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.

Mortgages

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.

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.

Checking Out Your Profile

The Pennsylvania Institute of Certified Public Accountants has come up with a set of mortgage guidelines, based on a borrower's profile. Read it over and see where you think you fit in, and what type of mortgage may be best for you.

• The Lifer. For borrowers who will stay in their home for many years, a fixed-rate mortgage may be the best. You pay slightly more in the first year than you would with an adjustable-rate mortgage, but you lock in the low fixed rate for the long term. It may be worth paying points up front to get a lower interest rate that will save you money over the years of the loan.

• The Mover. If there's a possibility that you may move again during the next few years, an adjustable mortgage might be best for you. You get a lower rate in the early years than with a fixed mortgage. And, because you'll be moving, you needn't worry much about the adjustable rate creeping up on you.

• The Income Climber. If you expect to receive pay raises, pay off debts, or experience increases in income due to an inheritance or some other reason, consider a graduated payment mortgage. Monthly payments will gradually rise on a fixed schedule.

• The Well-Heeled Buyer. If making a big mortgage payment isn't a problem, consider a mortgage for 15 or 20 years, instead of 30. You'll pay off the loan faster, and save a bundle on interest.

• The First-Time Buyer. If you can afford the monthly payments but don't have the savings for a 10 or 20 percent down payment, look around for a mortgage that requires little or no money down. One such loan is the Flexible 97 mortgage backed by Fannie Mae. It allows a down payment with an unsecured loan from a family member, something that isn't permitted with most traditional mortgages.

These profiles can give you an idea of what type of mortgage may work the best for you. It's a good idea, though, to talk to a mortgage counselor or your accountant before making a final decision.

If you're thinking about buying a vacation home and you have built up a fair amount of equity in your primary home, you might think about getting a home equity loan.

Home Equity Loans and Lines of Credit

Loans based on the equity in your home generally can be obtained at lower interest rates than nonsecured loans, and the interest is normally tax-deductible.

If you need cash out of your home, you probably don't have to refinance into a new first mortgage. Consider adding a second mortgage or getting a home equity loan. Second mortgages are loans you get on top of your primary mortgage, and they're not part of the national market. Held by local lenders, the interest rates on them can vary tremendously, so be sure to shop around.

Home equity loans are generally paid back over a much shorter time period than mortgages. Review your entire loan situation with your lender, looking at whether it's best to refinance everything into one loan or to add a home equity loan to your first mortgage. The lender will be able to provide you with comparison costs and total interest paid.

Using your home as collateral for a loan puts your home at risk if you should default. You should carefully assess your borrowing needs and your ability to repay before you decide to borrow against your house.

There are two types of equity loans. The first, a fixed, lump sum amount, is known as a home equity loan. Usually taken out for a car or home improvement project, there is a fixed term to the loan. That is, the interest rate and your monthly payment will remain fixed over the life of the loan.

An equity line of credit enables you to draw against a credit line as the need arises. You can pay for the kids' braces, car repairs, or whatever. Instead of borrowing a fixed amount of money, a line of credit qualifies you for a certain amount of credit. You can borrow up to your credit limit, if needed, but you don't need to. The monthly repayment amount depends on what you've borrowed and the interest rate charged is variable. Lines of credit generally carry higher interest rates than home equity loans.

Swing Loan

A swing loan is a mortgage loan necessary to tide you over when you need to buy a property while you already own another one. Some cases in which a swing loan comes in handy might be when one spouse gets a new job and goes off to the new location while the rest of the family stays behind. The spouse who's already moved finds a great house, flies the rest of the family out, and they agree to buy it, despite the fact that their original home isn't even up for sale, yet.

Or perhaps you have no intention of moving, but quite by accident, you find the house you've always wanted. You're afraid of losing your dream home, so you make a bid and start looking for a swing loan.

Swing loans are interest-only loans, using the first property as collateral for the second property. They're usually executed as equity loans on first property.

Swing loans require you to sign a mortgage note that collateralizes the first house. You'll pay interest only until the first property is sold. When you sell the property, you repay the loan and satisfy the mortgage.

Construction Loan

Construction loans are available to finance new construction. You can be a first-time homeowner and need a construction loan, or you can already be a homeowner who requires one while you build a second home.

The bank agrees to give you a specified construction mortgage, usually with four equal draws or payments to the contractor. When the contractor requests a draw, an inspector is sent to the property site to verify that the builder has completed everything that's been agreed upon to date.

To request a construction home loan, you'll need to take your building plans and a purchase contract to your lending institution. Although all lending firms are different, most require an initial settlement, which is held in escrow until spent.

A construction mortgage is interest only while the property is being built. Once the construction is completed, the bank has a formal settlement, any overages are accounted for, and a standard mortgage (with principal repayment and interest) begins.

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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