The Most Home For Your Money.
MIDWAY THROUGH LAST YEAR DEIRDRE BROWN-Postell discovered the house of her dreams--or so she thought.
"I was all set to buy a house," says Brow--Postell, 38, a divorced mother who works as an interior designer for Moody/Nolan Ltd., an architectural firm, while freelancing as a historical preservationist for the city of Dayton, Ohio. As part of the city's Nehemiah Project, which assists first-time home buyers, Brown-Postell was able to put down 3% on a home loan and pay no closing costs. Also, by supplying her financial information to her lender, Wells Fargo, in advance, she was preapproved for an $80,000 mortgage.
Her proactiveness and organization were rewarded with a smooth home-buying process, right? Wrong. "A title search revealed that the owner was in tax trouble, so the IRS had placed a lien on the house," recalls Brown-Postell. "We kept waiting, hoping the matter would be cleared up, but the deal eventually fell through."
Now for the good news: Brown-Postell found a house she liked even better, in Trotwood, a town adjacent to Dayton. And although interest rates went up while the first deal was pending, she had already locked in a 6.5% rate on her preapproved loan from Wells Fargo. Within a week and a half, she had an $80,000 mortgage on a beautiful home in a desirable neighborhood. "Because I was preapproved for the mortgage," she says, "there were no problems with the financing once I found a house I wanted with a clear title."
Brown-Postell's experience illustrates just how complicated buying a house can be. To help you navigate it, we've put together a step-by-step guide that gets you in the mortgage know.
KNOW YOUR CHOICES
Mortgage shopping is already different from what it was two or three years ago. Interest rates have risen sharply since late 1998--and forecasters expect them to go higher still. Fortunately, the mortgage industry has gone through a quiet revolution and introduced many types of loans and consumer services.
"Today, there's no reason to panic," says Keith Gumbinger, vice president of HSH Associates in Butler, New Jersey, which compiles industry data. "Mortgages are widely available at rates that are around the average for the 1990s."
Here are some of the selections on today's mortgage menu:
* Thirty-year fixed-rate mortgages. These mortgages carry the highest interest rates. In the spring of 2000, they averaged about 8.3%, up from a 30-year low of 6.9% in October 1998 (but still nowhere near the 18.31% rate reached in 1981). However, there is a twofold trade-off. First, because the amount of the monthly payment stays the same, fixed-rate mortgages can provide long-term security for home buyers whose income isn't likely to increase substantially.
Second, "A fixed-rate mortgage is a form of insurance against future interest-rate increases," says William Baldwin, an attorney and financial planner in Waltham, Massachusetts. "You'll pay for this insurance in the form of higher interest rates, so you shouldn't pay for it if you don't need it."
* Fifteen-year fixed-rate mortgages. These mortgages are paid off in half the time of a 30-year loan, so each monthly payment will be higher. (Remember: the shorter the loan term, the greater the amount paid in each installment). For example, going from a 30-year, $100,000 mortgage at an 8.5% interest rate to a 15-year loan at 8% might raise your monthly payment from about $730 to $930. However, you'll avoid 15 years of interest payments and get a slight break on rates, saving you around $90,000 in total outlays. However, 15-year loans are best for people who have solid job security as well as enough income to cover the monthly payments.
"Most people like the comfort of not having a mortgage," says Baldwin. "If you can afford the monthly payments, take a 15-year loan to get your mortgage paid down rapidly. Try to negotiate a loan with no points and low closing costs, and be ready to refinance when rates drop."
Daniel Boyce, a certified financial planner in Southfield, Michigan, offers another suggestion. "I often recommend a 30-year mortgage," he says, "and tell clients that they can pay it off at the same rate as a 15-year mortgage. That way, they can cut back to the 30-year payment [schedule] if they have cash flow problems and not jeopardize their credit rating or their ownership of the home." One caveat: make sure your lender allows prepayments. Some don't, or sock you with a penalty.
* Adjustable-rate mortgages (ARMs). These mortgages have a low initial rate but adjust each year to reflect the current mortgage environment. Generally, the introductory rates are the lowest available: the national average recently was under 7%. The low initial rate means a lower monthly payment, and may enable you to qualify for a larger loan in relation to your income. But because the loan rate goes up when interest rates do, ARMs work best for people who don't plan to stay in a house for long or who expect their income to increase substantially in the future.
This basic one-year ARM was a good fit for Brown-Postell, who was willing to assume the risk of higher future rates because her job was secure and her income from freelance assignments likely to increase. Also, "She got a 6.5% loan," says Virginia Siler, the loan officer at Wells Fargo in Dayton, who helped Brown-Postell through the process. "This loan is called a `1 and 5 loan,' meaning that the interest rate can go up no more than 1% per year and 5% over the life of the loan, for a cap of 11.5%. We used a 7.5% rate--assuming a 1% increase after one year--to compare the projected payment with her monthly income and qualify her for the loan."
