Which Mortage Is for You

Which Mortgage Is For You

It’s hard to keep track of all the different kinds of mortgages currently being offered, much less choose the one that’s the best deal for you. Here’s an explanation of some of the most popular varieties, adapted from the Mortgage Money Guide, published by the Federal Trade Commission, along with the pros and cons of each and some expert tips.

Fixed-rate mortgage: Fixed interest rate, usually long term; equal monthly payments of principal and interest until debt is paid in full.

Pros: Offers some stability and long-term tax advantages. Cons: Interest rates may be higher than other types of financing. New fixed rates are rarely assumable. Expert Tip: Can be a good financing method, if you are in a high tax bracket and need the interest deductions.

Fifteen-Year Mortgage: Fixed interest rate. Requires down payment or monthly payments higher than 30-year loan. Loan is fully repaid over 15-year term.

Pros: Frequently offered at slightly reduced interest rate. Offers faster accumulation of equity than traditional fixed rate mortgage. Cons: Has higher monthly payments. Involves paying less interest but this may result in fewer tax deductions. Expert Tip: If you can afford the higher payments, this plan will save your interest and help you build equity and own your home faster.

Which mortage is for you

Adjustable Rate Mortgage: Interest rate changes over the life of the loan, resulting in possible changes in your monthly payments, loan term and/or principal. Some plans have rate or payment caps.

Pros: Starting interest rate is slightly below market. Payment caps prevent wide fluctuations in payments. Rate caps limit amount total debt can expand. Cons: Payments can increase sharply and frequently if index increases. Payment caps can result in negative amortization. Expert Tip: Remember if your payment-capped loan results in monthly payments that are lower than your interest rate would require, you still owe the difference.

Renegotiable Rate Mortgage: Interest rate and monthly payments are constant for several years, changes possible thereafter. Long-term mortgage.

Pros: Less frequent changes in interest rates offer some stability. Cons: May have to renegotiate when rates are higher.

Balloon Mortgage: Monthly payments based on fixed interest rates usually short term; payments may cover interest only with principal due in full of term end.

Pros: Offers low monthly payments. Cons: Possibly no equity until loan is fully paid. When due, loan must be paid off or refinanced. Refinancing poses high risk it rates climb. Expert Tip: Some lenders guarantee refinancing when the balloon payment is due, although they do not guarantee a certain interest rate.

Graduated payment mortgage: Lower monthly payments rise gradually (usually over 5 or 10 years), then level off for duration of term. With adjustable interest rate, additional payment changes possible if index changes.

Pros: They are easier to qualify for. Cons: Buyer’s income must be able to keep pace with scheduled payment increases. With an adjustable rate, payment increases beyond the graduated payments can result in additional negative amortization.

Shared appreciation mortgage: Below-market interest rate and lower monthly payments, in exchange for a share of profits when property is sold or on a specified date. There are many variations.

Pros: Low interest rate and low payments. Cons: If home appreciates greatly, total cost of loan jumps. If home fails to appreciate, projected increase in value may still be due, requiring refinancing at possibly higher rates. Expert tip: You may be liable for the dollar amount of the property’s appreciation even if you do not wish to sell at the agreed-upon date. Unless, you have the cash available, this could force an early sale of the property.

Assumable mortgage: Buyer takes over seller’s original, below market rate mortgage.

Pros: Lower monthly payments. Cons: May be prohibited if “due on sale” clause is in original mortgage. Not permitted on most new fixed-rate mortgages. Expert tip: Many mortgages are no longer legally assumable. Be especially careful if you are considering a mortgage represented as “assumable”.

Seller Take-Back: Seller provides all or part of financing with a first or second mortgage.

Pros: May offer a below-market interest rate. Cons: May have a balloon payment requiring full payment in a few years or refinancing at market rates, which could sharply increase debt. Expert tip: If an institutional lender arranges the loan, uses standardized forms, and meets certain other requirements, the owner take-back can be sold immediately to Fannie Mae. This enables sell to obtain equity promptly.

Wraparound: Seller keeps original low rate mortgage. Buyer makes payments to seller, who forwards a portion to the lender holding original mortgage.

Pros: Offers lower effective interest rate on total transaction. Cons: Lender may call in old mortgage and require higher rate. If buyer defaults, seller must take legal action to collect debt. Expert tip: Wraparounds may cause problems if the original lender or the holder of the original mortgage is not aware of the new mortgage. Some lenders or holders may have the right to insist that the old mortgage be paid off immediately.

Growing Equity Mortgage: Rapid payoff mortgage. Fixed interest rate but monthly payments may vary according to agreed-upon schedule or index.

Pros: Permits rapid payoff or debt because payment increases reduce principal. Cons: Buyer’s income must be able to keep up with payment increases. Does not offer long-term tax deductions.

Land Contract: Seller retains original mortgage. No transfer of title until loan is fully paid. Equal monthly payments based on below-market interest rate with unpaid principal due at loan rate.

Pros: Payments figured on below-market interest rate. Cons: May offer no equity until loan is fully paid. Buyer has little protection if conflict arises during loan. Expert Tips: Land contracts are being used to avoid the “due on sale” clause. The buyer and seller may assert to the lender who provided the original mortgage that the clause does not apply because the property will not be sold to the end of the contract. Therefore, the low interest rate continues.

Buy-Down: Developer (or other party) provides an interest subsidy that lowers monthly payments during the first few years of the loan. Can have fixed or adjustable interest rate.

Pros: Offer a break from higher payments during early years. Enables buyer with lower income to qualify. Cons: With adjustable rate mortgage, payments may jump substantially at end of subsidy. Developer may increase selling price. Expert Tip: Consider what your payments will be after the first few years. They could jump considerably. Also check to see whether the subsidy is part of your contract with the lender or with the builder. If it’s provided separately with the builder, the lender can still hold you liable for the full interest rate.

Rent With Option: Renter pays “option fee” for right to purchase property at specified time and agreed upon price. Rent may or may not be applied to sales price.

Pros: Enables renter to buy time to obtain down payment and decide whether to purchase. Locks in price during inflationary times. Cons: Payment of option fee. Failure to take option means loss of option fee and rental payments.

Reverse Annuity Mortgage: Equity conversion. Borrower owns mortgage free property and needs income. Lender makes monthly payments to borrower, using property as collateral.

Pros: Can provide homeowners with needed cash. Cons: At end of term, borrower must have money available to avoid selling property of refinancing. Expert Tip: You can’t obtain a RAM until you have paid off your original mortgage.

Payments Month-by-Month

You can find charts showing the maximum monthly amount you could spend for home payments and total monthly credit obligations at a variety of income levels and meet the guidelines required by most lenders. As a rule of thumb, no more than 28 percent of your gross monthly income should be used for your mortgage payment (principal, interest, taxes, insurance, condo fees, owner association fees, mortgage insurance premium) and no more than 36 percent of your gross monthly income should be going toward your mortgage payment plus all other monthly credit obligations (car loans, credit cards, utility payments).