Fixed or Adjustable rate loan?
Fixed rate loans have a stated interest rate that does not change over the life of the loan, whereas the rates on adjustable rate loans are linked to an index and change as the index rate changes. Many mortgages, such as a 5-Year Fixed (30 Year), start as a fixed rate loan and then convert to an adjustable rate. Adjustable rate loans have more risk due to the possibility that the interest rate could increase. However, because you are assuming some of the risk the lender will generally reward you with a lower interest rate. These loans are best for borrowers who do not plan on keeping the loan for the full term.
Is an Adjustable Rate Mortgage (ARM) right for you?
The interest rate on this loan will be fixed for a stated period of time and will then become adjustable for the remainder of the loan. For example, a 5-year fixed (30-year) loan would have a fixed interest rate for the first five years and then convert to an adjustable rate for the remaining 25 years.
This adjustment is based on changes in a pre-selected index, and will take place according to a pre-defined schedule (generally every six months or every year). Your interest rate and monthly payment will fluctuate based on changes in your index. The most common indices are the Treasury Bill, Certificate of Deposit (CD), LIBOR and COFI.
Adjustable rate loans have more risk due to the possibility that the interest rate could increase. However, because you are assuming additional risk the lender will generally reward you with a lower interest rate and monthly payment during the initial fixed interest period. These loans are of particular benefit to borrowers that plan to either sell the property or refinance before reaching the adjustable period.
Why should I choose a Fixed Rate Mortgage?
Well Fixed-rate mortgages allows you for repayment of a debt in equal monthly mortgage payments over a specified period of time, from 10 to 50 years.
Fixed-rate mortgages have been the mainstay of the home loan industry for decades. Over the years, loan-to-value ratios have fluctuated and interest rates have moved up and down, but the security a fixed-rate mortgage offers has never lost its appeal.
Other Mortgage Programs
Stated Income Mortgage Products:
In qualifying for these products, the lender will not require you to provide standard explanations of your income, such as tax returns. This means that there is no verification of your income, but you must state the source of your income. Individuals likely to be interested in a stated income loan are typically self-employed or individuals who write-off a large portion of their income such as contractors, waiters & waitresses.
Home Equity Line of Credit (HELOC):
A home equity line of credit is a form of revolving credit in which your home serves as collateral. Think of it as a credit card that is secured by the equity in your home. Many homeowners use these credit lines for major items such as debt consolidation, travel expenses and home improvements.
Home Equity loan (also known as a “Second Mortgage”):
A home equity loan enables you to borrow money in a lump sum against the equity (the value of your home minus what you owe) you have built up in your home. This loan is subordinate to the existing first mortgage. Buyers commonly use a second mortgage to keep their first mortgage in the conforming range (which keeps the rate lower) and to avoid PMI. Home equity loans are often used to pay off credit card debt, buy a car or to make major renovations to a home.
Interest-Only loan option
Interest-Only loans are a good means of either increasing your home purchasing power or maximizing your flexibility to control cash flow. You can save significant amounts of cash for investment, savings, or other expenditures during the first ten years of your loan. This is also a solid strategy to maximize tax deductibility, with more funds available for paying down higher cost, nondeductible consumer debt. With these loans, the minimum payment required covers interest only-you decide how much or how little of the principal to repay each month. These loans should not be confused with negative amortization loans-with Interest-Only the principal balance NEVER increases.
Interest-Only is all about choices...
An ARM that doesn't leave your hands tied!
With an Interest-Only loan, home buyers choose their monthly payment and either qualify for more home, or have more cash in reserve for investment, paying down higher-cost debt, or making home improvements.
Interest-Only loans offer you:
- Potential for lower monthly payments: for the first 10 years of the loan you can opt to pay interest only-plus any portion of the principal you wish.
- The opportunity to afford your dream home-buy up to 25% more home with Interest-Only monthly payments.
- Tax deductibility benefits.
- A wealth of money-management opportunities, with savings for:
- Other investments, including high-yield and tax-deferred savings or maximizing your retirement contributions.
- Pay off high-interest, non-tax-deductible debts.
