Choosing a Mortgage FIXED-RATE MORTGAGES. ADJUSTABLE-RATE MORTGAGES (ARMs)

Transcription

1 Choosig A Mortgage

2 Like homes, home mortgages come i all shapes ad sizes: short-term, log-term, fixed, adjustable, jumbo, balloo these are all terms that will soo be familiar to you, if they re ot already. There s a mortgage out there that s right for you. To figure out which oe, though, you ll wat to take ito cosideratio such factors as your risk tolerace, the legth of time you pla o stayig i your home, whether you re lookig for a mortgage with low up-frot costs ad the size of the mortgage you eed. FIXED-RATE MORTGAGES As the ame implies, the iterest rate o a fixed-rate mortgage remais the same throughout the life of the loa. Your mothly paymet (cosistig of pricipal ad iterest) geerally remais the same, as well. The etire mortgage is repaid i equal mothly istallmets over the term (legth) of the loa. Mortgage legth does make a differece I the mortgage market, log-term loas are geerally cosidered to be 30 or more years i legth; short-term loas are those uder 30 years i duratio. While they may vary betwee 10 ad 40 years (depedig i part o the size of the loa), the usual terms for fixed-rate mortgages are 15 ad 30 years. Although the mothly paymet for a 15-year mortgage will be higher tha the mothly paymet for a 30- year mortgage, it wo t be twice as high, ad the shorter term of the loa will save you a substatial amout i total iterest charges. If you borrow $100,000 at 8% for 30 years, your mothly pricipal ad iterest paymet will be $733. Over the 30-year term, you ll pay a total of $164,155 i iterest. If you borrowed the same amout at the same iterest rate for 15 years, your mothly paymet would be $955 (about 30% higher tha the paymet for the 30-year mortgage), ad the total iterest you d pay over the 15- year term would be $72,017 a savigs of $92,138. Because the leder would lose moey o a log-term fixedrate loa if iterest rates were to rise, the leder may adjust the rate accordigly, i effect chargig you a premium to offset this possibility. As a result, a 30-year mortgage may have a higher fixed iterest rate tha a 15-year loa, ad both will carry higher iterest rates tha those iitially charged o a adjustable-rate mortgage (ARM). The good ews is, you re locked i; the bad ews is, you re locked i Lockig i a fixed iterest rate o your mortgage has its good ad bad poits. If iterest rates rise, yours wo t; as a result, your mothly mortgage paymet will always remai the same. This ca be reassurig to homeowers o tight budgets or with fixed icomes. For this reaso, fixed-rate mortgages ofte appeal to idividuals with a low tolerace for the risk associated with fluctuatig mothly paymets. But if iterest rates go dow, yours wo t, ad your (ow high) mortgage paymet will remai the same. While you might be able to refiace your home, payig off the higherrate mortgage with oe that carries a lower iterest rate, this is t always possible. I additio, the iterest rate might eed to drop sigificatly to offset the expeses associated with refiacig, ad you d eed to remai i your home log eough to allow the mothly savigs associated with the lower rate to recoup those expeses. ADJUSTABLE-RATE MORTGAGES (ARMs) Overview With a ARM, also called a variable rate mortgage, your iterest rate is adjusted periodically, risig or fallig to keep pace with chages i market iterest rate fluctuatios. Sice the term of your mortgage remais costat, the amout ecessary to pay off your loa by the ed of the term chages as your loa s iterest rate chages. Thus, your mothly paymet amout is recalculated with each rate adjustmet. 2 ATLANTICTRUST.COM

