
balance. In
other words, the seller acts as a lending institution. Typically, the
buyer takes possession of the
property, but the seller retains the right to sue to recover the property
if the buyer fails to fulfill his or her contractual obligations. As a
general rule, legal title is not transferred to the buyer until all payments
are made. Evidence of title, such as a warranty deed, usually is placed
with a third
person who holds the document until payment is completed, at which time
he or she delivers it to the buyer, who should make sure that it is recorded
in the proper local records office, for example, the recorder's office
or county clerk's office. Once again, because a contract is involved,
attorneys for both parties should be consulted to review its terms. Finally,
since title is not transferred until full payment has been made, the contract
should be recorded by the buyer with the recorder's or county clerk's
office so that his or her interest in the property is protected until
payment is made in full.
Q. I want to buy another home, but I haven't sold my present
home yet. Is there a way to finance until I can sell?
A. Many lenders offer a bridge loan to allow a buyer to buy another
home while waiting to sell his or her present home. You can obtain a bridge
loan if you have a contract to sell your present home and you need the
loan only for a specific, relatively short, period of time.
It is much more difficult to obtain a bridge loan if you do not have a
buyer for your home
and, thus, need to pay loans on two properties. Bridge loans usually carry
a higher interest than a traditional home loan.
Q. What is a fixed-rate loan?
A. Most prospective buyers prefer a fixed-rate loan because the
interest rate cannot be increased during the term of the loan, typically
15, 20, or 30 years. Under a fixed-rate loan, buyers can feel more comfortable
knowing the exact amount of their monthly loan payments throughout the
life of the loan.
Although the interest rate does not change, the way in which the payment
is divided
changes over the loan period. At the beginning, most of the payment is
applied to the interest owed to the lender. As the loan progresses, more
money is applied to the principal, the face amount of the loan. This also
means that the amount of interest deductible for a federal income tax
purposes will decline over the life of the loan.
The major difference between a fifteen-or twenty-year fixed-rate loan,
on the one hand, and
a thirty-year fixed-rate loan, on the other, is that the borrower will
pay higher monthly payments
on the shorter term loans than would be the case with a thirty-year loan
for the same amount of
money. Over the life of the loan, however, the buyer pays far less interest,
because he or she is
using the money for a shorter period of time.
Q. What is an adjustable-rate loan?
A. Adjustable-rate loans vary, but they all share one common
factor--some aspect of the terms of the loan can be changed by the lender
during the life of the loan. The specific type of adjustable mortgage
is tied to whether the change is in the rate of interest, amount of payment,
or length of time for repayment.
If you are considering applying for any type of adjustable-rate loan,
make sure you
understand exactly how the mortgage works, including the spread between
the interest rate and the index to which the rate is tied; how often the
loan can be adjusted; the maximum allowable
increase (or decrease) each year as well as over the life of the loan.
Adjustable-rate loans include:
• Adjustable-rate mortgages (ARMs). These loans typically offer
a lower-than-market interest
rate in the first year. The future interest rate, usually adjusted annually,
is tied to an index that
may move up or down but is not under the control of the lender. The index
might be the oneyear
Treasury bill (the T-bill rate) or some other rate that reflects the changes
in interest rates.
Note that the rate is tied to the index it is not the same as the index.
The mortgage might
specify, for example, that the future rate would be two points above the
average T-bill rate.
Typically, ARMs are adjusted once a year on the anniversary date of the
loan. Additionally,
ARMs usually have a provision for a cap, that is, the highest rate that
could be charged. Some
may include a minimum rate as well.
• Convertible ARMs. These loans usually offer a conversion factor
that allows the borrower to
convert to a fixed-rate loan at a specified period of time. For example,
a convertible ARM
could allow the borrower the option to convert to a fixed-rate loan once
a year over the first
five years of the loan. The interest rate to be paid would also be tied
to an index.
• Renegotiable-rate mortgage (rollover). These loans typically set
the interest rate and monthly
payments for several years and then allow both the rate and principal
payments to be changed
depending on general market conditions. If the new terms are unacceptable
to you, you can pay
the loan in full or refinance at prevailing interest rates.
• Graduated payment mortgage (GPM). With this type of loan, typically
sought by young buyers
who expect their incomes to rise, the payments are low in the first couple
of years and
gradually set to rise for five to ten years.
• Shared-appreciation mortgage. These loans offer lower-than-market
rates of interest and low
payments in exchange for a lender's share in appreciation of the property.
Usually, the lender
will require that its share of equity will be turned over when the home
is sold or at a specified
date set out in the loan agreement.
Q. What is a balloon loan?
A. With a balloon loan, the buyer is expected to pay off the
loan completely within a short period of time, usually in three, five,
or seven years. In other words, this is a short-term loan. The interest
rate can be fixed or variable, but in all cases the unpaid balance on
the principal is due at the time specified. The borrower must either refinance
or sell the home to pay off the loan.
To attract buyers, builders often offer balloon loans during periods of
high-interest rates
when home sales are sluggish. In most cases, the interest rate will be
lower than prevailing home loan rates. However, if interest rates are
high when full payment is due, refinancing may not be possible. The balloon
will "burst," resulting in foreclosure and loss of the home.
Q. How do FHA and VA loans work?
A. The Federal Housing Administration (FHA) offers insured low-interest
loans made by the
federal government and approved lending institutions. The cost for this
loan insurance varies and is charged at the closing. While FHA loans are
not available through all lenders, in some areas they are very popular
and can make the difference in obtaining a loan for some potential buyers
who do not qualify for conventional financing. The Veterans Administration
(VA) offers
government-insured loans to qualified veterans.
Income qualifications, required down payments, and the maximum allowable
loans under
these plans are changed periodically. Currently, the maximum FHA loan
is about $220,000 in
certain high-priced areas of the country.
For first-time home buyers, the federal government as well as state governments
offer loan
assistance to prospective buyers who meet eligibility requirements. For
current information about
these loan programs, consult local FHA and VA offices as well as your
real estate agent.
Q. What are jumbo loans?
A. Jumbo loans exceed the amount of loans allowed by the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan Association
(Freddie Mac), the federal agencies that oversee the secondary market
in mortgage loans. The maximum mortgage amount for Fannie Mae and Freddie
Mac can go up or down and presently stands at $203,150.
Fannie Mae and Freddie Mac are not loan guarantors, they are purchasers
from primary
lenders. Fannie Mae and Freddie Mac purchase loans from lenders and then
resell the loans to
other organizations such as insurance companies and banks. On the other
hand, FHA and VA are loan guarantors. Many FHA and VA loans are purchased
by Fannie Mae and Freddie Mac.
Interest rates on jumbo loans typically are slightly higher than other
loans, but this isn't always the case. Lenders who intend to keep the
mortgage in their portfolio tend to offer competitive interest rates.
Q. What is negative amortization?
A. In a typical home loan, the borrower pays off the interest
and principal in installments. This is
known as amortization because the debt is gradually reduced.
Negative amortization can occur when the installment payments do not cover
all the
interest due each month. This unpaid interest is added on to the principal
that is owed, resulting in a debt that increases, rather than decreases.
The worst problem with negative amortization occurs in a market in which
home values
decrease. Then the size of your debt could increase to the point where
it would exceed the equity in your home. Sadly, you could sell your home
and not be able to repay what you owe.
Most professionals advise buyers to avoid a negatively amortized loan.
The risks outweigh
the benefits of the lower payments. It may be better to postpone buying
a home until you can make higher payments or investigate a lower-cost
loan from the FHA or VA.
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