- Home improvements, tuition costs, or a dream vacation.
How it works:
Take advantage of this innovative approach to home financing and realize the double benefits of more affordable payments plus improved cash flow. Each month you choose the payment amount. You can make the minimum interest-only payment in order to maximize your available cash for other uses or allow you to qualify for more homes at a payment you can afford. Or you are free to pay down any portion of the principal you wish--it's your decision. Either way, your principal balance will NEVER increase.
Negative Amortization (Deferred Interest)
Negative amortization, or "deferred interest," describes loans that have payment adjustment caps in addition to interest rate adjustment caps. What does this mean? While your payment may stay the same, the loan's interest might increase. If the interest rate rises, and you choose not to pay off any of the principal, the overall loan amount will increase. This gives it the label "negative amortization." Most loans do not have a negative amortization feature, and are designed to reduce to a zero balance by the end of their terms.
How does negative amortization occur?
Negative amortization loans calculate two interest rates. The first is called the payment rate, which is shown in blue below; the second is the actual interest rate, which is shown in red. The payment rate is typically capped at 7.5% of the previous payment. Meanwhile, the true interest rate is calculated as the index plus the margin without periodic caps. This can lead to a cycle of growing interest without paying down the principal-causing you to owe more rather than less.
Borrowers are often given a choice of which rate to pay. Advertisers of negative amortization loans usually refer to them as "payment option" loans. However, while it is true that you have a payment option, which offers flexibility, you will still be subject to the true interest rate.
Risk Considerations
In exchange for lower payments, those of you with a negative amortization loan assume more speculation. The risk rests in the interest you pay, which does not have a monthly rate cap and can increase to the lifetime cap at any time. This is fundamentally different from "no negs," which always have periodic caps.
Therefore, in terms of building equity in your home, negative amortization loans can trap you in a cycle of paying only the constantly growing interest, completely neglecting the principal.
When to Consider a Negative Amortization Loan
Negative amortization loans can be useful if you are primarily concerned with cash flow instead of building equity. If you only pay the payment rate, the overall monthly mortgage payment might be much lower than a typical 30-year, "no neg" amortization loan. Given this, negative amortization loans may be a temporary solution if income is reduced for a period of time, or if the hold period is short term to minimize cash outflow.
Nevertheless, one of the main reasons for purchasing a home is to build equity and generate greater wealth. If you are primarily concerned with cash flow, a better strategy may be to simply rent rather than own
When does it make sense to pay points?
Points are a one-time fee that a borrower pays to lower the interest rate. Points are defined as a percentage of your loan amount, with one point being equal to one percent of your loan. For example, if you borrow $200,000, one point would be equal to $2,000. Paying one point will generally reduce your interest rate by approximately .25%.
An alternative to paying points is to receive a "credit" from the lender in exchange for a higher interest rate. Whereas points are added to your closing costs, a credit is used to reduce your closing costs. Once again, you can receive a credit of approximately one point by raising your interest rate .25%.
Whether you choose to pay points or receive a credit, this amount will be applied to your closing costs when your loan funds.
Learn more about pointsWhat are points?
Points are up-front mortgage interest fees paid on a loan to reduce the initial interest rate. For example, a one point loan will always have a lower interest rate than a zero point loan. Therefore, paying points is a trade off between paying money now versus paying money later.
When You Should Pay Points
Generally, you should only pay points if you plan on keeping the loan for at least four years. Because points are prepaid interest, you need to be sure you will keep the loan long enough to recoup these costs through lower monthly mortgage payments. If there is a chance you may move within a four year period or if the general interest rate market is declining (increasing the likelihood of refinancing), you should consider a no points or cash back loan.
Tax Issues
The tax treatment of points depends on what the loan is being used for. If you are purchasing a home, points are generally entirely deductible in the year you buy. This is true even if the seller is paying for your points.
In a refinance transaction, points must be amortized over the life of the loan. For example, on a 30 year loan, you can deduct 1/30th of the points paid each year. If you refinance for a second time, however, you can deduct the remaining unamortized points in the year you refinance the loan. Consult your tax advisor for more information.