3 You have a $100,000 ARM with a iitial iterest rate of 6.5% ad a 30-year term. Your mothly mortgage paymet (i whole dollars) is $632. The iterest rate is adjusted aually. At the ed of the first year, the iterest rate icreases to 8.5%. To reflect this icrease ad to repay the outstadig pricipal balace over the remaiig 29 years i the term, your paymet will icrease to $766 per moth. If at the ed of the secod year the iterest rate icreases to 10.5%, your paymet will icrease to $906 per moth. Depedig o what s specified i the mortgage cotract, a ARM ca be adjusted semi-aually, quarterly or eve mothly, but most are adjusted aually. The adjustmets are made o the basis of a formula specified i the mortgage cotract. To adjust the rate, the leder uses a idex that reflects geeral iterest rate treds, such as the oe-year Treasury securities idex, ad adds to it a margi reflectig the leder s profit (or markup) o the moey loaed to you. Thus, if the idex is 5.75% ad the markup is 2.25%, the ARM iterest rate would be 8%. What s to keep the iterest rate from goig through the roof or, for that matter, from plugig through the floor? Most ARMs specify iterest rate caps. The periodic adjustmet cap may limit the amout of rate chage, up or dow, allowed at ay sigle adjustmet period. A lifetime cap may idicate that the iterest rate may ot go ay higher or lower tha a specified percetage over or uder the iitial iterest rate. Your ARM has a iitial rate of 9% ad is adjusted aually. The periodic adjustmet cap is 1.75 percet per year, ad the lifetime cap is 5%. This meas that at your first adjustmet, your iterest rate ca t exceed 10.75% or go below 7.25%. Over the life of your loa, your iterest rate ca t exceed 14% or fall below 4%. Cautio: Some ARMs cap the paymet amout that you are required to make, but ot the iterest adjustmet. With these loas, it s importat to ote that paymet caps ca result i egative amortizatio durig periods of risig iterest rates. If your mothly paymet would be less tha the iterest accrued that moth, the upaid iterest would be added to your pricipal, ad your outstadig balace would actually icrease, eve though you cotiued to make your required mothly paymets. The iitial iterest rates (referred to as teaser rates ) o ARMs are geerally lower tha the rates o fixed-rate mortgages. If you ca tolerate ucertaity i your mortgage iterest rate ad fluctuatios i your mothly mortgage paymet amout, believe that iterest rates will stay low or go lower i the future, or pla to live i your home for oly a short period of time, the you may wat to cosider a ARM. Hybrid ARMs Hybrid ARMs are mortgage loas that offer a fixed iterest rate for a certai time period (3, 5, 7 or 10 years) ad the covert to a 1-year ARM. Your mortgage offers a fixed rate of 7% for 5 years. At that poit, the mortgage coverts to a 1-year ARM with a periodic adjustmet cap of 1% ad a lifetime cap of 4%. For the first 5 years, you pay 7% iterest. I the sixth year, whe the mortgage coverts to a 1-year ARM ad your first aual rate adjustmet is made, your iterest rate ca t go above 8% or below 6%. Over the life of the loa, the iterest rate ca t go over 11% or below 3%. The iitial fixed iterest rate o a hybrid ARM is ofte cosiderably lower tha the rate o either a 15-year or 30- year fixed-rate mortgage. The loger the iitial fixed-rate ATLANTICTRUST.COM 3

4 term, however, the higher the iterest rate for that term will be. Geerally speakig, eve the lowest of these fixed rates is higher tha the iitial (teaser) rate of a covetioal oe-year ARM. Hybrid ARMs are ideal for idividuals who pla to stay i their homes for a short period of time (3 to 10 years), sice they ca take advatage of the low iitial fixed iterest rate without worryig about how the loa will chage whe it coverts to a ARM. If you thik your plas may chage or you are plaig o stayig put for a while, look for a hybrid ARM with a coversio optio. This optio will allow you to covert your loa to a fixed-rate loa before it turs ito a ARM. GOVERNMENT MORTGAGE PROGRAMS Geerally, govermet mortgage programs offer mortgages isured ad/or guarateed by agecies of the federal govermet. These programs are ofte attractive to buyers (particularly first-time homebuyers) because they: are isured by the federal govermet. The borrower pays mortgage isurace premiums (MIPs). The iitial premium is based i part o the term of the loa ad the size of the dow paymet, ad ca equal as much as 2.25% of the amout borrowed. This iitial premium ca be fiaced ito the loa. Depedig o the same factors, the aual MIP varies from.25 to.5% of the amout fiaced; it is collected as a part of the mothly mortgage paymets. I part because of the security this isurace offers, leders sometimes set their FHA mortgage rates below the curret iterest rates o covetioal mortgages. Ad depedig o the amout you borrow, a FHA loa may allow a dow paymet of as little as 3.5% of the purchase price of your home. FHA mortgage amouts are limited, ad the maximum loa amout varies amog geographic regios. Cautio: Offer fixed iterest rates that are lower tha those offered by covetioal loas Require little or o dow paymet Use more liberal qualifyig guidelies tha covetioal loas Allow the buyer to work with a third party to pay part or all of the mortgage closig costs or allow the buyer to fiace the closig costs as part of the mortgage balace Carry o prepaymet pealties If you re buyig a ewly costructed home (less tha 12 moths old) ad are applyig for a FHA mortgage, you may eed to covice the builder to sig a warraty as part of your loa package. If the home is t ew, FHA loas require that the home be i good repair. VA loas If you are a vetera, you may qualify for a Departmet of Veteras Affairs (VA) mortgage, which is similar to a covetioal fixed-rate mortgage. The VA guaratees to the leder that a certai portio of the mortgage will be repaid by the federal govermet if the borrower defaults o the loa. Based o the size of the loa, the VA guaratees: FHA loas 50% of a loa up to $45,000 Federal Housig Admiistratio (FHA) mortgages are similar to covetioal fixed-rate mortgages, except that they Up to $22,500 for loas over $45,000 ad ot more tha $56,250 4 ATLANTICTRUST.COM

