Guest Author - Katie Murphy

Avoid financial surprises by understanding mortgage details before you sign the paperwork. There are numerous terms you should know if you are in the market for home financing. When comparing products you must know what fees and points you will be charged because these can really add up. Additionally, don’t be fooled by introductory teaser-rates or pre-payment penalties.

The first question you need answered: Is the financial institution a “prime” or “sub-prime” lender? They may sound similar; however, Buyer Beware!

There are “prime” mortgages and “sub-prime” mortgages. The name alone tells you which product is better. Traditionally, prime lenders finance homes at 80 percent loan to value. Simply put, this means the borrower pays 20 percent of the value of the home in cash. Prime lenders offer an alternative: if you can not put 20 percent down, you pay for “private mortgage insurance” or PMI. This provides the lender with insurance in the event the borrower defaults. Prime mortgages generally serve individuals who have good credit and are qualified to make the monthly payments.

The sub-prime market offers loans for those with poor credit and can not afford to pay for private mortgage insurance required by prime lenders. Sub-prime lenders used to be synonymous with predatory lending, which has been discussed on this site in the past. I think the term predatory lending is the correct moniker. The fact that the sub-prime market is now coming to a grinding halt is confirmation.

Rising home values in 2002-2005 created a market for alternative loans because there were many people who wanted to become homeowners and take advantage of the absurdly increasing home values. The sub-prime or “predatory” lenders were there to “help”. Lenders financed 100 percent of the value by combining an 80 percent mortgage and a second 20 percent mortgage at a higher rate. The sub-prime lenders also allowed the seller to pay the mortgage closing costs; thereby, allowing people to move in without any money down.

This created a population that simply had zero equity in their home. Guess what happened when home values started dropping in 2006-2007? Homeowners began losing their homes because they had high mortgages and no equity; therefore, unable to break even on a sale of their home.

Be very careful when you are searching for a mortgage. Whether you have good or not-so-good credit, you must compare and research the products. If your credit is not perfect, research the alternatives with a qualified mortgage professional. Get a good faith estimate from the professional. This will outline all costs (line-by-line), which will allow you to compare apples-to-apples before you decide on which company to use.





Fixed Rate or ARM?

Generally, a fixed rate mortgage will remain at the same interest rate for 15, 30, or 40-years. This means your principal and interest payment will remain the same for the life of the loan. Taxes and insurance may be escrowed by your bank and these payments can change year-to-year, but will not impact your principal and interest payment. The shorter the term, the higher the payment will be. But, the longer the term of the loan, the more interest you will pay over the life of the loan.

An Adjustable Rate Mortgage or ARM changes based on the terms of your loan. The cost of your loan (interest rate) could adjust each year, every three years or every five years. Generally, this translates into payments that go up or down at those intervals. When shopping for an ARM, ask about three things: the index, the margin and the adjustment period. Don’t forget to get the good faith estimate and compare products each lender is offering. ARMs are offered by both prime and sub-prime lenders.

Introductory Teaser Rates
Introductory Teaser Rates are low up-front interest rates to entice borrowers. For instance, the borrower may pay 1 percent interest on the principal for the first three months, but after the three-month period the rate reverts to the market rate specified at closing. This will cause your mortgage payment to jump…and sometimes skyrocket. Be sure you understand all the terms of your mortgage before signing.

Prepayment Penalties
Some loans, especially those offered to sub-prime borrowers, may charge prepayment penalties. The lending institution may require you pay penalties if you pay back the loan within a given period of time, say first three to five years. Some charge the penalty if the borrower tries to refinance into a different type of mortgage. Others will even charge a prepayment penalty if you sell the house and pay off the mortgage. Avoid loans with prepayment penalties because the costs can devastate your bottom line.

Balloon Payment
Some lenders will charge a reduced interest rate for the first few years and then require the entire loan to be paid off at the end of that period. These types of loans may help a borrower get into the home with lower payments, but you must refinance before the balance becomes due. Refinancing will cost money in terms of points and fees, so you may not be saving any money in the long run.

Now you know the basic terms of mortgages including prime and sub-prime; fixed and ARM; teaser rates; prepayment penalties; balloon payments and good faith estimate. Mortgages are not difficult to understand, but the legal terms and forms are quite daunting. If you know the right questions to ask, you will not feel intimated by the mortgage professional. Knowledge is power, so keep learning!



This Week’s (3-31-07) Interest Rates:
Mortgage rates were essentially unchanged this week. The 30-year fixed rate is 6.22 percent. The 15-year rate is 5.92 percent. Adjustable-rate mortgages slipped: the 5/1 ARM fell to 6.05 percent and the one-year ARM dropped to 5.94 percent.