Adjustable Rate Mortgage
(ARM) does not apply the same interest rate toward monthly payments for the life of the loan. Throughout the life of that loan, the homebuyer's principal and interest payment will adjust periodically based on fluctuations in the interest rate.
For example: a lender could offer a 30-year ARM loan to a homebuyer at an initial 6.5% interest rate. During an adjustment period for the ARM loan, the market interest rate could rise to 8.0%, resulting in a significantly larger interest payment. Similarly, the market interest rate could decrease to 6.0%, resulting in lower interest payments.
ARM benefits include:
» Initial payments lower due to lower beginning interest rate, usually about 2 percentage points below the fixed rate
» Ability to qualify for a higher loan amount due to lower initial interest rates
» Lower interest payments if the interest rate drops over time
» Interest rate caps limit the maximum interest payment allowed for the loan
ARM disadvantages include:
» Initial lower interest rate and monthly payments are temporary and apply to the first adjustment period. Typically, the interest rate will rise after the initial adjustment period.
» Higher interest payments if the interest rate rises over time
Source
Rates and Points
The interest rate determines the monthly interest payments over the lifetime of the loan. A "point" or "discount point" is equivalent to 1% of the loan amount and usually reduces or "discounts" the loan rate by an eighth of a percentage point.
For example: You want to get a loan for $100,000 to buy a home. Each "point" would cost you 1% of $100,000 or $1,000 but would reduce your loan's interest rate by .125%. The lender might offer you an 8.0% loan with zero points, a 7.875% loan with one point, or a 7.75% loan with 2 points.
Points are an up-front payment, in addition to the down payment that is required upon closing. In some cases, lenders will allow borrowers to finance the points over the term of the loan. Lenders sometimes use points to make their interest rates appear lower. Be aware that lower interest rate offered by a lender may translate into higher points requirements.
The down payment, a cost that you pay at closing, can affect your mortgage in a number of ways.
Higher up-front payments result in:
» lower monthly payments
» lower private mortgage insurance (PMI) costs (if applicable)
» lower interest payments
In fact, making a down payment of 20% or more can save the homebuyer money by avoiding the monthly mortgage insurance payments.
On the other hand, lower up-front costs mean that your cash requirements at closing are much less, although monthly payments may be somewhat higher.
These lower up-front costs may be a significant benefit for first-time homebuyers and people who simply don't have a lot of cash on hand. The Department of Housing and Urban Development (HUD) has some tips that may be helpful to you as you shop for mortgages.
Buydowns vs. Graduated Payment Mortgages (GPMs)
While these two mortgage types start the homebuyer off at one rate and increase the rate over time, one of these types of mortgages may be right for you:
Buydowns
Type of mortgage loan where the loan rate is reduced by paying more up-front at closing and is increased by one percent each year for the period set for the loan product. For example: For a 2-1 buydown at an 8% rate, Year 1 the rate is 6%, Year 2 the rate is 7%. For Year 3 through the life of the loan, the rate is 8%.
Qualification rules for the loan programs remain the same. Depending on the lender, though, the buyer can qualify using the reduced rate. (Example: For a 3-2-1 Buydown at a rate of 8%, the buyer could qualify using the 5% rate.)
The difference between the actual payment schedule and the rate schedule is usually paid "up-front" at closing. This can be paid by the seller, the buyer, the homebuilder, or in some cases, the lender. If the cost is borne by the lender, it is usually offset with increased rates or in points. Generally the funds used to buy down the loan are held in a separate account and are applied with the borrower's payment to equal the true interest rate.
Graduated Payment Mortgage (GPM)
Type of mortgage loan where the mortgage payments increase gradually for a period established in the loan product, typically five years. This is a negatively amortizing loan, which means that the difference between the interest paid and the interest due is deferred and added to the loan balances. Because of this, your loan amount will increase once you start paying off the loan; it will amortize normally at the end of the loan period. These loan products are more popular when the interest rates are higher, providing a financial incentive for potential buyers.
Since many lenders will qualify a buyer at a lower rate, a buyer can secure a larger mortgage. These loan types are good for those buyers who are fairly certain that their incomes will increase to cover the increase in loan amount.
Basic Mortgage Math
Mortgage lenders use many of the following basic mortgage calculations in their mortgage qualification process. You may want to reference this information when you visit the Affordability section.