5 40% of loas over $56,250 ad ot more tha $144,000 25% of loas over $144,000, up to a maximum of 25% of the FHA coformig loa limit for a sigle-uit dwellig (curretly $104,250) Geerally, a leder will offer a VA loa equal to four times the VA guaraty amout to a qualified borrower with o dow paymet required. As a result, a qualified vetera with a available guaraty of $104,250 could receive a mortgage of up to $417,000, or up to $625,500 i the most expesive parts of the coutry. Some leders may allow servicemembers ad veteras to borrow more tha this amout if they re able to make a additioal cash dow paymet. I part because of the security this guaraty offers, leders usually set their rates o VA mortgages lower tha those for covetioal mortgages. Bod-backed mortgages A bod-backed mortgage is a mortgage loa issued by a city, state or couty govermet. The govermet etity sells bods to ivestors ad uses the proceeds from the bod sales to fud the mortgage loas. The iterest rates o these mortgages are ofte lower tha rates available from covetioal leders. Mortgage terms ad stadards of eligibility are set by the idividual govermet etity ad will vary amog differet commuities. OTHER TYPES OF MORTGAGES Balloo mortgages A balloo mortgage is a short-term mortgage with a large pricipal paymet due at the ed of the loa s term. With this type of mortgage, you make fixed mothly paymets for a certai period of time (3, 5, 7 or 10 years, with 5- ad 7-year terms beig the most prevalet). However, these mothly paymets are based o the same repaymet schedule (called a amortizatio schedule) as those for a 30-year fixed mortgage. For this reaso, the fixed paymets durig this period are relatively low. At the ed of this period the loa matures, ad the remaiig pricipal balace is due as oe large fial paymet (called the balloo paymet). Your $150,000 balloo mortgage has a iterest rate of 6.5% for 5 years, after which time the remaiig pricipal comes due. Based o a 30-year amortizatio schedule, your mothly mortgage paymet agaist pricipal ad iterest will be $948. At the ed of the 5-year term, you ll owe a remaiig pricipal balace of $140,422. This is your balloo paymet. The short-term ad relatively low mothly paymets make balloo mortgages attractive, particularly for buyers who do ot ited to remai i the property beyod the term. However, this type of mortgage is best suited for idividuals who are certai they ll be able to make the large paymet due at the loa s maturity. If you wat the optio of covertig the balloo paymet to a differet type of mortgage (perhaps you ll decide to stay i the house), look for a balloo mortgage with a reset feature. The reset feature allows you to covert the balloo paymet to, for example, a fixed-rate mortgage at the curretly prevailig rate for the remaider of the origial amortizatio schedule. Your balloo mortgage described above has a reset feature that allows you to covert the remaiig pricipal balace to a fixed-rate mortgage with a 25-year term (the remaiig term of the origial amortizatio schedule). Whe the balloo paymet of $140,422 comes due, the prevailig rate is 7.5%. Exercisig the reset optio, your ew fixed paymet becomes $1,048 per moth. ATLANTICTRUST.COM 5

