Deciding How You'll Pay for a Home
If you've decided to go ahead and buy a new home, chances are that you'll need to borrow some money, at least temporarily. If you've got a lot of equity built up in your current home, and are buying something that's less expense or about the same price as where you're living now, you may only need to borrow money for a short time. You borrow to pay for your new home, then repay the loan when your current home sells.
If you've always lived in an apartment, however, or are buying a second home, chances are that you won't have the cash available to buy your home outright. Very few people pay 100 percent of the price of a home before they move in. Most folks, and chances are that you're one of them, will need to get a mortgage and make monthly payments on their home. And don't forget about the extra costs you will incur with the purchase of a new home.
Getting a mortgage sounds simple, but the problem is that there are many kinds of them out there. The trick is deciding which kind of mortgage is right for you. Get ready for a quick, crash course on mortgages, and then we'll show you a profile of what types of mortgages seem to work best for certain types of people. You can figure out where you best fit in, and what type of mortgage you might consider.
Adding It Up
A fixed-rate mortgage is one where the interest rate remains constant over the life of the loan. An adjustable-rate mortgage normally has the same interest rate for a specified time, after which the rate may fluctuate.
The two most common types of mortgages are fixed rate and adjustable rate. Fixed-rate mortgages are those on which you agree to pay a certain amount of interest every month for as long as you have the mortgage. If your mortgage rate is 7 percent, you'll pay 7 percent every month from the time you get the loan, until it's completely paid back.
An adjustable-rate mortgage is a loan on which the interest rate varies. For that reason, your monthly payments don't stay the same.
The interest rate on an adjustable-rate mortgage rises and falls in line with changes in overall interest rates. The typical rate changes once a year—and usually can't rise more than two points annually or six points over the life of the loan.
Adjustable-rate mortgages generally offer lower beginning interest rates than fixed-rate loans, and you generally don't have to pay points if you get this type of mortgage. Remember though, that points are really prepaid interest, so if you don't pay them up front, you'll end up paying over the life of your mortgage.
The total interest paid on a 15-year mortgage with a 7 percent interest rate is $46,350. Total interest on a 30-year loan at the same interest rate is $104,632. Big difference!
Some other types of mortgages include the following:
Hybrid mortgage. This kind of mortgage mixes fixed and adjustable-rate loans. There are different types of hybrids, among them are balloon mortgages and two-step mortgages. Hybrids allow you to pay a certain amount of interest for a while, and then change to a different rate, either higher or lower. A balloon mortgage allows you to pay a lower-than-normal interest rate for a while, and then requires you to pay the off the balance of your principal in a lump sum payment. Even though you could refinance a balloon mortgage to get a more traditional one, that particular type of mortgage isn't for everyone.
Graduated-payment mortgage. This type of loan allows you to start out paying less than the full monthly payment that you'd have with a traditional mortgage for the same amount. Your payments gradually increase as you get further into the life of your loan. The interest rate is usually fixed, so you don't face the risk of unexpected increases you would have with an adjustable mortgage. This type of mortgage can be advantageous for someone buying a second home, because it allows lower total payments in the early years, giving the borrower time to pay off his first home or other debts.
Assumable mortgage. This is when the buyer assumes the mortgage of the seller. There are advantages if the seller got the mortgage when interest rates were low, and they've risen dramatically.
Seller financing. This is when the person selling the house provides financing to the buyer, and the buyer repays the seller instead of to a mortgage lender.
Jumbo mortgage. These are, as the name implies, large mortgages, and they generally carry higher interest rates than regular ones. A loan of more than $275,000 currently is considered a jumbo mortgage, but the amount increases at regular intervals.
Biweekly mortgage. You pay twice a month instead of once on this kind of mortgage, and it has the attractive benefit of shortening the length of your loan.
In addition to different types of mortgages, you can pay them back over different periods of time. The most popular payment periods are 15 and 30 years.
If you choose a 30-year mortgage, you get to pay less each month because your loan is spread out over a longer period of time. A 15-year loan means higher payments, but you can usually get a slightly lower interest rate. And paying the mortgage off in half the time results in big savings overall.
There are, however, some advantages to a 30-year mortgage. Mortgage interest is 100 percent tax deductible, and having a longer-term loan allows you to claim the deduction for many years. Also, if you're paying less per month on your mortgage, you may have more money to invest.
More on: Family Finances
Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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