The loan is structured so that Brown-Postell can refinance it easily if interest rates fall in the future, according to Siler. "No credit check will be necessary; all that will need to be done is to reconfirm the value of the house. Even if rates don't fall, she should be all right because [Brown-Postell] can expect her income to increase during her professional career," says Siler.
* Hybrid mortgages. "We're seeing tremendous interest in fixed-adjustable loans," says Doug Perry, vice president of production, Countrywide Home Loans, in Calabasas, California. "They offer a fixed rate for three, five, seven or 10 years, after which the rate adjusts every year." Thus, borrowers have some security, knowing that their monthly payments won't increase for a certain number of years, as well as a lower rate. Choosing a three-or a five-year hybrid mortgage (the most popular types) could shave 0.5% to 0.65% from a 30-year fixed mortgage rate. A hybrid mortgage can help home buyers buy more house than they would otherwise qualify for, with the expectation that future increases in the buyer's income will cover interest-rate hikes.
A hybrid loan appealed to Stan Carter, 37, and his wife, Amey, 32, both teachers in Montgomery, Alabama. "We shopped around and wound up with a three-year ARM," says Stan, "because the rate was attractive." The Carters paid one point [see sidebar for an explanation of these upfront fees], "and got a 6.5% loan. After three years, the loan can go up by as much as 1% per year, but no more than five percentage points over the life of the loan." With a loan of over $190,000 from Countrywide, the Carters were able to move into a $200,000 house in Montgomery.
In terms of what's most attractive to home buyers right now, "We've seen fixed-rate mortgages go from 90% to 70% of the overall market," says Gumbinger. "Adjustable-rate loans, especially hybrids, are becoming more popular." In fact, according to the Mortgage Bankers Association, 28% of all loans made in the third quarter of last year were adjustable-rate loans (up from 12% for the same period a year ago). "However, an 8.3% rate on a 30-year mortgage is not the end of the world, so there are plenty of takers out there," he says. (For more on today's mortgage choices, see "Playing the Mortgage Game" in Moneywise, this issue.)
STEP TWO: SEPARATE THE GIMMICKS FROM THE GOOD DEALS
In addition to the mortgage products listed above, lenders have rolled out other options designed to take the sting out of high rates. However, these alternatives--which include 40-year fixed-rate mortgages and negative amortization loans--earn few kind words.
"Forty-year mortgages are a tough sell," says Gumbinger, referring to loans that stretch payments out over an additional 10 years. "They don't save borrowers very much on monthly payments, but they add on 10 years of interest." For example, on a $100,000 loan at 8.5%, you'll pay $177,064 in interest over a 30-year period, but $252,250 over 40 years--an additional $75,186. Similarly, with negative amortization mortgages, you pay a lower "teaser rate" for the first few months, but your debt keeps building up.
On the other hand, Gumbinger is not as concerned about the trend toward smaller down payments. "Instead of the traditional 20%, we're seeing lenders who require only 5% or 10% down," he says. "In fact, in some cases it's possible to borrow 103% of the purchase price, with the lender paying the closing costs as well." Low-down-payment mortgages, which are offered by private lenders and through government-backed Federal Housing Administration (FHA) and Veterans Administration (VA) programs, may be attractive to borrowers with ample income but insufficient savings. (For more information, see www.hud.gov and www.homeloans.va.gov.)
STEP THREE: KNOW YOUR FINANCIAL PROFILE BEFORE YOUR LENDER DOES
Regardless of the type of mortgage you seek or the size of the down payment you can make, there are certain steps you should take to get the best deal. First and foremost, get a handle on your credit profile.
You can order a copy of your credit report by visiting the Websites of the "big three" credit bureaus at www.equifax.com, www.transunion.com and www.experian.com. "Correct any inaccuracies and dear up any issues," says Perry. "If you missed some debt payments because you were preoccupied with a family illness, for example, you can attach an explanation to your report. Many lenders will understand." The major bureaus generally let you include a statement of up to 100 words with your report.
In general, your credit report will focus on your history of paying off debt such as credit cards and auto loans. "Problems you've had in the distant past won't be counted as much as recent delinquencies," says Perry. Take heart: after seven years, delinquent payments are no longer reported. (For bankruptcies, it's 10 years.)
If you have a less than perfect credit history, there will likely still be a mortgage available for you, although you may have to pay a higher interest rate than borrowers with perfect credit. Subsequently, when your accounts are up to snuff, you can refinance your loan at a better rate.
That's what Damond Johnson, 27, a loading dock worker in Indianapolis, and his wife, Catherine, 27, a college student, did. "We went looking for a house to rent in 1995," Damond recalls, "and we were told we qualified to buy it instead. That's what we did, but we found that the rates were high. So we refinanced it last year at a much better rate. Refinancing was simple. We just had to show pay stubs to verify current income and have a satisfactory credit report."
The Johnsons were able to go from a $48,000 loan at 13% to a $51,000 loan at 8.5%; they put the extra $3,000 toward property taxes and home insurance. Their current payment is under $500 a month, about $40 lower than the old one. "This means a huge savings for them," says Michelle Hall, a home mortgage consultant with Wells Fargo Home Mortgage in Indianapolis. "Now they'll be able to build equity in their home. They took a 30-year fixed mortgage, which protects them from having their rate change every year or so. Therefore, they have protection against rising mortgage rates. If rates drop, they'll be able to refinance.