6 Graduated paymet mortgages A graduated paymet mortgage (GPM) begis with low mothly paymets that gradually rise (usually over a 5- to 10- year period) ad the level off for the remaider of the loa term. The iterest rate o a GPM remais fixed throughout the life of the loa (usually 30 years). You borrow moey at 8% for 30 years. Each year for 5 years, your paymets will icrease by 7.5%. Thus, if your paymet is $500 per moth i the iitial (0) year, it would be (i whole dollars) $538 per moth after year 1, $579 per moth after year 2, $621 per moth after year 3, $668 per moth after year 4, ad $718 per moth after year 5 ad thereafter. The greater the aual icrease rate ad the loger the period of icreases, the lower the iitial mothly paymets o a GPM will be. Cautio: Because mothly paymets o a GPM ca start out quite low, egative amortizatio ca occur i the early years of these loas. If the mothly iterest charge accordig to the amortizatio schedule is greater tha the mothly paymet amout, the overage is added to the pricipal, ad your loa balace will cosequetly icrease util such time as your mothly paymet amouts grow large eough to reverse this process. A GPM is best suited for a homeower who ejoys predictable aual icome icreases (ad so ca afford the icreasig paymets) ad who (i order to reverse the effects of egative amortizatio) will ow the home for loger tha the short term of the periodic icreases i the mothly paymets. Growig equity mortgages A growig equity mortgage (GEM), also referred to as a rapidpayoff mortgage, is actually a formalized method of prepayig your mortgage. The iterest rate for a GEM is geerally lower tha that for a covetioal fixed-rate mortgage ad remais fixed throughout the life of the loa. However, the mothly paymets geerally begi at approximately the same level as those of a 30-year fixed-rate mortgage. The paymets gradually rise, usually over a period of 5 to 10 years, ad the level off for the remaider of the loa term. The icreases may be based o a predetermied schedule or o chages i a ecoomic idex specified i the mortgage cotract. For 10 years, the chages i your mothly GEM paymet will be made aually, ad your mothly paymet will icrease by 75% of the rate of icrease i a U.S. Departmet of Commerce idex that measures per-capita icome growth. Thus, if the idex icreases by 6.8%, your paymet would icrease by 75% of that, or by 5.1%. If your mothly mortgage paymet is $500 at the time of the adjustmet, it will icrease to $ ($500 x 1.051). Whe your paymet icreases, the additioal fuds are applied each moth directly to your loa s pricipal balace. This will accelerate the timetable for your mortgage payoff ad reduce the total amout of iterest you ll pay over the (shorter) life of the loa. As a result, while a GEM does t offer ay log-term tax deductio advatages, it allows you to build equity i your home more rapidly. Shared appreciatio mortgages A shared appreciatio mortgage offers you a low fixed iterest rate i exchage for your agreemet to share with a leder a sizable share (usually 30 to 50%) of the appreciatio i your home s value, either upo its sale or at a specified date. As part of the cotract, the leder may also agree to make a portio of your mothly paymets. 6 ATLANTICTRUST.COM

7 You wat to buy a home with a sale price of $200,000. Normally, your leder charges 9% o covetioal mortgages. If you put $40,000 dow, your mothly mortgage paymets o $160,000 for 30 years at 9% would be (i whole dollars) $1,287 more tha you ca afford at the time. The property values i the eighborhood are appreciatig, ad both you ad the leder feel that the home will be worth at least $250,000 i 5 years. The leder the offers to give you a 7% fixed-rate mortgage for a 30-year term. Further, the leder agrees to make half the mothly mortgage paymets for 5 years, if you ll agree to repay the leder those costs ad 50% of the appreciated value of the property at that time (or upo the sale of the property, should that occur first). At 7% for 30 years, the mothly mortgage paymets would be $1,064. The leder will pay half this, or $532 per moth, for 5 years (60 paymets). At that poit, your property is worth $250,000, ad you pay the leder $31,920 i costs ($532 per moth x 60 moths) plus half the appreciated value ($25,000) for a total of $56,920. You the elect to stay i your home ad repay the remaiig mortgage balace at 7% over the 25 years left of the origial 30-year term. Over the previous 5 years, you ve gotte regular salary icreases, ad you ca ow afford the mothly mortgage paymets of $1,064. A shared appreciatio mortgage may limit or preclude your ability to borrow agaist the equity i your home. I additio, at the time you must meet your obligatio to the leder, you may eed to sell your home if you do t have a alterative meas to meet that obligatio. Moreover, if the value of your home has ot icreased as expected, the leder may require you to pay additioal iterest. Jumbo loas A jumbo loa (also kow as a ocoformig loa ) is ay mortgage over $417,000, or over $625,500 i the most expesive parts of the coutry, for a sigle-family home or codomiium. This figure is set by the Federal Natioal Mortgage Associatio (Faie Mae) ad the Federal Home Loa Mortgage Corporatio (Freddie Mac), ad is adjusted aually. Jumbo loas are called ocoformig loas because these orgaizatios will ot uderwrite them, makig them more risky to leders. As a result, leders ofte set their jumbo loa iterest rates higher tha covetioal mortgage rates. This ca make a sigificat differece over time. If you re just over the uderwritig limit for coformig loas ad are havig to cosider a jumbo loa, you might wat to either look for a cheaper house or cosider icreasig your dow paymet i order to qualify for a coformig loa with a lower iterest rate. Over the life of your mortgage, this could create sigificat savigs. O a $160,000 loa at 7% for 30 years, the total iterest you pay is $223,214. Had you take the same loa at 9%, your total iterest paymets over the full 30-year term would have bee $303,462. Your savigs equal ($303,462 $223,214) - $25,000, or $55,218. Cautio: Give that you are ot payig all of the mortgage iterest o a shared appreciatio mortgage i a regularly scheduled maer, you should check with a tax advisor to determie its deductibility. MORTGAGES FROM NONTRADITIONAL LENDERS Seller-fiaced mortgages With a seller-fiaced mortgage, also called a take-back or purchase-moey mortgage, the seller of the home actually acts as the leder. You buy the home uder a istallmet sale arragemet, which meas that you take possessio of the house ad pay for it i periodic istallmets uder the terms of a mortgage cotract. You ad the seller egotiate the terms of the cotract, ad you make your mortgage ATLANTICTRUST.COM 7

