A 30-year loan will provide larger tax deductions, as you will be paying more interest than principal during the first 23 years of the loan. A 15-year loan, on the other hand, is paid off twice as quickly and usually has a lower interest rate. You build more equity because your payments pay more principal. As mentioned earlier, you (or the seller) also can “buy down” your loan by paying more tax-deductible points up front, to lower your fixed interest rate.

Balloon Loan A fixed loan that is amortized over a 30-year period but becomes due and payable at the end of a shorter term (i.e., 5, 6, 7 or 10 years). Some of these loans have an option to be extended with a new rate or rolled into another type of loan. Usually, the rates of these loans are lower than those for a regular 30-year fixed rate loan, but they are not recommended if you plan to stay in the home for a longer period of time.

Graduated Payment Mortgage (GPM) A fixed-rate loan that has payments starting lower than the payments on a standard fixed rate loan, which increase by a predetermined amount each year for a specific number of years, usually five years.

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Adjustable rate mortgages (ARMs) have payments that increase or decrease on a regular schedule, and are linked to specific economic indexes or margins. These indexes measure borrowing and lending costs throughout the United States and are independent of the lender and can be independently verified at any time. (Many ARMs are indexed to Treasury bills or securities, Certificates of Deposit and other rates.)

How and When do ARMs Adjust?
When comparing ARMs that have different indexes, look at how the index has performed recently. Some indexes are published in newspapers, making them easy to track. Lenders are required to provide you with information on how to track the index and a 15-year history of the index, but keep in mind that past performance is not necessarily indicative of future performance.

An ARM will have a low Initial Interest Rate, sometimes called “teaser” rate. The loan will begin to adjust at a certain interval, usually every six months or annually. When the loan adjusts, the lender will use three things to determine the new interest rate: the index, the margin and the cap(s).

Index
The index is a benchmark by which changes in the market interest rates are gauged. Common indexes include the 1 Year T-bill, the 11th District Cost of Funds, Prime, LIBOR, or even Certificate of Deposit (CD) rates.

Margin
In order to determine the new rate on the adjustment date, the index is added to the margin. The easiest way to understand the margin is to put the word “profit” in front of it. It is the amount of excess of the index that the lender is going to charge in interest; it is essentially the lender’s profit margin.

Rate Caps
To insure that your payments do not change dramatically in any given six-month or one-year period, adjustable rate mortgages provide protection in the form of interest rate caps. There are two kinds of interest rate caps: periodic (annual, semi-annual, etc.) and lifetime. For example, a loan may have a semi-annual rate cap of 1%, or an annual rate cap of 2%. The loan will also have a lifetime rate cap, frequently 6% over the initial rate. The caps insure that even if interest rates rise rapidly, the monthly mortgage payment will not be as dramatically affected.

Is an ARM for You?
Would you like a loan with an interest rate below a 30-year fixed rate mortgage and pay zero points? A loan for which you do not have to document your income, savings history or source of down payment? These benefits can all be possible with an Adjustable Rate Mortgage. There are numerous advantages to ARM loans. Some common advantages are:

• The ability for borrowers to qualify when they might not do so with a fixed rate mortgage;
• The possibility of obtaining a larger loan and a more expensive home;
• The chance that the rates may go down without refinancing; and,
• Often, there are less costs to obtain the loan.

However, with an ARM, there is the likelihood that your rate and payment will increase during the life of the loan. Adjustable Rate Mortgages all have an adjustment period, an index, a margin and a rate cap. The “adjustment period” simply indicates how often the rate changes. Some rates change monthly, some change every six month, and some only adjust once a year. Indexes are monitored interest rates over time. ARMS have different indexes. The margin does not change during the life of the loan.

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Principal
The original balance of money loaned, excluding interest. Also, the remaining balance of a loan, excluding interest. Interest is calculated based on the principal.

Interest
The charge, in dollars, for the use (loan) of the money.

Taxes
The county assessor determines the property tax based on the value of your home. There are two tax installments due each year. The first installment is due November 1st and is delinquent after December 10th. The second installment is due February 1st and is delinquent after April 10th.

Taxes may be impounded, depending on the amount of your down payment. (A down payment of less than 20% usually requires an impound account).

An impound account, set up by the lender, is a trust account to which a portion of the monthly payment is credited so that funds will be available for the payment of taxes and insurance when they’re due. This way, the lender actually pays your tax bill for you. (Supplemental taxes usually are still the responsibility of the homeowner.)

Hazard Insurance
An insurance policy pays for the loss of a home from certain hazards, including fire. You obtain homeowner’s insurance from your own insurance agent. The standard policy pays replacement costs, minus depreciation based on actual cash value. Talk to your insurance agent about the different types of insurance available. Hazard insurance expense may also be impounded in the trust account with taxes.

Private Mortgage Insurance (PMI)
Depending on the amount of your down payment, you may be required to have PMI. A down payment of less than 20% usually requires PMI. Because loans with small down payments involve substantially more risk for the lender, they need protection in case the loan goes into foreclosure. Mortgage insurance helps cover the lender’s loss in the event of a foreclosure. Because of this insurance, lenders are able to offer loans with lower down payments.