Cash Required
Funds required at closing. This is the total of a buyer's closing costs and down payment amount.
Total Closing Costs
+ Down Payment
= Cash Required
Debt Ratio
The percentage of monthly income that can be applied toward monthly long-term debt obligations. Loan programs have different guidelines on debt ratio percentages. Government loan programs typically have higher debt ratio percentages, allowing more homebuyers to qualify for loans.
PITIO
------------------------ = Debt Ratio
Total Monthly Income
Down Payment
The Down Payment can be shown as:
» The difference between the Home Sales Price and the Loan Amount
» One of the main parts of the "up-front" cash required at closing
» A percentage of the home sales price paid at closing. For example, a 20% down payment on a $100,000 sales price is equivalent to a down payment of $20,000 at closing.
Home Sales Price
- Loan Amount
= Down Payment
Front-End Ratio
The percentage of monthly income that can be applied toward monthly house payments. Each loan program has different guidelines on front-end ratio percentages. Typically, government loan programs have higher front-end ratio percentages, allowing more homebuyers to qualify for loans.
Front-End Ratio
----------------- = PITI
Total Monthly Income
Maximum Loan Amount
Sum of the total loan amount and other financed fees. It represents the maximum amount that the lender is willing to offer based on constraints including income, debt, and cash available. This maximum loan amount is set by the lender or by the specific loan product.
For example, a lender offering to finance a $100,000 home with a LTV of 97% approves a maximum loan amount of $97,000. The buyer must include the remaining 3% ($3,000 in this example) in the down payment.
Home Sales Price
x Loan to Value (LTV)%
= Maximum Loan Amount
PITI
Sum of Principal, Interest, Property Taxes, and Insurance payments. For most homeowners, PITI represent the amount of their monthly mortgage payment.
+ Principal
+ Interest
+ Property Tax
+ Insurance
= PITI
PITIO
Sum of Principal, Interest, Taxes, Insurance, and Other monthly non-housing costs.
+ Principal
+ Interest
+ Property Tax
+ Insurance
+ Total Other Costs
= PITIO
This section gives you an overview of some important rights you have as a homebuyer:
Consumer Credit Protection Act (1960) - Guarantees confidentiality of credit reports and allows customers to correct inaccurate information in their reports.
Equal Credit Opportunity Act of 1975 (ECOA) - Prohibits the discrimination in any credit action based on race, sex, marital status, color, religion, age, handicap, or national origin.
Equal Housing Opportunity - Prohibits housing discrimination based on race, sex, marital status, color, religion, age, handicap, family status or national origin.
Fair Housing Act - Prohibits the discrimination based on race, sex, marital status, handicap, or national origin in any real estate transaction.
Federal Consumer Credit Protection Act (commonly known as the Truth in Lending Act) (1969) - Requires that lenders disclose the actual terms and conditions of a loan before an applicant commits to the loan.
Home Mortgage Disclosure Act (1975) - Provides information to help determine whether public institutions are assisting the housing needs of their communities and neighborhoods.
Real Estate Settlement Procedures Act of 1974 (RESPA) - Encouraging homeownership through consumer protection, this act regulates certain lending actions related to closing/settlement. Some of its provisions are:
» RESPA requires lenders to provide buyers a good faith estimate of the cost of the loan, including disclosure of the Annual Percentage Rate (APR).
» RESPA requires lenders to provide buyers with general information about settlement costs.
» Lenders must provide buyers a copy of the Mortgage Servicing Disclosure Statement, regarding loan servicing and transfer.
» Within three days after receiving the loan application, lenders must provide the buyer with an estimate of closing costs and monthly payments.
» RESPA provides the borrower the opportunity to see the Settlement Statement one day before the actual settlement.
» Prohibits kickbacks between Real Estate professionals for referrals and prohibits fee-splitting and receiving unearned fees for services not rendered.
Regulation B of the Consumer Credit Protection Act - Requires lenders to inform potential borrowers of any adverse actions taken on their loan applications.
Regulation Z - Includes regulations related to consumer credit disclosures identified in the Consumer Credit Protection Act.
Veterans Housing Benefits Act (1978) - Increases the housing benefits for eligible veterans including increased loan amounts.
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