8 paymets directly to the seller, rather tha to a bak or mortgage compay. Tip: Uder such a arragemet, your property taxes ad homeowers isurace are ot icluded i your mortgage paymet, as they ofte are with may traditioal mortgages. Whe the seller receives your mothly mortgage paymet of $1,496, a portio of it goes to the seller s ow mortgage paymet. The seller s mortgage is for $150,000 at 6.5% for 30 years; the mothly paymet is $948. As a result, each moth the seller pockets $548 ($1,496 $948). Over the life of your mortgage with the seller, the seller takes i $197,280 ($548 per moth x 360 moths), clearig a profit of $122,280 o the $75,000 ($225,000 $150,000) he or she directly fiaced for you. Wraparoud mortgages A wraparoud mortgage is a type of mortgage i which the seller of the home you re purchasig also acts as your leder. You ll geerally make your mothly paymet o a wraparoud mortgage directly to the seller. Each moth, the seller uses a portio of your paymet to make the paymet o his or her origial mortgage. The seller also fiaces a additioal amout that covers the remaiig purchase price of the home mius ay dow paymet you tedered. These two parts the seller s origial mortgage ad the additioal balace the seller fiaced for you combie to create the wraparoud mortgage. The iterest rate o a wraparoud mortgage is somewhat higher tha the rate o the seller s origial mortgage, but it is ofte lower tha iterest rates available from covetioal leders. This ca create a situatio favorable to both you ad the seller. You re buyig a home for $250,000, ad have $25,000 for a dow paymet. The curret rate for a 30-year fixedrate mortgage is 7.5%. For a $225,000 loa, this would mea a mothly mortgage paymet of $1,835. The seller offers to fiace the $225,000 for 30 years at 7%. This would make your paymet $1,496 per moth. At a savigs of $339 per moth ($1,835 $1,496), you ll save $122,040 i total iterest ($339 x 360 moths) over the life of the loa. 8 ATLANTICTRUST.COM

9 Atlatic Trust Private Wealth Maagemet, a CIBC compay, icludes Atlatic Trust Compay, N.A. (a limited-purpose atioal trust compay), Atlatic Trust Compay of Delaware (a Delaware limited-purpose trust compay), ad AT Ivestmet Advisers, Ic. (a registered ivestmet adviser), all of which are wholly-owed subsidiaries of Atlatic Trust Group, LLC. This documet is iteded for iformatioal purposes oly, ad the material preseted should ot be costrued as a offer or recommedatio to buy or sell ay security. Cocepts expressed are curret as of the date of this documet oly ad may chage without otice. Such cocepts are the opiios of our ivestmet professioals, may of whom are Chartered Fiacial Aalyst (CFA ) charterholders or CFP professioals. Chartered Fiacial Aalyst ad CFA are trademarks owed by CFA Istitute. The Chartered Fiacial Aalyst (CFA ) desigatio is a globally recogized stadard for measurig the competece ad itegrity of ivestmet professioals. Certified Fiacial Plaer Board of Stadards Ic. ows the certificatio marks CFP ad CERTIFIED FINANCIAL PLANNER i the U.S., which it awards to idividuals who successfully complete CFP Board s iitial ad ogoig certificatio requiremets. There is o guaratee that these views will come to pass. Past performace does ot guaratee future comparable results. The tax iformatio cotaied herei is geeral ad for iformatioal purposes oly. Atlatic Trust does ot provide legal or tax advice, ad the iformatio cotaied herei should oly be used i cosultatio with your legal, accoutig ad tax advisers. To the extet that iformatio cotaied herei is derived from third-party sources, although we believe the sources to be reliable, we caot guaratee their accuracy. Approved For Public Use. Ivestmet Products Offered are Not FDIC-Isured, May Lose Value ad are Not Bak Guarateed. ATLANTICTRUST.COM