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What questions do I need to discuss with my mortgage originator?

The purchase of a home is likely to be the largest financial transaction in a person’s lifetime. Since few people have enough cash to purchase a home, most homes are purchased with borrowed money. In recent years, there have been many changes in the way home purchases are financed.There has been an explosion of mortgage products available to home buyers. Each mortgage product is designed to afford some benefit to the appropriate borrowers. Not every mortgage product will meet your needs equally. Therefore, it is important that you consider such questions as:

  • How long do you anticipate living in the house?
  • Do you expect your income to increase significantly in coming years?
  • How large a monthly mortgage payment can you afford?
  • How close to retirement are you?
  • What other financial obligations do you presently have or do you expect to have?
  • What percentage of your wealth or current income do you wish to commit to your home?

The answers to these and other fundamental questions about you and the lifestyle you anticipate will come in handy when selecting the type of mortgage that best meets your needs. Even though there are many variations available, there are basically two types of mortgages:

Fixed rate and adjustable rate
As the name suggests, a fixed rate mortgage gives you an interest rate that is fixed for its entire term. The monthly mortgage payments that you will make are determined in advance according to a repayment/amortization schedule. At the end of the schedule you will have repaid the entire debt, interest and principal. This type mortgage is popular with borrowers because the interest rate and monthly payments are known in advance. This allows you to manage your finances with more certainty than with other types of mortgages.

The principal advantage of the fixed rate mortgage is its certainty. You will know what your mortgage payments will be for as long as you have that mortgage. Also, during the early years of the mortgage, when most of your payment is earmarked for interest payments, you will have a significant tax deduction for federal and most state income taxes.

The major disadvantage of the fixed rate mortgage is that it does not adapt to meet market conditions. If interest rates drop after you obtain your mortgage, you will have to continue making your payments at the higher than market rate unless you refinance your mortgage. Another disadvantage of a fixed rate mortgage is that it generally has a higher interest rate than adjustable mortgages. This means that your monthly payments will be higher than if you had an adjustable rate mortgage.

Adjustable rate mortgage
The second type of mortgage is the adjustable rate mortgage. As the name suggests, the interest rate for this type of mortgage adjusts according to market conditions throughout the term of the mortgage. At certain established points called anniversary dates, the interest rate on your mortgage is adjusted to reflect current market conditions. Most often these adjustments are made annually. However, they can be made at any time:  6 months, 3 years, 5 years. The adjustment is made based on the change in a preselected index since the last change or anniversary date. Your payments may move up or down, based on the change to the index. The more commonly selected indexes are “treasury bills” and “prime rate.” In order to protect you from dramatic changes in the economy, most adjustable rate mortgages have rate caps. These caps limit the size of the adjustment. Typically, rate caps are 1% or 2% per rate change. Most adjustable rate mortgages also have lifetime caps, meaning the maximum increase or decrease that can occur to the rate over the life of the loan. Lifetime rate caps are most often in the 5% to 6% range.

Adjustable rate mortgages will generally have lower initial interest rates rather than fixed rate mortgages because they are tied to general economic conditions during their entire term. This means you will have lower income requirements and lower initial costs. A second advantage of the adjustable rate is if interest rates decline while you hold an adjustable rate mortgage, you will get the benefit of a lower rate without the expense of refinancing your mortgage.

The principal disadvantage of the adjustable rate mortgage is its lack of certainty. With an adjustable rate mortgage, while you obtain the benefit of lower payments if your index moves down, you will have the burden of higher payments if your rates go up. You may decide that the benefit of lower initial payments offsets the risk of higher payments. If you do not plan to be in this particular home for very long, anticipate income increases, plan to refinance in the not too distant future or obtain a very low initial interest rate.

After deciding what type of mortgage best meets your needs, you will have to select a mortgage lender. A mortgage lender may be a bank, savings and loan, credit union or mortgage banker. There can be substantial differences in costs and procedures among mortgage lenders. In selecting a lender, you should ask for recommendations from your attorney or real estate agent.

DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. See competent counsel for advice on any legal matter.

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