What Type of Loan For You?


What's the best way to pay for the biggest purchase you'll likely ever make?  You can be sure of two things: Some lenders may offer you more money than you can truly afford to repay, and the fine print of those loans can have life-changing consequences.

First, visit a lender and find out how much of a home you can afford.  Your loan officer will consider your income and debts, even your credit, before figuring out the maximum amount you should borrow.  Whatever the verdict, make sure the monthly figure is within your means to repay.  Once you've got an idea of how much you can afford to borrow, you can get pre-approved for a mortgage.  Unlike "pre-qualifying," pre-approval means you have a loan lined up, which makes your offer more attractive to sellers.  It’s basically a commitment from the lender.

If you suspect interest rates are going to rise, it’s a good idea to lock your rate in place.

Consider buying discount points to reduce your interest rate if you plan to be in the house long enough to recoup that money and then some -- usually five years or longer.

If you're a first-time homebuyer or are low-income, look for financing through your local or state board of housing.  The federal Department of Veterans Affairs offers help for military personnel and veterans by allowing a purchase with no money down and no mortgage insurance.  Dozens of mortgage products are available.  You have to decide which one best fits your spending plans.  Consider these:

30-year fixed rate.   You'll pay a slightly higher interest rate than for a adjustable mortgage or ARM, but you’ll have the comfort of knowing it won't change over the life of the loan.  Or, consider a 15-year mortgage to save thousands in interest if you can afford a higher payment.

ARMs.   Sometimes known as "hybrid" loans, ARMs offer a low fixed rate of interest at the beginning of the loan, followed by rate adjustments that are tied to an index.  For instance, a 5/1 loan has a fixed rate in the first five years and a rate that's adjusted every year after that.  These mortgages may work well for people who plan to move or refinance their homes with a fixed-rate mortgage before the interest begins to ratchet up.

Option ARMs.  You can pay the full interest and principal due each month or just the interest, or make just a partial interest payment.  The third option is particularly hazardous because the unpaid interest will be added to the principal you owe.

Interest only.   You pay only interest for the first five to ten years and both interest and principal in the remaining 20-25 years.  Another version is the interest-only fixed-rate mortgage.  Like ARMs, you'll end up with substantially higher monthly payments unless you sell or refinance your home.  If your income can support only the interest payment, rather than principal and interest, perhaps you should not be buying a home.

With so many types of mortgages to choose from, it's essential to understand the terms of the loan before you sign:

* Will the interest on your ARM be adjusted every year, every six months or every month?

* Is there a cap (maximum possible rate) on the interest?  Does the cap apply to the first adjustment or only to subsequent adjustments?  Is there a cap on your payments, which could cause your obligation to soar?

* And watch out for prepayment penalties and balloon payments.

* Private mortgage insurance, known as PMI, can cost hundreds of dollars a month and may be require on the loan you are considering.  You can avoid mortgage insurance (which protects the lender, not you) by putting down at least 20% on your home.

Make sure you are working with a mortgage lender who is willing to explain all the details and show you all the numbers. As they used to say in the grade B westerns, make sure you know the "Good, the bad and the Ugly."