The Mortgage Facts:
What You Need to Know
Feel free to skip straight to the section that pertains most to you, but it is best to read all the sections. You may learn something you didn’t know before. After all, you need to remember this rule: Learn all the terms of a mortgage before signing the dotted line.
My Mortgage Story
We purchased our home right in the middle of the real estate market bubble, in 2006. And that was well before I took any finance classes for my college major. I had only just completed my AS degree in general education. To show you how unfamiliar I was with the whole mortgage/home buying process, I made my mother tag along with us when we talked to the broker about the terms of our loan. My mom was familiar with this process because she was a real estate agent working in the area. I felt confident that because my mom was there, she’d be able to wave any red flags if she saw any. No one told us we couldn’t afford the house. The mortgage payments ended up being over $1,000 per month (mortgage payment + homeowners insurance + property taxes), and that was almost 50% of my husband’s take home pay (I wasn’t working). I never crunched the numbers. I never felt like I had to, I suppose. Up until that point, we never worried about money. I always paid the bills as they came in. There was never a pile of “to be paid.” But boy was there a pile after the fact. Actually, just 3 months after moving in, my husband had to take a job across the country just to support us. But my mortgage story alone won’t help you out. Keep reading and I will explain to you the basics of getting a mortgage so that you can understand what you’re getting yourself into before you sign the paperwork.
Put Money Down
The first part of understanding the process of buying a home is accepting the fact that you’ll need to come up with a sizeable down payment.The reason many homeowners are currently under water (they owe more than what the home is worth) is because they failed to come up with a large enough down payment, if one at all. I know that in my situation, we didn’t have to put anything down, not even closing costs. We took out an FHA loan for 30 years. We currently owe about $20,000 to $30,000 more than it is worth. Today, you can still get a loan for very, very little down. However, you should caution this. With the way the markets are today, values could still go down and you could still end up under water with your little down payment. The rule of thumb is to put 20% of the purchase price down. It might take longer for you to move into your home to take the time to save that much, but it will be well worth it.
15-yr VS 30-yr
While there might be other terms available, the 15-yr and 30-yr options are the most popular. The main differences between the two are interest rates and monthly payment amounts. Interest Rates 15-yr mortgages are offered at a lower rate of interest than 30-yr ones. For example, you might be charged 5% on a 30-yr, but if you take the 15-yr instead, the bank will offer you a 3% rate. The difference might not look like much, but over time, it can save you thousands of dollars. Monthly Payments Extending your home loan by making 12 payments per year for 30 years will cost you much more in interest. However, your monthly payments will be lower than the 15-yr option. For example, the monthly payment on a 30-yr loan for $100,000 at 5% would be $536.82 (not including home owners insurance and property taxes). The monthly payment on a 15-yr loan for the same amount at 5% would be $790.79 - $253.97 more. Realistically, your interest rate for the 15-yr would be less than the rate for the 30-yr, as I mentioned before. However, for the sake of making a simple calculation, I wanted to show you the monthly payment difference if they are the same. Now, realistically, if the 15-yr loan was offered at 3%, the monthly payment would still be more, costing $690.58 per month. If you paid $536.82 per month for the next 30 years, you will have paid back a total of $192,255.20 (or $92,255.20 in interest alone). If you paid $690.58 per month (3% rate) for the next 15 years, you will have paid back a total of $124,304.40 (or $24,304.40 in interest alone). Total interest savings by opting for the 15-yr vs the 30-yr: a whopping $67,950.80! However, it all comes down to affordability per month, right? If you can easily manage to make the payment for the 15-yr vs the 30-yr, the obvious choice would be the 15-yr.