"What's more," says Damond, "with our new loan, we make one monthly payment that also includes property tax and home owner's insurance, so it's much more convenient." Regarding home owner's insurance, most lenders require private mortgage insurance until you've built up 20% equity in your home. In the past, lenders were reluctant to drop this portion of the monthly payment, but a new bill calls for the automatic cancellation of private mortgage insurance once homeowners hit the 22% equity mark.
STEP FOUR: YOU HAVE THE TECHNOLOGY. USE IT.
As part of shopping for your loan, go online to get an idea of the current mortgage climate. Stan Carter, for example, did some preliminary research on the Internet, starting with the U.S. Department of Housing and Urban Development's Website, which referred him to the sites of various lenders. "I shopped around and saw that Countrywide seemed to have a good mix of rates and loans," he says. "Then I contacted the company's local office, where the people helped us with all the paperwork."
"There are some great tools and mortgage calculators on the Net," says Gumbinger. "You can get an idea of how large your monthly payments will be with different loan amounts or interest rates" (see sidebar for suggestions).
What about getting a mortgage online? If you're a home buyer, especially a first-time home buyer, "the Net can be very confusing, and there's more of a chance of falling victim to some scheme or having your privacy invaded," says Gumbinger. For example, beware of sites that ask for up-front processing fees. "Use the Net for preliminary research, then go find a lender that will provide the personal service you want. The information you've gotten on the Internet can help you make sure you get a competitive rate."
However, says Gumbinger, "If you want to refinance a loan, you can rely on the Internet. Be ruthless. Search the entire Net for the lowest rate." If there are no cumbersome fees, generally you can refinance whenever rates drop. Otherwise, do the math: How much are the costs? How much will you save each month? Do you plan to keep the loan long enough to make refinancing worthwhile?
STEP FIVE: LINE UP A LENDER
Once you've done your due diligence, contact potential lenders to become prequalified or preapproved for a loan, as Brown-Postell did. To do so, you'll have to supply your financial data before you have a specific purchase in mind. "Preapproval is different from prequalification," says Perry. "Someone who's prequalified has a good idea of how much money can be borrowed and how much can be spent on a home. Someone who's preapproved is further along in the process. Financial information has been verified, so your loan can be ready faster. Some realtors and sellers prefer to work with buyers whose loans are preapproved."
In terms of the lender you eventually settle on, know that if you deal with a mortgage broker or referral service, you'll wind up paying a fee for their assistance in finding you a lender. Unless you have special circumstances that will make getting a mortgage difficult, it's best to eliminate the middle man and deal directly with lenders.
After you know what kind of a loan you'll get, you can go shopping for a home you can afford. This may mean working with a real estate agent, but you shouldn't relinquish control of the entire process. "Some agents will refer buyers to lenders who only make conventional loans," says Siler. "However, government-backed loans from FHA or VA may be a better deal, because you might be able to make a smaller down payment. Federal loans don't require a credit score, which may help borrowers who have had problems in the past."
Remember that buying your dream home is a long process, one that probably won't be without bumps. But if you do your homework and arm yourself with the right tools, the end result will be a home you can live well in and a mortgage you can live with.
What to Know Before You GO
Before you begin house hunting, here are some tips and terms to keep in mind:
* Income counts. As a rough guideline lenders want to see a monthly payment (including mortgage, taxes and insurance) that equals no more than 28% to 36% of your gross monthly income. As a rule of thumb, this means you generally can borrow about three times your income. With a family income of $50,000, for example, and no exceptional circumstances, you probably qualify for a $150,000 loan.
* Lock in, float down. Under these terms, some lenders will charge you the current interest rate but allow your rate to drop if mortgage rates move down by the time you close on the home. You'll generally pay several hundred dollars for this type of can-win, can't-lose guarantee.
* Log on. The following Websites are useful for finding information about mortgages, calculating payments and comparing current offerings: www.hud.gov, www.hsh.com, www.countrywide.com, www.wellsfargo.com, www.homeadvisor.msn.com, quickenloans.quicken.com, www.eloan.com, www.iown.com, www.lendingtree.com and www.prigeline.com.
* Points. Points are upfront fees (typically included in the amount you'll borrow) you pay in return for a lower interest rate. On a $100,000 loan, for example, one point equals $1,000, two points cost $2,000, etc. Each point you pay drops your mortgage interest rate by about 0.25%. Generally, it makes sense to pay points if you plan to stay in the house for five years or longer. According to HSH Associates, on average, borrowers pay almost one point on most mortgage loans.
(For information on getting free government guides to mortgage terms, see "Home Buying 101" in Shopsmart, this issue.)
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|Title Annotation:||selecting the best mortgage|
|Author:||KORN, DONALD JAY|
|Date:||Jul 1, 2000|
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