PMI premiums are collected monthly as a part of your mortgage payment. The cost of PMI varies with the amount of your down payment. Can you pay off your loan ahead of schedule? Yes. By sending in extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal. Most lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so. Ask your lender for details.

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In exchange for your mortgage, you will pledge your home as security for repayment of your loan. The lender agrees to hold the title to your property until you have paid back your loan plus interest. A mortgage loan is composed of two major components: principal and interest.

Principal is the actual amount of money you borrow. If you borrow $150,000, your mortgage principal is $150,000.

Interest is what you pay for the use of the money you borrow. How much you pay depends on a number of factors, including the interest rate, the type of loan and other factors, which are outlined in this guide. Interest can be deducted from your taxes, making it one of the most attractive practical benefits of home ownership. Your tax advisor will be able to provide more details about the tax savings benefits.

Amortization refers to the way in which the balance of principal versus interest changes over time. During the first few years of your mortgage (typically for the first 2 to 3 years of a 30-year loan) most of your payments will be applied toward interest. During the final years of your loan, your payments will be applied almost exclusively to the remaining principal. This process is called amortization.

How should I choose a lender?
Carefully! Look for financial stability and a reputation for customer satisfaction. Select a company that gives helpful advice and that makes you feel comfortable. It is best to select a lender that has the authority to approve and process your loan locally, so you can more easily monitor the status of your application and ask questions. Plus, it helps when the lender knows about local home values and conditions. Do research — ask your agent, family and friends for recommendations.

What is the best way to compare loan terms between lenders?
Speak with companies by phone, in person, or search the Internet. In addition to your research, I can provide a variety of proven lender and mortgage options. While competitive rates are important, remember that most lenders get their money from the same sources and therefore essentially have the same rates. As a result, the decision often comes down to other factors.

The Interest Rate
Interest Rates are most important when you lock a loan. What is important is that you have a loan program that fits your particular financial situation and needs at the time you purchase your home. Remember that each 1/4 point (0.25%) may not have as much impact as you think.

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• Do you expect your finances to change over the next few years?
• Are you planning to live in this home for a long period of time?
• Are you comfortable with the idea of a changing mortgage payment amount?
• Do you wish to be free of mortgage debt as your children approach college age or as you prepare for retirement?

Your lender can help you use your answers to questions such as these to decide which loan best fits your needs. The remainder of this article will outline for you why these questions – and the answers you provide to them – are a crucial part of your loan search.

How large of a down payment do I need?
There are mortgages now available that only require a down payment of 5% or less. But, generally speaking, the larger the down payment, the less you have to borrow, and the more equity you’ll have. Mortgages with less than a 20% down payment generally require a private mortgage insurance policy (PMI), which can be expensive.

Nevertheless, PMI is a fact of life for many homeowners. Even if you begin your mortgage with PMI, with time and appreciation, you often can reach 20 percent equity – at which time you can have the PMI removed. Often, removing PMI is just a matter of asking the lender, paying for an appraisal, paying a fee to the lender (approximately $300 – $500) and providing the necessary paperwork.

What does the interest rate really mean to me?
A lower interest rate allows you to borrow more money than a high rate with the same monthly payment. Interest rates fluctuate from day-to-day, so ask lenders if they offer a rate “lock-in,” which guarantees a specific interest rate for a certain period of time.

Remember that a lender must disclose to you the Annual Percentage Rate (APR), which shows the cost of a mortgage in terms of an annual interest rate. Because it includes the cost of points, mortgage insurance and other fees, the APR generally will be higher. It will provide you with a good estimate of the actual cost of the loan.

What happens if interest rates drop after I finalize my fixed-rate loan?
If rates drop more than two percentage points or so and you plan to be in your home for the next 18 months, you may want to consider refinancing. However, since refinancing may require you to pay many of the same fees paid at the original closing, plus origination and application fees, you should make this decision carefully.

What are discount points?
Discount points (or just plain “points,” as they are frequently called) allow you to lower your interest rate by paying prepaid interest up front. Each point equals 1% of the loan amount, and generally, each point paid on a 30-year mortgage will reduce the interest rate by 1/8 (or.125) of a percentage point. Sometimes lenders will provide you with the opportunity for a “buy down” – which literally offers you a chance to buy down the cost of the loan by paying more points up front.

When you shop for a loan, ask lenders for an interest rate with no points. Then, ask them how much the rate decreases with each point paid. Discount points are smart if you plan to stay in a home for some time since they can lower your monthly loan payment. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay some of them.

What’s considered a reasonable loan fee?
In most cases, loan fees should not exceed 5 percent of the loan amount, unless you are paying for a lower interest rate. However, there may be exceptions. I can help you evaluate loan fees and to understand exactly how much the entire loan will cost. It’s important to know all your loan costs up front.

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