Fixed Rate VS Variable Rate
The example above used a fixed interest rate for the life of the loan. However, if you sign up for a loan that has a variable rate, you will be in for some nasty surprises. Currently, interest rates are at all time lows. Taking a variable rate loan today is only asking for payment increases since rates can only go up from here. Fixed rates mean the interest rate will never change. It will remain the same for the entire life of the loan. Variable means the rate will fluctuate with the market. If the market rates go up, the rate on your loan will, too, and vice versa. (However, vice versa is not really happening right now because rates are already low.) What the bank will do after the market rates change is adjust your loan rate. This will be done in a number of different ways, depending on the terms of the loan. For many loans, the rate could be fixed for the first few years, and then revert to a variable rate after that and adjust every year or every two years. Today, it is not wise to agree to a variable term mortgage. Rates will go up eventually and so will your monthly payments. The only reason a variable loan would make sense would be if you expected rates to drop. Do I need to repeat myself? They aren’t going to drop! They are already low!
Escrow Your Taxes & Homeowners Insurance
You probably noticed early that I told you my mortgage payment included the property taxes and homeowners insurance. Part of the FHA program, that’s how my mortgage needed to be set up. It is called putting them in escrow. But this is not a requirement.I caution taking on a mortgage and then agreeing to pay your taxes and homeowners insurance annually. You might find it hard to save up during the year for them. My annual insurance is around $1400 and my property taxes run around the same. For me, it is much easier to pay a higher mortgage payment to my mortgage lender each month and have them take care of paying those bills for me rather than the year sneak away from me and be slammed with a huge annual bill. And don’t forget to include those costs when you figure your monthly mortgage payment. Your lender won’t include that into the equation when they tell you the mortgage payment (at least ours didn’t. I recall the number $800 being quoted as the monthly mortgage payment). Research what the property taxes and estimated homeowners insurance will be. Otherwise, you will be just as surprised as we were when we got our first mortgage statement.
Foreclosure VS Refinance
You might be thinking the above information does not apply to you because you’ve already gone through the home buying process and now you are looking for a way out. If that sounds like your case, this section is for you.While it is never part of the plan to willing agree to foreclosure, sometimes it needs to be done. However, you should make every attempt possible to refinance or renegotiate the terms of your loan before you go down the road to foreclosure or short selling. Refinancing A refinance is when you take out another loan to pay off the one you currently have. You can contact a bank and tell them your situation with your home and see if they can refinance it under better terms. You will most likely need to come up with a down payment, especially if the home is underwater. The new bank lender won’t agree to take on a loan that you don’t have a stake in, so be prepared to balance out the equation. The bank wants the home’s value to be more than the loan amount. That is how they protect themselves. Restructuring Renegotiation (or restructuring) is when you contact your current mortgage lender and ask them to restructure the terms of the loan. Usually this will still mean you put some sort of payment into it, but it would be less hassle to do it this way than refinancing the whole thing, but only if your lender will work with you. I have heard stories that many won’t unless you are already behind on your payments. Please don’t miss payments just because they say that. Continue to pay on time and work around that flaw. You’ll figure it out, even if it means going to one bank after another after another. Someone will work with you. Foreclosure
Foreclosure happens when you stop making house payments and the bank decides to take the home away from you and sell it at auction to help pay off the loan you took out. Currently, foreclosure processes are lengthy and can take well over a year to complete. Short Selling Short selling is when the bank agrees to accept a purchase offer for the home for less than what your loan is worth and the bank forgives the balance. For example, if you owe $100,000, but can only get an offer for $80,000, the bank can approve (if they want to) the sale and forgive the $20,000 difference. However, depending on your relation to the home (if it was your primary residency or a rental), you may need to pay income taxes on the amount forgiven. In most cases, income taxes are no worry, especially if it was your own home that you lived in. Those rules are set to change in 2013. Rent Your Home If you can, another option for you could be to rent the home out in the meantime, until you can figure things out. If you are not sure if you want to continue to live in the same area or if you have to move for work, but might want to return, rent your home out. That’s what I did. While it isn’t rented out for the full amount of the mortgage, every little bit helps. We may or may not move back, at some point in time, so in the meantime, we are collecting a little bit of rent to help offset the mortgage cost. Rent to Own Actually, another option after renting your home out could be to sell it to your tenants. You could enter into a rent to own contract and they pay rent for the next 2 years and that rent could be considered the down payment. After that, they have to go through the buying process at the already agreed upon purchase price. It is a great way, in this economy, to make the home buying process easy, since many people are stuck and don’t have the down payment money.
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