Home Mortgage Loans

Choosing the Best Mortgage

Selecting a mortgage can be perplexing, and time consuming. Mortgage lenders offer a variety of loan
packages under different names with different interest rates, up-front costs, and fine print terms, all of
which can change frequently. You need a lot of information to get a mortgage that best fits your needs at
a competitive price.

There are many online sources for mortgage loans from place such as savings and loan associations and
commercial banks.

When you start to shop for a mortgage, you will find a number of factors may cause interest rates to
vary, such as differences in lenders, the size of the mortgage, and the amount of down payment.

A number of mortgage types are on the market today, including: fixed rate, adjustable rate, graduated
payment, growing equity, balloon, wraparound, and others. In addition, you have other choices to make:

Fixed versus adjustable payments.
Fixed interest rate with payments that usually do not vary versus adjustable and variable-interest
rates where payments do vary.
Variations of fixed or adjustable payments.
"Creative financing" alternatives.
Form of payments.

Your challenge is to match a mortgage to your personal situation. You need to consider current market
conditions, the age of your family, your attitude toward risk, and how long you plan to stay in the house.

FIXED RATE MORTGAGES
The traditional, fixed rate mortgage (FRM) is considered the granddaddy of all mortgages. Its advantage
is that neither the interest rate nor the monthly payment (principal and interest) ever changes over the life
of the loan. If money is borrowed at 10 percent and rates go up to 18 percent, the rate stays the same.
You know at the outset exactly how much the loan will cost each month until it is paid off.

The price paid for this predictability usually comes in the form of a higher interest rate than on an initial
adjustable rate mortgage (ARM). Lenders often charge as much as 2 to 3 percentage points more. They
do this to offset the risk that sometime during the life of the loan overall interest rates will increase but
they will not be able to adjust the fixed rate. This same risk applies to you in reverse. If overall interest
rates go down, you will still be locked in at the higher rate.

If your family's income is not high enough to qualify for a fixed rate, you might seek an ARM. However,
75 percent of borrowers choose to go with a fixed rate because they favor predictability and are averse
to financial risk. The amount is set in advance and by prepaying they can substantially reduce the loan
balance at any time. The rate can never increase.

Short-term mortgages of 10-, 15-, and 20-year maturity periods have become popular variations on
fixed rate mortgages. They are often just like the 30-year loans but offer a lower interest rate because
there is less long-term risk. You are rewarded by a dramatic reduction in overall interest charges. That
means that you build equity faster and thus own the house sooner. However, higher monthly payments
may make it more difficult for you to qualify.

An alternative to a shorter-term loan is to sign up for a biweekly mortgage. Biweekly mortgages are
amortized as regular 30-year loans but the monthly payments are divided in half and you make a
payment every other week. This amounts to 26 payments a year or 13 monthly payments in 12 months.
It will shorten the length of time and reduce the interest charges for repaying the loan.

ADJUSTABLE RATE MORTGAGES
If you plan to move or refinance in 3 to 4 years, you may want to forego a fixed rate mortgage and
choose an adjustable rate mortgage (ARM). Flexible or variable rate loans are two other names for this
popular mortgage choice. They have one characteristic in common--the interest rate can and probably
will change periodically during the life of the loan.

With an ARM, you pay a lower interest rate at the beginning of the loan term. This means you can
qualify with a substantially lower income than for a comparable fixed rate loan and your initial monthly
payments are lower. The interest rate, however, can go up over the life of the loan, and you must
consider whether your future income will be enough to meet the greatest possible increase in payments.

If ARM interest rates increase enough, the monthly payment may be more than that paid for a fixed rate
mortgage. However, if interest rates decline, so do monthly payments.

To avoid constant and drastic fluctuations, most ARMs have caps or limits on how much the interest rate
or payments can change, both per adjustment period (every time the rate changes) and over the life of
the loan. Adjustments are made periodically, as specified in the loan contract. The most common
adjustment periods are every 6 months, 1, 3, and 5 years. If you have an ARM with a one-year
adjustment period, the interest rate can change only once a year on a specified date. Also, lenders may
allow you to convert your ARM into a fixed rate mortgage under certain terms and conditions.

Some ARMs allow "negative amortization," which cancels out most of the protection offered by caps.
This occurs if the monthly payment is capped, but the interest rate rises so the payments may not cover
the full interest amount the lender is owed. The difference is added to the loan balance. That means that
after you make your capped monthly payment, the mortgage debt will increase, not decrease.

ARMs may be your only choice initially if you do not have income to qualify for a fixed rate mortgage.
Look for ARMs which can be converted to a fixed rate interest at a later date. Remember, ARMs can
be very complicated. It is very important that you have a clear understanding of the pros and cons of
fixed rate and adjustable rate mortgages. Despite the lower initial interest rate of an ARM, the
traditional, fixed rate mortgages may be the better choice for you based on your income, credit history,
and lifestyle.

ALTERNATIVE MORTGAGES (FIXED AND ADJUSTABLE RATE)
There are a number of types of alternative mortgages offering both fixed and adjustable rates. The major
ones are:

Graduated Payment Mortgage (GPM). This was one of the first alternatives to the fixed rate
mortgage. It usually offers a fixed interest rate with low monthly payments in the early years. Payments
rise at a set rate over a set period of time (usually 5 to 10 years) and then remain constant for the
duration of the loan. Payments usually increase once a year. During the early years of the loan, the
borrower will pay less than the interest rate requires but will make up for it in later years when the
payment is higher.

Pledged Account Mortgage. This offers an effective lower first-year interest rate because a large initial
payment is made to the lender when the loan is originated. The payment may be made by the buyer,
builder, or any other interested party. This subsidizes the interest payments over the first years of the
loan, because the payment is put in an account where it earns interest.

Balloon Mortgage. This mortgage is not for the faint of heart. The amount of the mortgage usually is
amortized for a 30-year period, but the borrower makes payments for only 3 to 5 years. After a period
of time, the remaining principal, or balloon payment, is due in a large final payment. If the final payment
cannot be made, it will be necessary to refinance. Often the lender will offer automatic refinancing as one
of the contract terms. If automatic refinancing is not included in the contract, the borrower could be
forced to start a mortgage search all over again and thus will have to pay closing costs and up-front
charges again.

Renegotiated Rate Mortgage. This is a variation of the balloon mortgage. The interest rate is fixed
for a period of time, 3 to 5 years, after which it is renegotiated. The lender is obligated to offer
refinancing with minimum or no fees, but the homeowner can shop around for more favorable terms.
These are sometimes called rollover mortgages. The advantage is that monthly payments are fixed for 3-
5 years and there is an agreement to refinance with the original lender.

Growing Equity Mortgage (GEM). This mortgage offers a fixed interest rate with a changing monthly
payment that offers just what its name implies--speedy buildup of equity. The interest rate is usually a
few points below market and does not change. However, the monthly payment increases according to
an agreed-upon index. These increases are then applied directly to the principal on the loan. Thus, a 30-
year mortgage could be paid off in 15 to 20 years.

The advantages of this method are that equity is rapidly acquired and the loan is paid off much sooner
with low interest costs. The disadvantage is that income over the life of the loan may not keep pace with
the increased payments.

CREATIVE FINANCING MORTGAGE ALTERNATIVES
In recent years, a number of creative financing mortgage alternatives have appeared on the market.
These include:

Shared Appreciation Mortgage (SAM). With this mortgage, the buyer must agree to share with the
lender an agreed-upon amount of the home's appreciation value (usually 30 to 50 percent) when it is
sold or transferred or after a specified number of years.

Assumable Mortgages. These mortgages became popular during periods of high interest rates. The
seller of the home passes on the existing mortgage to the new owner, who takes over the remaining
payments. The new owner assumes the lower interest rate, but the buyer must have a large enough down
payment to make up the difference between the selling price of the home and the balance on the old
mortgage.

Seller Take-back Mortgages. If the buyer doesn't have a large enough down payment to cover the
difference between the selling price and the balance on an assumable mortgage, a seller take-back
mortgage may be used. It is considered a second mortgage because the buyer uses the new home as
collateral and borrows an amount (from the seller) necessary to finance the down payment and equity
buyout of the seller. Remember that the mortgage was assumed and is still outstanding.

These mortgages frequently involve paying only interest with the principal due in full at some later date. A
borrower can take advantage of an assumable mortgage but will have to make a large balloon payment
at maturity.

Wraparound Mortgage. This is a variation on the second mortgage. For example: Imagine a borrower
has $25,000 for a down payment on a $75,000 condominium but cannot afford the payments because
the current interest rate is 12 percent for the additional $50,000. The present owner currently has a
$30,000 mortgage at 8 percent. The owner offers the borrower a $50,000 mortgage at 10 percent--a
blended rate of 8 percent on the $30,000 and 13 percent on the remaining $20,000. The new loan
"wraps around" the existing mortgage of $30,000. In essence, the borrower is assuming the existing
mortgage and adding another. The borrower makes the payment through the seller, who then forwards
the appropriate payment to the lending institution.

To take advantage of the wraparound, the borrower must make sure that the holder of the original
mortgage is aware of the arrangement. Some lenders do not allow these mortgages, and may have the
right to insist that the old mortgage be paid off immediately. Also, the borrower is relying on the seller to
make the original mortgage payment on time. This can be very risky.

Buy-downs. In a buy-down, a developer or some other interested party offers to subsidize part of the
interest for a set period of time (1 to 5 years) so that the buyer has a lower initial monthly payment.
Before choosing this type of mortgage, a borrower should consider what the payments will be after the
subsidy period ends.

If the loan has a fixed rate, the payment will rise to the actual amount of principal and interest. If it is a
variable rate, the payment may go up even higher depending on the index to which it is tied. Borrowers
need to give careful consideration about their ability to make future payments before getting a mortgage
like this.

Buyers and builders may offer buy-downs to make financing arrangements look more attractive. They
may increase the price of the home to make up for the money paid to the financial institution to buy
down the interest rate for the first several years. Borrowers should ask what the price of the property
would be if they did not choose the buy-down mortgage. They may realize substantial savings by taking
a lower price and finding a mortgage elsewhere.

OTHER CONSIDERATIONS
In addition to choosing among the various fixed and adjustable mortgages, you can choose the way in
which to make your monthly payments. The most popular payment formats are:

Regular--1 payment/month = 12 payments/year
Bimonthly--2 payments/month = 24 payments/year
Biweekly--payments every other week = 26 payments/year

Not every mortgage will fit all your specific needs, but once you determine your personal goals, you will
have made a good start. To keep monthly housing costs down, consider the following:

Make as large a down payment as possible.
Take the mortgage over a longer period of time (although this will cost more total dollars to pay
off the loan).
Shop for the lowest interest rate - the Internet is a great place to shop for a mortgage loan!
Keep the mortgage payment within affordable limits.

The Loan Guide provides access to free Home Mortgage Loans information.